How flat rate VAT is changing for companies from April 2017
The Flat Rate Scheme (FRS) is a simplification measure for small traders with an annual turnover of less than £150,000. Users issue VAT invoices to business customers as normal, but only account for VAT at a flat rate percentage of turnover. The rate is calculated depending on the business sector but is normally significantly less than the 20% standard rate of VAT. The percentage includes an allowance for input tax.
Legislation is being introduced so that, with effect from 1 April 2017, any business using the scheme, or wanting to use it, will have to decide if it is a limited cost trader. A limited cost trader is one whose VAT inclusive expenditure on goods for the business in a prescribed accounting period is less than 2% of VAT inclusive turnover, or is more than 2% but less than £1,000 a year. Limited cost traders will have to use a flat rate percentage of 16.5% irrespective of the type of business. Certain low value everyday purchases are excluded from the definition of goods, as is capital expenditure. Expenditure on services is not mentioned.
Anti-forestalling legislation has also been introduced to ensure that any limited cost trader using the scheme cannot use a flat rate of less than 16.5% beyond 1 April 2017. This higher flat rate percentage will impact on the savings the scheme can deliver to users with lower VATable costs.
What is the FRS?
The FRS was introduced by HMRC to simplify the process of paying and reclaiming VAT for small businesses. On the standard scheme, businesses need to add up the VAT they have charged to clients and deduct the VAT they have paid on goods and services purchased. The difference is then payable to HMRC.
With the FRS, businesses pay a fixed rate of VAT to HMRC. The business then keeps the difference between what they charge their customers and what they pay HMRC. Under the FRS, businesses do not reclaim VAT on their purchases (except certain capital assets). For many contractors, consultants and small businesses the FRS is a preferred and simplified method.
The changes have been designed to restrict potential abuses of the FRS by ensuring all businesses are paying the appropriate VAT. At the heart of the reform is the introduction of a new flat rate category; the Limited Cost Trader. This new category introduces a 16.5% rate for businesses with limited costs.
A limited cost trader is a business whose VAT inclusive expenditure on goods is either:
- less than 2% of their VAT inclusive turnover
- less than £1,000 in total, per year
A key change here is the definition of goods. When working out the amount spent on goods, it cannot include purchases of any capital expenditure (i.e. asset purchases), food or drink, or vehicles and fuel. This definition also excludes the purchase of services such as hosting fees, subscriptions to online journals, phones, email, insurances, accountancy fees, associate fees.
HMRC will soon be releasing an online tool to help businesses see if they fall into the limited cost trader category.
Should I leave the FRS?
If you meet the definition of a limited cost trader, and staying on the flat rate scheme means an increase in your VAT bill, then now may be the time to consider moving to the standard VAT scheme.
When does this start?
The new rules start on 1 April 2017, but may also affect invoices issued, and goods bought slightly earlier.
For further information visit: https://www.gov.uk/government/publications/vat-notice-733-flat-rate-scheme-for-small-businesses
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