VAT: Flat rate scheme letters may confuse taxpayers

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Rebecca Cave
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Taxwriter Ltd
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HMRC has written to all traders who are registered to use the flat rate scheme, warning them about the 16.5% flat rate, but the wording may confuse both taxpayers and advisers.

No way out

As Neil Warren explained the apparent loophole in the proposed new rules for the VAT flat rate scheme (FRS), has been closed. To determine whether the trader is a limited cost business the trader must review what he spends on “relevant goods”. However, the exclusions from relevant goods have been expanded to make it difficult for FRS traders to manipulate their goods buying strategy to avoid becoming a limited cost business, which must use the new 16.5% flat rate.

New regulations

VAT regulations passed on 8 March 2017 exclude from relevant goods any goods which are not used exclusively for the business, and all of the following: 

  • vehicles, vehicle parts and fuel except where the trader is in the transport sector and owns or leases a vehicle for his business
  • food or drink for consumption by the trader or his employees
  • capital expenditure (of any value)
  • goods acquired for the purpose of resale, leasing, letting or hiring out except where the main business activity trader ordinarily consists of selling, leasing, letting or hiring out such goods
  • goods for disposal as promotional items, gifts or donations

HMRC letter

The letter to FRS traders from HMRC says: “You are a limited cost business if the cost of your goods is below 2% of your turnover, or below £1,000 per year.”

Taxpayers may read “your goods” as meaning the cost of the goods which they sell or create, and interpret “cost” as being the price at which the business sells the item for. The correct interpretation of “cost of your goods” is the gross amount paid for the goods purchased by the business, and this is clear if the taxpayer continues to read to page two of HMRC’s letter.

If your clients don’t get that far, you may have to explain what HMRC is getting at.

Further information

The HMRC letter advises the taxpayer to read VAT Notice 733 for more detailed guidance. This notice has been updated for the new FRS rules, but it doesn’t include the last bullet point concerning promotional items, which is in the regulations.  

HMRC doesn’t advise the trader to discuss his future VAT status with his tax adviser or accountant, but that would be the best course of action for most FRS traders.

Leaving the FRS

A trader whose main business is the provision of services is unlikely to meet the 2% goods threshold, so will want to stop using the FRS before 1 April 2017. There is no online form for the trader to complete to tell HMRC he is leaving the FRS. This notification must be done in writing (see para 12.1 of VAT notice 733), but that letter can be sent after the fact. The trader doesn’t have to inform HMRC in advance if he is reverting to normal VAT accounting.  

Deregister

Where the trader’s turnover for the next 12 months is expected to be no more than £83,000, he may well wish to cancel his VAT registration with effect from 31 March to completely avoid VAT administration. This will give a limited company the added advantage of delaying MTD quarterly reporting until the start of its accounting period which starts on or after 1 April 2020.

You can cancel a VAT registration on behalf of your client, and the easiest way to do this is online. The cancelation can’t be backdated for a business that continues to trade, so you need to make sure this is done before midnight on 31 March 2017. If the trader is in the FRS, he is deemed to leave that scheme the day before VAT registration is cancelled (VAT Notice 733, para 12.4), so on 30 March, for a 31 March deregistration.   

Invoice now

The trader should be advised to issue any outstanding invoices by close of business on 30 March. Once the trader is deregistered from 1 April onwards, he won’t be able to reclaim VAT on any purchases and must not charge VAT on his sales. However, purchases on 31 March will fall inside normal VAT accounting, and outside the FRS, so VAT can be reclaimed on those items. A good day to buy a new computer to prepare for MTD perhaps?

Replies

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28th Mar 2017 11:35

I have had best part of a dozen calls / emails on this from clients who we wrote to last week advising them to opt out of the flat rate thinking we got it wrong and they now don't need to.

HMRC at their infuriating best.

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28th Mar 2017 11:42

If you are an IT professional/tax adviser/accountant etc, presumably you can still get to the 2% goods spend required by spending on technical books/legislation etc.

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to SarahVAT
28th Mar 2017 11:47

You could as long as the books etc are relevant to the work you are currently doing.

Another winner from the Numpties.

Out of interest, if the promotional items clause is not in the VAT Notice 733 does that mean it's legally unenforceable?

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to sushi_ginger
28th Mar 2017 13:52

No. The exclusion for promotional items IS in the regulations (the law) but is not in the guidance Notice 733 (not the law). The courts enforce the law not HMRC guidance.

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to taxwriter
28th Mar 2017 14:37

Damn!

Another anomaly: I understand printed letterheads qualify, but business cards do not as they are bought to "give away". Presumably if I get "With compliments" slips printed to save wasting a whole sheet of letterhead every time I send something, these would fall foul of the "giving away" rule?

What a farce.

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to sushi_ginger
31st Mar 2017 18:10

Business cards:
These will qualify if you use them to advise your clients of your details.
It is "goods for disposal as promotional items, gifts or donations" which do not qualify.
The business card is clearly not a gift, it is not a promotional item, nor is it a donation.
If they were intended to be given to potential new clients, then this is a different matter.

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By sawebs
to Tonykelly
31st Mar 2017 18:44

I seem to recall a specific question on the webinar about business cards and the HMRC guy said they would be classed as items to be given away so are not relevant goods.

Maybe I'm wrong or maybe (heaven forbid) the HMRC guy got it wrong but that's how I remember it.

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to SarahVAT
06th Apr 2017 11:28

According to the HMRC guidance technical guidance would qualify as goods if you subscribe for it in paper form, or the guidance is sent to you in the form of a CD. An online subscription, for exactly the same information, does not qualify as "goods".

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to SarahVAT
03rd Apr 2017 12:05

Sarah,

Aren't books zero rated?

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to Malcolm McFarlin
03rd Apr 2017 12:29

To be Relevant Goods, there need not be any VAT on them.

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to Malcolm McFarlin
03rd Apr 2017 12:29

Books are zero rated but ebooks are not.

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to barrykernon
03rd Apr 2017 13:06

Being zero rated does not seem to prevent books from being Relevant Goods. But would books be capital expenditure goods (for the purpose of the FRS) and therefore excluded from being Relevant Goods?

VAT notice 733, para 15.1 says Capital expenditure goods in the Flat Rate Scheme are capital goods, which it says are "those goods which are bought to be used in the business but are not used up by it, except through normal wear and tear over a number of years". Most reference books are not used up by the business.

Certain capital goods are excluded from being capital expenditure goods, but I don't think these exclusions would apply to books.

Perhaps hard copy periodicals?

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to garethgreen
04th Apr 2017 12:01

Books would not be capital if they had a useful life of less than two years and I have always taken the view that few, if any, tax reference books can have a useful life that exceeds two years since there are bound to have been changes to either legislation or guidance which will not be reflected in the book if it is so old.

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29th Mar 2017 22:18

I'm thinking of hairdressers, where the cost of products used is going to be more than 2%. There must be plenty of this kind of service business which​
are not affected.

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31st Mar 2017 22:58

Basil has become exceedingly enervated by the onset of MTD, and coping with HMRC personnel seemingly unable to construct an intelligible letter. Hence he intends to have a career change and operate in a similar trade (one which however falls within the 12.0% "Business services not listed elsewhere" category, compared with 14.5% for those purportedly wealthy accountants).

Basil has been considering applying for the VAT FRS ("swimming against the tide" of those enlightened souls who are "jumping ship" from the FRS scheme).

Basil is now operating a "paperless" office (utter drivel in truth, but please bear with me) and would do so in future (as he will have no real requirement for letterheads) in his proposed new trade.

His future annual fees will be around £65,000 (excluding VAT) and, without a change of heart, he will henceforth sadly have little or no expenses which fit the "qualifying goods" definition for FRS purposes. Hence he would be saddled with the iniquitous 16.5% "limited cost traders" rate, and will thus probably deregister.

HOWEVER, Basil has yearned to return to those olden "quill pen" days when he visited his local stationers to collect a few months' supplies of letterheads. Basil is a pompous old soul who used to adore the feel of top-quality luxury letterheads, and his OCD persuades him that he needs to buy 250 letterheads within 2 days, for which he will of course pay a "premium" price for the almost immediate delivery. He has located a luxury printers, which is offering 250 letterheads for £325 (excluding VAT) and this will be sufficient for 3 months (no doubt he will henceforth purchase another 250 letterheads each quarter). He will reserve the use of those top-quality letterheads for the "A-list" clients in his new venture (being careful not to inadvertently use any of the letterheads for "private" letters or to "promote" his new business).

Basil has calculated that, by sheer good fortune of course, he will benefit to the tune of £2,080 per annum, as a result of his purchasing these luxury letterheads, courtesy of HMRC's "limited cost trader" rules (with a year's "free supply" of luxury letterheads effectively thrown in too).

Basil.
EDIT. Yes, there is a serious message to the above, in terms of valid "VAT-planning".

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By sawebs
to fawltybasil2575
01st Apr 2017 07:54

fawltybasil2575:

For sale: Biros (pack of 10) £250

Wanted: Pencils (pack of 10), happy to pay up to £250.

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to sawebs
03rd Apr 2017 18:37

I see there is a new VAT notice 733 as of today. This says that Relevant Goods excludes:
"goods which are bought solely to meet the test, as these would not be used exclusively for the purposes of your business. For example, if the quantity of goods being bought can’t reasonably be used by the business and are simply ‘stockpiled’ or thrown away, even if the business may normally use those items is smaller quantities such as office materials"

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By sawebs
to garethgreen
04th Apr 2017 20:39

garethgreen wrote:

I see there is a new VAT notice 733 as of today. This says that Relevant Goods excludes:
"goods which are bought solely to meet the test, as these would not be used exclusively for the purposes of your business. For example, if the quantity of goods being bought can’t reasonably be used by the business and are simply ‘stockpiled’ or thrown away, even if the business may normally use those items is smaller quantities such as office materials"

I believe I'm correct in saying that notice 733 doesn't have the force of law. The numpties shouldn't add these kind of comments made up on the hoof when there is no legislation to back it up.

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to sawebs
06th Apr 2017 08:57

sawebs wrote:

I believe I'm correct in saying that notice 733 doesn't have the force of law. The numpties shouldn't add these kind of comments made up on the hoof when there is no legislation to back it up.

I wouldn't say there is nothing to back it up. The legislation says "“relevant goods” are goods used or to be used by a flat-rate trader exclusively for the purposes of the trader’s business". The notice is their interpretation of "exclusively". Personally, I think it is a tenable interpretation.
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03rd Apr 2017 11:17

Surely no one will want to stop actually using it? All the government have done is to remove a loophole that was effectively leaving excess cash in the pocket for some businesses, specifically service businesses who were getting something for nothing?

Hence they have lifted the rate to an effective max of 16.5% (rather than 16.67%)

The scheme is surely still simpler all the way to this level. Or have I misunderstood?

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to ChuckieB
03rd Apr 2017 11:40

Well it all depends whether the client or their accountant wants to do the maths. The increase to 16.5% means that you will only very slightly 'gain' on the FRS scheme compared to previously, but the alternative is that if they revert back to the normal VAT scheme then they can claim back VAT on their expenses, so they may well gain even more on that scheme.
For an IT contractor, for example, I may choose to charge them £50 per quarter to submit a normal VAT scheme return (it will probably only take me 30 mins tops), but they will now be able to claim VAT on my annual accountancy fees (which would be say £1,200 gross), which would offset my extra VAT processing fee each quarter. Then it all depends what other input VAT expenses the client has. They may only marginally benefit from the normal VAT scheme, but if it exceeds the FRS benefit figure then most of my clients would choose to do that, they like to know that they have achieved a 'win' still against HMRC, particularly if they know that I'm still in charge of everything for them and there's nothing extra for them to do.
Of course it all depends on their VATable expenses, and the clients level of turnover. You just have to do the maths and let the client decide. Personally I'd prefer them to stay on the FRS, even though I may generate more fees on the normal VAT scheme, I just value my time higher than that at present.

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03rd Apr 2017 11:24

These letters came so late that we had all advised our clients of the effectiveness or otherwise of them staying on the FRS, determined by their spending patterns over the last quarter or two, far before HMRC thought it would be a good idea to write to taxpayers.
I don't quite understand how cancelling their VAT registration has an effect on their MTD date though. I thought all companies were 2020 - as per 'those who pay corporation tax' which I have seen in various updates.

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03rd Apr 2017 11:38

The original purpose of the FRS was to simplify record keeping (para 2.2 of VAT Notice 733), as a business needed to track only its sales (not costs) mid-year in order to meet its quarterly (VAT) filing obligations. The tax saving was a beneficial by-product, accepted by HMRC as a cost of getting more businesses to charge VAT (generating a greater tax-take from B2C traders).

Under MTD, all businesses (except those with turnover below £10k pa) will need to make a quarterly filing, so the benefit of simplified bookkeeping will have been eradicated. So the question surely arises: why are HMRC retaining the FRS at all once MTD starts? This should have been an issue for the OTS to have dealt with. Now, instead of a FRS that makes VAT simpler, we have a scheme that is hugely complex, requiring a regular check on costs to ensure that they do not fall foul of the 2% rule! This is yet another example of our tax system becoming more complex for no good reason. If HMRC don't want to lose tax from FRS, then they should abolish it instead of adding levels of complexity.

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By ShayaG
to charliecarne
03rd Apr 2017 12:02

Maybe they *did* want to lose tax....? I know literally nobody on the FRS who is on the FRS for simplified book-keeping. Everyone did a back of the fag packet gain / loss calculation beforehand.

To add to my conspiracy theorising - a lot of politicians are self employed writers / speakers....!

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to charliecarne
03rd Apr 2017 13:26

[quote=charliecarne]

The original purpose of the FRS was to simplify record keeping (para 2.2 of VAT Notice 733)

Exactly. Well put Charlie Carne.

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03rd Apr 2017 12:07

Expect to wait about 5 weeks for a reply from HMRC if you decide to opt out of the FRS -nearer 6 weeks for the letter to actually be received.

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03rd Apr 2017 12:22

Letter from VAt office confirming cancellation arrive today. 6 weeks is about right. Notifying is the key and if you use the email link you will have proof.

As so many of our items are services and not goods (software licences etc) we calculate that it will be a no win for HMRC as we have now withdrawn from the flat rate. I wonder how many others are in a simalar position.

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By Vince54
03rd Apr 2017 16:31

The email link for deregistering is good news. I tried to use my VAT account for this. it took HMRC 20 (calendar) days to reply and said I needed to write to an address in Grimsby. so much for digital communication!

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03rd Apr 2017 18:28

What does this mean re Ltd Co?
I read somewhere that VAT returns will at some future date only be permitted via commercial software, and not thru present system. Has this statement got something to do with it???

"Where the trader’s turnover for the next 12 months is expected to be no more than £83,000, he may well wish to cancel his VAT registration with effect from 31 March to completely avoid VAT administration. This will give a limited company the added advantage of delaying MTD quarterly reporting until the start of its accounting period which starts on or after 1 April 2020"

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to rboggon.yahoo.co.uk
07th Apr 2017 14:15

rboggon.yahoo.co.uk wrote:

What does this mean re Ltd Co?
I read somewhere that VAT returns will at some future date only be permitted via commercial software, and not thru present system. Has this statement got something to do with it???

"Where the trader’s turnover for the next 12 months is expected to be no more than £83,000, he may well wish to cancel his VAT registration with effect from 31 March to completely avoid VAT administration. This will give a limited company the added advantage of delaying MTD quarterly reporting until the start of its accounting period which starts on or after 1 April 2020"


As I understand it, MTD for CT is still delayed until 2020. But MTD for VAT happens in 2019, including for limited companies.
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04th Apr 2017 15:51

(1) I thank Gareth for his post at 18.37 on 3 April 2017, re the LATEST HMRC interpretation of the new rules (whether or not, at Tribunal, HMRC would "win the day" in applying that ever-narrowing interpretation, is an entirely different matter). I firmly believe that (notwithstanding that latest HMRC attempt) my plan of campaign, as per my post at 22.58 on 31 March 2017, would be entirely unaffected.

(2) I thank Malcolm and Paul (their posts at 12.07 and 12.22 respectively on 3 April 2017) for their comments regarding the timing factor re receiving responses, from HMRC, to notifications that a business is no longer to operate the FRS. Might I however respectfully point out that the date of receiving that response from HMRC is of no consequence, and specifically that it has no impact on the "leaving FRS" date.

Indeed, it is worth noting that there is "no rush" to notify HMRC of that leaving date, and that such notification can be made "after the event". To explain, if for example one submits "calendar quarter" VAT Returns (ie to 31 March, 30 June etc.) then, in relation to the quarter to 30 June 2017, one can wait until one has provisionally prepared the VAT Return for that quarter.

Hence, for example, one PROVISIONALLY prepares that VAT Return for the quarter to 30 June 2017, using the FRS scheme, on (say) 24 July 2017, and finds that one's qualifying goods do not meet the "2%/£1,000 p.a." threshold. The penal 16.5% "limited costs trader" FRS rate WOULD thus apply. One calculates the "16.5%" VAT payable at £5,000 (and finds that this compares with £4,000 based on "standard VAT"). So one simply then notifies HMRC that one is opting out (of FRS) WITH EFFECT FROM 1 April 2017. Authority for this is at 12.1 here:-

https://www.gov.uk/government/publications/vat-notice-733-flat-rate-sche....

The important point is that, on my above example, one must notify HMRC BEFORE submitting the VAT Return for that quarter.

Basil.

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By sawebs
to fawltybasil2575
04th Apr 2017 19:46

Like I said fawltybasil2575 I am willing to sell you a pack of biros for the sum of £250. All I request in return is that you sell me a pack of pencils for which I am willing to offer around, say £250. Let me know if interested. That can hardly be construed as stockpiling can it?

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to sawebs
06th Apr 2017 09:00

sawebs wrote:

Like I said fawltybasil2575 I am willing to sell you a pack of biros for the sum of £250. All I request in return is that you sell me a pack of pencils for which I am willing to offer around, say £250. Let me know if interested. That can hardly be construed as stockpiling can it?

It could be construed as not exclusively for the purposes of the business. And also as tax avoidance.
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By sawebs
to garethgreen
07th Apr 2017 12:07

@garethgreen

OK my comment was a bit tongue in cheek but I think you get the gist. Using the same two entities for both transactions would be pretty stupid but that's easy to solve.

Also it doesn't need to be £250, it could be more realistic. As far as I'm aware HMRC does not have the right to decide what I think is the best commercial deal for my business.

Why is this "not exclusively for the purposes of the business" by the way if I only use the pencils in my business?

Also it appears that businesses may not buy in bulk any more to achieve higher discounts, as this would be "stockpiling". Ridiculous.

Why is it tax avoidance? Maybe morally it doesn't smell good but what's the statute being broken? I see examples all the time on here of accountants' immediate responses to something slightly maverick as being illegal or not possible, without quoting any legislation or case law to back it up, just because to them it "doesn't feel right". Anyone with a bit of nouse could come to this decision without the years of training and practical experience of an accountant.

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to sawebs
07th Apr 2017 14:08

sawebs wrote:

@garethgreen

...Why is this "not exclusively for the purposes of the business" by the way if I only use the pencils in my business?...

...Why is it tax avoidance? Maybe morally it doesn't smell good but what's the statute being broken? ...

If you pay more than the market price for goods and would not have done so were it not for the desire to avoid being a LCT, then I think HMRC would argue that the payment was not exclusively for the purpose of the business, because one of the purposes was avoiding being a LCT.

To me, this would be tax avoidance because it is an attempt to bend the rules to gain a tax advantage that was clearly not intended and because it is contrived and artificial. (https://www.gov.uk/guidance/tax-avoidance-an-introduction) Whether it could, legally, be challenged purely on the grounds of being tax avoidance I couldn't say, but I think it would certainly embolden HMRC in taking a very tough line on the "exclusively" test.

In my view, buying in bulk is fine, as long as the quantities are not beyond the amount that any rational business would want to purchase in advance.

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By sawebs
to garethgreen
07th Apr 2017 17:59

garethgreen wrote:

sawebs wrote:

@garethgreen

...Why is this "not exclusively for the purposes of the business" by the way if I only use the pencils in my business?...

...Why is it tax avoidance? Maybe morally it doesn't smell good but what's the statute being broken? ...

If you pay more than the market price for goods and would not have done so were it not for the desire to avoid being a LCT, then I think HMRC would argue that the payment was not exclusively for the purpose of the business, because one of the purposes was avoiding being a LCT.

To me, this would be tax avoidance because it is an attempt to bend the rules to gain a tax advantage that was clearly not intended and because it is contrived and artificial. (https://www.gov.uk/guidance/tax-avoidance-an-introduction) Whether it could, legally, be challenged purely on the grounds of being tax avoidance I couldn't say, but I think it would certainly embolden HMRC in taking a very tough line on the "exclusively" test.

In my view, buying in bulk is fine, as long as the quantities are not beyond the amount that any rational business would want to purchase in advance.

So it sounds like HMRC need to know your state of mind at the time of purchase i.e. Did you buy the goods knowing that you had not bought enough relevant goods already and that this purchase would take you over the 2% required and there was no other motivation for this purchase.

There are many reasons why you might pay over the market price for things. Quality or speed of service is a common one. Brand loyalty and knowing that quality will be assured. The last minute purchase of a train or plane ticket that would have been a lot cheaper in advance. Or sometimes just ignorance of the market where you don't have time to do the research.

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to sawebs
08th Apr 2017 10:18

Yes, if there's a good reason why a rational business would have paid the higher price or bought the volume that was bought, I would expect that would be fine. If you can think of a good reason to pay £250 for a pack of pencils then good luck!

Bulk buying is, at best, a short term solution. Even if you can justify that buying, say, two years worth of a certain type of goods is exclusively for the purpose of the business, you surely can't justify buying more of those goods until you have used the first lot.

If you buy so much that you end up throwing some away, I think the onus would be on you to rebut the presumption that you did not buy exclusively for the purpose of the business.

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By sawebs
04th Apr 2017 20:03

Just has another thought. Promotional material is not allowed within relevant goods. But if I spend £200 a month on toner and paper to print my own promotional material (after buying a separate printer, only for business use of course) would that be allowed?

What a complete farce. Why didn't they just say if you're a PSC you can't use the flat rate scheme? That is what the numpties intended after all. Oh and umbrella companies too.

I hope the numpties get completely tied up in knots (hopefully legal ones) trying to enforce this totally ridiculous attack on small business. I'm sure the increased admin costs and legal costs will dwarf any savings they hope to make.

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to sawebs
08th Apr 2017 10:21

sawebs wrote:

What a complete farce. Why didn't they just say if you're a PSC you can't use the flat rate scheme? That is what the numpties intended after all. Oh and umbrella companies too.

I hope the numpties get completely tied up in knots (hopefully legal ones) trying to enforce this totally ridiculous attack on small business. I'm sure the increased admin costs and legal costs will dwarf any savings they hope to make.

There I agree with you. It is clear that the real policy is that any service that primarily involves brainpower, rather than physical activity (eg, using spanners, hair brushes or mops), cannot use the FRS. HMRC/HMT will clearly do whatever is necessary to ensure that any such companies that stay in the FRS will be LCTs.
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05th Apr 2017 10:33

Oh my Gosh. its gets worse, the FRS was a great little scheme, oh I forgot George Osborne promised to balance the books, even if it lead to lots of problems on the way, and throwing out the baby with the bathwater.

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By peterjl
06th Apr 2017 10:33

I presume that all VAT exempt expenses such as interest payable and insurance are excluded from the test. These are neither goods nor services, however if we include these then I have several companies that would pass the test.

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to peterjl
07th Apr 2017 10:49

AFAIK, being VAT exempt does not prevent goods from being Relevant Goods. However, interest and insurance are not goods.

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