The VAT Flat Rate Scheme was originally designed to simplify record keeping for businesses in relation to sales and purchases. It allows businesses to apply a fixed flat-rate percentage to their gross turnover to arrive at the VAT due.
Fixed-rate percentages vary depending on the type of business. The main benefits of the scheme are:
- simplified record keeping, as detailed records of sales and invoices don’t need to be kept
- fixed-rate percentages that are lower than the standard rate
- it helps manage cash flow
The scheme is for businesses with a turnover no more than £150,000 a year, excluding VAT. Though there are some additional rules to stop abuse of the scheme.
The Flat Rate Scheme is a simpler method of working out the VAT that needs to be paid to HMRC and so is unsuitable for businesses that regularly receive repayments from HMRC. The reason being VAT is usually a two-stage process where VAT registered businesses are required to deduct the VAT on their purchases (inputs), from the VAT on their sales (outputs). Under the Flat rate scheme registered businesses use a simplified single step process, whereby they only pay VAT on the sale at a rate determined by the company’s industry type, which varies from business to business.
One of the biggest advantages of this system for small businesses is that they do not need to analyse quarterly expenses identifying in detail any VAT paid to decide whether the VAT can be claimed. Each industry’s Flat Rate Scheme percentage takes into account VATable costs as considered by HMRC.
HMRC has decided to make some changes to what is a simple approach as some businesses were effectively paying less tax than they would do under the standard VAT regime. HMRC’s announced changes, which come into effect this April, to the Flat Rate Scheme are intended to limit those ‘profiting’ from the system.
Under the new rules, those businesses using the scheme which have a very low cost base, referred to as ‘limited cost traders’, will see the rates they pay increase. Typical limited cost traders include consultants, IT contractors, journalists or entertainers, hairdressers and beauticians, construction (labour only), accountancy and legal services.
A business or sole trader is considered a limited cost trader when VAT inclusive expenditure on goods 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, if the prescribed accounting period is one year (if it is not one year, the figure is the relevant proportion of £1,000).
When working out the amount spent on goods, it cannot include purchases of:
- capital goods;
- food and drink; and
- vehicles or parts for vehicles.
This must be assessed and reported on a quarter-by-quarter basis and this requirement, along with the new rules on eligibility, somewhat undermines the original ‘simplicity’ of the flat rate scheme.
Businesses currently registered with the Flat Rate Scheme need to carefully consider whether they are likely to be considered limited cost traders, if they are the simple solution may be to leave the scheme.
Our VAT experts can help accountants and their clients determine whether or not it’s worth remaining within the Flat Rate Scheme once the changes come into effect. You can read more blogs on VAT related issues here.
