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February 13, 2017
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The Flat Rate Scheme - What's changed?

In the Autumn Statement 2016, the Chancellor announced the introduction of a new 16.5% VAT flat rate for businesses with limited costs. The new rate will take effect from 1 April 2017, and will affect traders using the flat rate scheme where VAT inclusive expenditure is less than 2% of their turnover, or £1,000 per annum.

Background

The flat rate scheme is a simplified accounting system which enables businesses to calculate their VAT liability as a flat rate of total VAT inclusive turnover, thereby reducing the administrative burden of keeping detailed records.

This is in contrast to the standard method of calculating VAT payable, whereby the input VAT on business expenses is offset against the output VAT charged.

Those on the flat rate scheme charge output tax as normal but do not reclaim input tax on their business expenses (except for certain capital assets exceeding £2,000). Instead, a flat rate percentage is applied to the VAT inclusive turnover for that period. The flat rate percentage applied depends on the trade sector in which the business operates, and is designed to represent the net VAT that an average trader would pay in each profession. The business then keeps the difference between what is charged to clients and what is paid to HMRC.

In theory, the net VAT payable to HMRC should be broadly the same under each method. However, for traders with few expenses (e.g. labour only businesses), the VAT payable under the flat rate scheme will be less than under standard VAT.

Example

The below calculation illustrates how a limited cost trader may be financially better off on the flat rate scheme:

Accountant with Flat Rate Percentage of 14.5%

Turnover in Q1              £25,000 (plus £5,000 output VAT)

Expenses in Q1                   £250 (plus £50 input VAT)

VAT payable under standard method       £5,000 less £50 =          £4,950

VAT under Flat Rate Scheme                        £30,000 x 14.5% =        £4,350

Difference (VAT saving)                                                                                   £600

What’s Changed?

It was felt by HMRC that businesses with limited costs were gaining a cash advantage from using the scheme as they could use the percentage appropriate to their trade sector, but in reality have significantly lower costs than anticipated.

Therefore the new VAT flat rate of 16.5% will apply to businesses with limited costs. A limited cost trader will be defined as one whose VAT inclusive expenditure on goods (not services) is either:

  • less than 2% of their VAT inclusive turnover in a prescribed accounting period, or
  • greater than 2% of their VAT inclusive turnover but less than £1,000 per annum (this £1,000 threshold is time apportioned for accounting periods less/more than 1 year).

In order to prevent traders from inflating their costs by making large one-off purchases or a high number of low cost purchases, capital expenditure, motor expenses and subsistence is to be ignored when working out the threshold.

Anti-forestalling provisions

Anti-forestalling provisions exist to prevent limited cost traders from maximising their turnover under the current regime, by billing for future work prior to the implementation of the new rules and rates.

For businesses issuing invoices or receiving payments between 23 November 2016 and 31 March 2017 for services to be performed on or after 1 April 2017, the supplies of those services will be deemed to have taken place on 1 April 2017 for the purpose of ascertaining relevant turnover. This can be apportioned where services span before and after 1 April 2017.

Contact us today to discuss your tax requirements.
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