Bad news for some users of the flat rate VAT scheme
Changes to the flat rate VAT scheme from April 1st 2017 - and what they might mean for you
HMRC is introducing an additional test from 1 April 2017 that will determine the VAT flat rate percentage used by VAT registered businesses using the Flat Rate scheme. It appears that HMRC considers the benefits obtained by certain businesses to be excessive, and they're closing this down wherever possible
What is the flat rate VAT scheme?
The amount of VAT a business pays or claims back from HM Revenue and Customs (HMRC) is usually the difference between the VAT charged by the business to customers and the VAT the business pays on their own purchases.
With the Flat Rate Scheme, you pay a fixed rate of VAT to HMRC and you keep the difference between what you charge your customers and pay to HMRC. You can’t reclaim the VAT on your purchases - except for certain capital assets over £2,000.
To join the scheme;
- your VAT turnover must be £150,000 or less (excluding VAT), and
- you must apply to HMRC.
Talk to us if you're wondering whether the Flat Rate Scheme is right for you.
From 1 April 2017 HMRC are introducing an additional flat rate of 16.5%. This rate will apply to businesses in any sector, but only if they have limited costs. The existing flat rates will continue to be available for those flat rate businesses that don’t qualify as a limited cost business.
What do I do next?
Use the HMRC calculator to see whether you are a limited cost business. If you're a limited cost business you'll need to use the new rate from 1 April 2017.
The flat rate
The VAT flat rate is a percentage of your ‘flat rate turnover’. Flat rate turnover is different from standard VAT turnover - for example, as well as business income (eg from sales), it includes the VAT paid on that income.
- You bill a client for £1,000, adding VAT at 20% to make £1,200 in total.
- You’re an IT consultant, so the VAT flat rate for your business is 14.5%.
- Your flat rate payment will be 14.5% of £1,200, or £174.
The VAT flat rate you use depends on your business type. If the rate changes, you must apply the new rate from the date it changes. There's a complete list of flat rates here.
The change in the flat rate scheme from April 1st 2017
HMRC is introducing an additional test from 1 April 2017 that will determine the VAT flat rate percentage used by VAT registered businesses using the Flat Rate scheme.
Traders that meet the new definition of a 'limited cost trader' will be required to use a fixed rate of 16.5%, irrespective of the flat rate for their industry. This will include traders who are already using the Flat Rate scheme, with many at rates lower than 16.5%.
A limited cost trader is defined as one whose VAT inclusive expenditure on goods is either:
- less than 2% of their VAT inclusive turnover in a prescribed accounting period;
- greater than 2% of their VAT inclusive turnover but less than £1,000 per annum if the prescribed accounting period is one year (if it is not one year, the figure is the relevant proportion of £1,000).
For some businesses - for example, those who purchase no goods, or who make significant purchases of goods – the outcome of the test will be self-evident. Other businesses will need to complete a simple test, using information they already hold, to work out whether they should use the new 16.5% rate. Businesses using the scheme will be expected to ensure that, for each accounting period, they use the appropriate flat rate percentage.
What costs are included, and what's excluded?
HMRC have provided a calculator for this - find it here - but essentially it's the ratio of (cost of goods) /(income) for the quarter. "Goods" are "moveable items or materials exclusively used in your business. You can also include gas and electricity." HMRC have given some examples of goods which meet this criterion; this is not a complete list.
- stationery and other office supplies to be used exclusively for the business
- gas and electricity used exclusively for your business
- fuel for a taxi owned by a taxi firm
- stock for a shop
- cleaning products to be used exclusively for the business
- hair products to use to provide hairdressing services
- standard software, provided on a disk
I.e., relevant goods are used exclusively for the purposes of your business, but don’t include:
- vehicle costs including fuel, unless you’re operating in the transport sector using your own, or a leased vehicle
- food or drink for you or your staff
- capital expenditure goods of any value
- goods for resale, leasing, letting or hiring out if your main business activity doesn’t ordinarily consist of selling, leasing, letting or hiring out such goods
- goods that you intend to re-sell or hire out, unless selling or hiring is your main business activity
- any services
HMRC have also given examples of items that are NOT relevant goods:
- accountancy fees, these are services
- advertising costs, these are services
- an item leased/hired to your business, this counts as services, as ownership will never transfer to your business
- food and drink for you or your staff, these are excluded goods
- fuel for a car this is excluded unless operating in the transport sector using your own, or a leased vehicle
- laptop or mobile phone for use by the business, this is excluded as it is capital expenditure
- anything provided electronically, for example a downloaded magazine, these are services
- rent, this is a service
- software you download, this is a service
- software designed specifically for you (bespoke software), this is a service even if it is not supplied electronically
As you will see from the above examples of costs , the majority of freelancers and contractors, as well as service based businesses, are likely not to have much in the way of relevant goods, so are likely to be categorised as limited cost traders.
If you are categorised as a limited cost trader it means that you may end up paying more VAT than if you were on the standard VAT scheme instead, so you should check your circumstances to see if you would be better off either leaving the flat rate scheme, or de-registering for VAT if you are below the de-registration threshold which is £83,000 from 1 April 2017 (rolling 12 months turnover pre VAT).
Contact us if you need any help.