Independent VAT Consultant
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VAT: Builders must review flat rate scheme

20th Aug 2019
Independent VAT Consultant
Columnist
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Neil Warren explains that the new reverse charge rules for the construction industry mean that many builders should leave the flat rate scheme on 30 September.

The new reverse charge rules for the construction industry, which are due to take effect on 1 October 2019, have attracted a lot of interest from accountants. One AccountingWEB member recently contacted me with a very important question: how will the new rules affect builders that use the flat rate scheme?

My answer is simple: if most or all of the work carried out by the builder will be subject to the reverse charge, ie the builder will no longer charge VAT on his work, it will make sense in most cases to exit the flat rate scheme (FRS) very quickly.

Three flat rates

Despite the aim of simplifying VAT, the flat rate scheme allows builders to use one of three different flat rate percentages according to their business circumstances (see VAT Notice 733, para 4.3):

  • 9.5%: General building or construction services – if they supply labour and materials as part of their work, where the material sales exceed 10% of total sales.
  • 14.5%: Labour-only building or construction services – used by labour-only builders and those that supply less than 10% of their sales as materials.
  • 16.5%: Limited-cost trader category – applied if goods purchased by the business are less than either £250 in a quarter or less than 2% of total sales.

Example

John is a VAT-registered electrician and his annual sales (all standard-rated) are £200,000 plus VAT. His annual input tax on building materials is £4,000, and on overheads £1,000, and he uses the 9.5% flat-rate percentage.

Until 30 September 2019, the FRS serves John well. He has collected £40,000 VAT from his customers and paid out £5,000 VAT on his expenses, a net figure of £35,000. But he only pays £22,800 with the FRS (gross sales of £240,000 x 9.5%), an annual VAT windfall of £12,200.

John’s annual turnover exceeds the FRS joining threshold of £150,000 excluding VAT. However, once in the scheme, a business does not need to leave until annual sales exceed £230,000 including VAT on the anniversary of when it joined the scheme (VAT Notice 733, para 12.2)

Reverse charge

The reverse charge is not new in the VAT world, having already been introduced for a range of other supplies, including sales of mobile phones and computer components exceeding £5,000.

There is already an existing HMRC public notice in place that gives plenty of information, including the reference to the flat rate scheme, and the fact that reverse charge supplies are excluded from the supplier’s return (see VAT Notice 735, para 10.8.1)

Result

The end result of the new rules is that John will submit nil VAT returns from October if he continues to use the FRS. His reverse charge sales are all excluded from the return and scheme users only claim input tax on capital goods costing more than £2,000 including VAT.

That’s nice and easy, you might think, even though John has lost his annual £12,200 windfall. But the situation needs more thought. If John withdraws from the scheme and reverts to normal VAT accounting, he regains his right to claim input tax on his expenses ie £5,000 in my example. So, he will get rebates from HMRC each period, rather than submitting nil returns under the FRS.

Conclusion

The new reverse charge rules are about cash flow issues rather than bottom-line profit. But there is a potential profit hit against builders who use the FRS and pay less VAT than with normal accounting. The situation obviously depends on what percentage of a builder’s total sales are subject to the new rules. It is certainly time to review the situation.

As a final tip, there is no problem leaving the FRS midway through a VAT period, so a builder whose VAT quarter ends on 30 November can leave on 30 September, and enjoy a final month of scheme windfalls before the October rule changes take effect.

Replies (5)

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By Andrew1946
21st Aug 2019 18:03

Most interesting, however, without being pedantic, my understanding is if as per example 1 the T/O of £240K exceeds the FRS of £230K will not this builder be forced to join the Standard VAT reporting Scheme

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By fawltybasil2575
22nd Aug 2019 12:38

@ Andrew1946.

To respond to your question, and as Neil's guidance states:-

" . . . . a business does not need to leave (the scheme) until annual sales exceed £230,000 including VAT on the anniversary of when it joined the scheme".

[As a small point, I have noticed in the past that the words "the anniversary" are likewise included in HMRC's guidance: in my submission, and as I pointed out to HMRC some years ago, the words "the anniversary" should really be "each anniversary", since one has to consider on each and every anniversary date, whether one still qualifies to use the FRS scheme].

Neil has, re his example, stated that the "annual sales (all standard-rated) ARE [my emphasis] £200,000 plus VAT". Given that it is implied, in Neil's example, that "John" is VALIDLY operating the FRS, then it is likewise implied that, at the LAST anniversary date, the previous year's sales had NOT exceeded the £230,000 threshold (ie that the increase in annual sales to £240,000 had only arisen AFTER that last anniversary date).

Such being the case, then "John" is ONLY required to consider whether he is entitled to remain in FRS on the NEXT anniversary date [even if, hypothetically, the annual sales had increased, in the meantime, to (say) £600,000].

On a general level, the central thrust of Neil's article is valid, and ALL builders operating FRS, and agents acting on their behalf, should NOW consider whether to notify HMRC of leaving the FRS with effect from 1 October 2019 (whether such notification is advantageous can only be determined by considering to what extent the reverse charge rules will affect the amounts payable to HMRC on their VAT Returns).

Basil.

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Replying to fawltybasil2575:
Quack
By Constantly Confused
22nd Aug 2019 14:07

fawltybasil2575 wrote:

@ Andrew1946.

" . . . . a business does not need to leave (the scheme) until annual sales exceed £230,000 including VAT on the anniversary of when it joined the scheme".

I, for one, hadn't realised it was an annual check, so thanks for that Basil.

Thanks (2)
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By cne333
23rd Aug 2019 09:15

Where a supplier has a mix of CIS (reverse charge) sales and end-user sales, am I right to conclude that the FRS will continue to (and only) apply to the end-user sales because "reverse charge supplies are excluded from the supplier’s return"?

Also will the CIS (reverse charge) sales still count towards turnover for the FRS annual limit review?

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By Andrew1946
26th Aug 2019 23:42

Basil, I can only speak from our own personal experience whereby my company breached the £230k threshold during one particular quarterly VAT period, based upon a 12 month rolling average. HMRC wrote saying as from a certain date in the following quarter (mid month) that we would cease to be in the FRS. Fortunately having argued that the previous quarter was exceptionally high due to a non continuing contract,, and by the Year End the level of Turnover would be likely to be below the £230k threshold, HMRC accepted this reasoning and reversed their decision

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