Background
In his autumn statement the Chancellor announced a change to the VAT Flat Rate Scheme (FRS) to take affect from 1st April 2017.
The change has been made to counteract what HMRC perceive to be “aggressive abuse” of the FRS.
What is the FRS?
The FRS is a simplified VAT accounting scheme for small businesses whose annual taxable turnover is less than £150,000.
Under FRS a business VAT liability is calculated by applying a fixed rate percentage to their VAT inclusive turnover. The fixed percentage is determined by the trade sector of the business concerned and includes an allowance for input VAT.
FRS percentages range between 6% – 14.5%.
HMRC have announced that some businesses will have to apply a 16.5% rate if the level of input VAT is particularly low. Some types of businesses may now find themselves worse off by using the FRS.
What is HMRC’s problem?
HMRC have always believed that service businesses who do not incur much input tax – “limited cost traders” do not pay enough VAT under the FRS. In particular, they are concerned by abuses of the FRS by employment businesses supplying staff.
The problem with the FRS is the limited number of trade sector categories. The obvious service related categories and their flat rate percentages are
- Accountancy and legal services 14.5%
- Journalism/entertaining 5%
- Computer or IT consultancy 5%
- Management consultancy 14%
- Estate agents and property management 12%
Any business that does not obviously fall within one of these categories will fall within the category “business services not listed elsewhere” – 12%.
What is HMRC’s solution?
HMRC will introduce a new top rate of 16.5% which will apply to “limited cost traders”.
A “limited cost trader” is defined as anyone 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.
When making the above calculation the following items should be excluded
- Capital expenditure
- Food or drink consumed by the FRS business or its employees
- Vehicles, vehicle parts and fuel
This calculation should be made for every VAT return period.
Who will it affect?
All businesses currently on FRS or who are considering joining the scheme.
Example
A medico – legal consultant – FRS rate 12%
Annual VAT inclusive income £160,000
Annual VAT inclusive expenditure on goods £1,639
Annual VAT inclusive expenditure on goods net of motoring costs £450
Annual VAT inclusive expenditure on goods is 0.28% of annual VAT inclusive turnover.
Therefore, the business is a “limited cost trader” and should apply new FRS rate of 16.5%.
Affect on FRS VAT due to HMRC
£
£160,000 x12% = 19,200
£160,000 X16.5% = 26,400
Compare with declaring VAT under normal VAT accounting rules
This business has suffered input VAT on both goods and services of approximately £760.
Therefore, under normal VAT accounting the business would pay VAT as follows;
£
Output tax due is £160,000 x 1/6 = 26,666.66
Input tax reclaimable = 760.00
Net VAT due = 25,906.66
In this example the business will pay significantly more VAT under the FRS then was previously the case. Indeed they will pay less VAT under the normal VAT accounting rules and may wish to consider leaving the FRS.
If you have any questions, please speak to Simon Buchan or your usual BHP contact.
