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ANY ANSWERS: VAT Flat rate scheme ' blessing or curse? By Rebecca Benneyworth

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3rd Jul 2006
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A number of questions crop up on the VAT flat rate scheme from time to time, Recently there have been two questions regarding detailed operation of the scheme, so maybe an examination of some of the aspects of the scheme is worthwhile.

Rachel asked what flat rate category should be applied to plumbers. The prompt response was that the rates applying to general construction should be used ' there are two rates depending on whether the builder supplies a significant amount of materials or labour only. However, Rachel noted that another plumber was using a different rate. This does highlight probably the most tricky aspects of the flat rate scheme for smaller businesses ' that of applying the correct flat rate.

There is a list of trade categories accompanying guidance material on the flat rate scheme (Notice 733), and further information on the website, but in fact the deeper you look, the more confusing it can get!

Where no suitable match appears in the basic list of trade sectors, businesses may need to select one of the generic trade sectors, such as 'Business services not listed elsewhere'. As the list is fairly brief, this would tend to lead to many businesses selecting the generic categories, but here lies a risk. The business or adviser may be confident that the correct trade sector has been identified from the Notice, and may not need to refer to the further help and guidance available. However, has he selected the same category as HMRC would? And if not, does this present a potential problem?

Studying the HMRC internal guidance on the subject indicates that there is a more extensive list of trades (known as the 'long list') which shows the categories Customs allocated trades to when the scheme was originally developed. For example, studying the 'long list' reveals that Financial consultancy is regarded as being within the 'management consultancy' category with a flat rate of 12.5 per cent, rather than 'financial services' with a flat rate of 11.5 per cent. For a business at or near the limit of the scheme, this would make a significant difference to the financial implications of using the scheme.

Dance instructors are classified as 'Entertainment or journalism' with a rate of 11%, as are, rather surprisingly, authors. Gambling is, however, 'Sport and recreation' rather than entertainment!

Where HMRC disagrees with the flat rate selected, they will normally notify that a new percentage should be used from the anniversary of joining the scheme. Businesses are required, in any event, to check that the rate they are using is appropriate at each anniversary of joining the scheme.

There will not normally be an assessment of VAT on a business which has used an incorrect flat rate, provided that the rate selected was reasonable. It is therefore important that the process of selecting a rate is documented and the records are retained for subsequent inspection, and that reviews of the rate made annually are also recorded. Where a business cannot reasonably justify the rate used, there may be a retrospective assessment for the VAT underpaid, and the business may additionally be barred from using the scheme. HMRC's example in internal guidance is of an architect using the flat rate for pubs, so it is clear that officers are intended to take a sympathetic approach to traders selecting the incorrect rate.

Barry Phillips asked how the VAT should be accounted for under the flat rate scheme, and a number of readers offered views, and indeed more questions. Normally a business operating the scheme should keep accounting records which show the VAT inclusive amounts ' this is of course the main benefit of the scheme ' not having to separate out VAT in the accounting records.

The VAT paid on the quarterly (or annual) return then becomes a cost of the business, and HMRC's self employment pages (and the guidance relating to them) allow the taxpayer to prepare all figures gross and then to include the VAT paid as 'Other expenses'. As this would make this entry significant, a reference and the amount might be useful in the white space. However, many practitioners will feel more comfortable deducting the VAT paid from sales, showing sales net of VAT. This would be an obligation for a company which is required under company law to disclose sales net of VAT in the accounts. The VAT to deduct is the amount paid over to HMRC, not the 'gross' VAT on sales, as such a concept does not exist under flat rate.

VAT recovered on fixed assets at the commencement of the scheme, or indeed on assets costing in excess of £2,000 once the scheme is running should be deducted form the cost of the asset ' the entries being debit VAT account, credit asset cost, rather than a credit to P & L. The reduced cost of the asset should then be used to compute any capital allowances. Such assets need careful treatment ' when sold they attract 'normal' VAT which is paid in addition to the flat rate result for the period. A tricky twist that many smaller businesses will overlook!

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By AnonymousUser
07th Jul 2006 18:20

See BIM31585
See penultimate paragraph of BIM31585 for HMRC interpretation of this issue.

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By User deleted
09th Jul 2006 13:57

Where is the "long list"
Can anyone say where the HMRC internal guidance on the flat rate shows the more extensive list of trades (known as the “long list”)?
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By AnonymousUser
05th Jul 2006 23:25

VAT Flat Rate Schemes
Another slightly tricky point I have come across is the interaction between the VAT Flat Rate Scheme and IR35 calculations.

IR35 tax is usually calculated with reference to the VAT Exclusive value of sales or fee income. Which VAT Exclusive value are we talking about when someone operates a Flat Rate Scheme - sales net of the normal 17.5% Standard Rate or net of the hybrid Flat Rate?

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