Important changes to the VAT Flat Rate Scheme came into effect from April 2017.
HMRC have introduced a new flat rate of 16.5% which must be used by a “Limited Cost Trader” irrespective of their industry sector.
What is a limited cost trader?
A business is a limited cost trader if its VAT inclusive expenditure on goods is:
- Less than 2% of its VAT inclusive turnover in a VAT period, or
- Greater than 2% of their VAT inclusive turnover but less than £1,000 per annum (£250 per quarter).
What are “goods”?
Goods are those used exclusively for business purposes, but exclude:
- Capital expenditure (e.g. equipment)
- Food & drink for consumption by the business owner
- Vehicles, vehicle parts and fuel (except where the business is one that carries out transport services using its own vehicles e.g. couriers & taxi firms)
Software bought off the shelf i.e. on a disk (how old fashioned!) will be regarded as goods.
Downloaded software will not be goods.
So much for the digital economy and Making Tax Digital!
Exclusively for business
As goods have to be “exclusively for business” it would appear that any expenditure on goods with a non-business element, e.g. for personal purposes, would be excluded.
RIP Flat Rate Scheme
This all but kills off many small service sector businesses using the scheme as, whilst they may have expenditure on services e.g. telecoms, internet, accountancy, travel etc, the spend on goods would likely be limited.
The new rules apply from 1st April 2017
Each quarter you must apply the test i.e. check if the VAT inclusive expenditure on goods is less than 2% of the VAT inclusive turnover or greater than 2% but less than £250.
This means that it is possible to use a low rate for one period and the 16.5% for other periods.
Sounds complicated – yes it is!
What is the impact?
Let’s look at the impact by way of an example. If you currently use a 12% rate and your turnover is £50,000 plus VAT, your flat rate profit is £2,800. Using the 16.5% rate your flat rate profit will only be £100.
What should you do?
Over VAT Registration Threshold
If your turnover is over the VAT registration threshold of £85,000 then changing to standard VAT accounting is probably the best option.
This means that you will reclaim VAT on your costs, deduct this amount from the VAT you receive from your clients, and pay the difference each quarter to HMRC.
This means that the bookkeeping is more complicated as you have to record the VAT on every purchase, which isn’t necessary under the simplified Flat Rate Scheme.
If the VAT you are reclaiming on costs is very small, keeping the flat rate could be an option for simplicity’s sake; you’ll need to crunch the numbers to see which is best.
Below VAT Registration Threshold
If your turnover is below the VAT registration threshold and the amount of VAT you are reclaiming on your costs is small, you may choose to de-register for VAT and save all the hassle.
Again you’ll need to crunch the numbers on this. You don’t need to make a decision now. You can file a couple of VAT returns under the standard accounting system and see if it is worthwhile.
First Year Discount
The 1% first year discount will still apply to the Flat rate percentage used in the first year of VAT registration; so new businesses will benefit.