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VAT: Closing a loophole in the FRS

3rd Mar 2017
Independent VAT Consultant
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bolted stable door
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Neil Warren considers the latest significant change to the limited cost trader rules which will affect flat rate scheme users from 1 April.

Planning thwarted

HMRC has closed the stable door on an easy way for a business to escape being a limited cost trader (LCT) within the revised flat rate scheme (FRS) rules which apply from 1 April 2017. I shared this method in my article ‘Limited cost trader category for FRS users’, which involved creating a secondary activity buying and selling goods. What has HMRC done?

Relevant goods

The draft regulations issued by HMRC on 5 December 2016 listed certain exclusions from the class of “relevant goods” with the LCT category. For example, capital items, road fuel and motor parts, and food and drink for employees are all excluded from the definition of relevant goods. In a webinar on the new FRS scheme rules, HMRC clarified that road fuel and motor parts are classified as relevant goods only where they are used by a business in the transport sector, such as a taxi or road haulier. But those items are excluded from relevant goods for all other businesses, including for vehicle repair businesses.

In the same webinar HMRC emphasised that goods must be used exclusively for the business purposes with no private use, to be treated as relevant goods. Gas and electricity are treated as goods, but those supplies must be used exclusively for business to be included as relevant goods.

Example 1

An office printer is used for private as well as business purposes. All the paper and ink for that printer must be excluded from the definition of relevant goods.

All other goods purchased by a business are treated as relevant goods. The total cost of the relevant goods bought in a VAT quarter is tested to see whether it is either; less than £250, or less than 2% of VAT inclusive sales for the period. A “yes” answer to either of these tests means the business must apply the FRS percentage of 16.5% for the VAT period in question. However, the list of exclusions on the draft regulations did not include any goods bought by a business for resale – that has now changed.

New exclusion

HMRC issued a revised VAT Notice 733 on 1 March 2017, with LCT issues analysed in new paragraphs 4.4 to 4.6. Paragraph 4.6 defines “relevant goods” and extends the exclusions to:

  • goods for resale, leasing, letting or hiring out if your main business activity doesn’t ordinarily consist of selling, leasing, letting or hiring out such goods
  • goods that you intend to re-sell or hire out, unless selling or hiring is your main business activity

In the HMRC webinar the following new exclusion from relevant goods was also listed:

  • goods for disposal as promotional items, gifts or donations

It is assumed that the above changes will be given force of law in the final regulations to be passed by Parliament before 1 April 2017.

Example 2

John trades as a limited company with the following sources of annual income:

  • football coaching: £90,000 including VAT
  • buying and selling footballs and kits: £10,000 including VAT (50% gross profit margin i.e. £5,000 cost of sales figure)

Until the amendment to the definition of “relevant goods”, John would never have been a LCT because the £5,000 cost of stock clearly exceeds both the £1,000 annual deminimis figure and 2% of his gross annual sales of £100,000. Now he must hope that his other purchases of goods (for example stationery, books) exceeds the thresholds. He can’t include his stock for resale in the test of relevant goods, because it does not relate to his “main business activity”, which is clearly football coaching.

What does the change mean?

I don’t blame HMRC for making this amendment. The previous loophole put advisers in a very difficult position. If we had encouraged clients to introduce a secondary activity of buying and selling goods, this would carry a sniff of tax avoidance. Other advisers would have played the game with a very straight bat on the basis that a new secondary selling activity would be stretching the rules, and would go against the spirit of the legislation. The former approach would, in many cases, have meant that the VAT savings made by keeping clients out of the LCT category would have exceeded the potential losses of the new activity, even if goods were sold at a massive loss.

The latest change shows that HMRC is determined at all costs to cut out the tax avoidance it has identified in relation to agency workers using the FRS, even if it captures genuine FRS users such as John in example 2.

Replies (63)

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By Rich61
03rd Mar 2017 11:46

Good Morning.
Just a quick question, i work as an aircraft mech. Could i use tools purchased for business use in my 2% allowance, or are these classed as capital expenditure.
Would hotel bills classed as a service or goods.
Thanks in advance

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Replying to Rich61:
7om
By Tom 7000
03rd Mar 2017 12:28

tools are assets and hotels a service....
You would need to buy parts and fit them and charge for the supply and fit of a new spark plug etc etc

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By Trethi Teg
03rd Mar 2017 13:09

"would go against the spirit of the legislation"?

I am getting the impression that the HMRC bullying of taxpayers and agents is paying dividends.

Our role is to help our clients reduce their taxliability in accordance with the law. To do this we have to understand the huge amount of tax legislation which has been put in place.

It now seems that we have to also understand what the "spirit of the legislation" is as well.

In my view it's time advisers "manned up" and stopped doing HMTRC's job for them. If they can't draft legislation properly then that's their problem.

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By sushi_ginger
03rd Mar 2017 13:17

Totally agree. Accountants should add value not just regurgitate the rules.

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By sushi_ginger
03rd Mar 2017 13:24

HMRC have specifically included water, gas and electricity in relevant goods.

If a contractor is renting a flat in another part of the country to use as a base for a job, he will be paying say £100 a month on leccy/gas and £30 a month on water. That's a decent contribution towards 2% expenditure on relevant goods.

He only uses the flat on the days he is working ie not weekends and holidays.

Does this still fall foul of the "no private use" condition?

If he buys printer cartridges but does a bit of his own printing apparently that's excluded.

This is an example of inconsistency in the tax rules. He can still class the print cartridges as a business expense, but not as "relevant goods". Crazy.

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By acceje
03rd Mar 2017 14:30

How can it be fair that a motor mechanic can not class motor vehicle parts as "goods". Has someone at HMRC got a problem with motor mechanics ?

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Replying to acceje:
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By sushi_ginger
03rd Mar 2017 16:05

acceje wrote:

How can it be fair that a motor mechanic can not class motor vehicle parts as "goods". Has someone at HMRC got a problem with motor mechanics ?

He can. It's only if he's not a mechanic or in the motor trade then it wouldn't be allowed.

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Replying to sushi_ginger:
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By acceje
03rd Mar 2017 18:07

No he can't - he is not classified as transport services - this question was asked and answered in the webinar.

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Replying to acceje:
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By sushi_ginger
03rd Mar 2017 19:27

I totally disagree. If he is a mechanic then vehicle parts are allowed as relevant goods. I think you must have misunderstood.

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Replying to sushi_ginger:
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By acceje
03rd Mar 2017 20:59

Whilst I agree with you that they should be allowed the point was made in the webinar and in the article above that motor parts are excluded from relevant goods for all other businesses including for vehicle repair businesses.

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By ireallyshouldknowthisbut
03rd Mar 2017 14:41

Legislative "catch up" then as normal from HMRC. If they were a competent organisation they would think of this stuff BEFORE releasing the legislation, not waiting for us lot to tell them the problems.

One "simple" change, begats reams of legislation to paper over the cracks, and then in term create more arbitrary problems.

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By ohgoodgodno
03rd Mar 2017 14:50

maybe I'm being dim but in the example of the football coach how can the stock not be part of the business

we have a client who runs a gymnastics club, a significant part of this involves selling kits and appropriate clothing to the members, its part and parcel of the business activity, not an add on

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By Duncan Cameron
03rd Mar 2017 15:10

What Neil, do you mean by ‘sprit of the legislation’? Your football coach on £90K has no choice about VAT registration and, if he was selling balls and kit before the LCT regime was announced, he is not even trying to side-step it. It seems to me that his use of the FRS is entirely legitimate, yet he is treated the same as those who voluntarily register solely to gain from the FRS.

By what criterion is ‘main’ to be judged? Turnover, profit, time spent, value of assets engaged? Or perhaps, like the trading company test, the matter is to be judged in the round? In any event, is coaching and selling football paraphernalia two activities? They are obviously closely linked.

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Replying to Duncan Cameron:
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By sushi_ginger
03rd Mar 2017 19:25

It's quite clear from the example given that it is the activity with the biggest gross turnover.

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Worm
By TheLambtonWorm
03rd Mar 2017 16:28

It would have been so much easier if HMRC just stopped people registering for FRS if their turnover was below the registration threshold.

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Replying to TheLambtonWorm:
RLI
By lionofludesch
03rd Mar 2017 18:00

It's not just that, though. I have a client company who will be paying much more VAT from 1st April though its turnover is way over the threshold.

On a slightly different issue, has anyone seen any guidance on cases where the client's stagger is not 31 March ?

Trader doesn't want to deregister but needs to come out of FRS.

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By sushi_ginger
03rd Mar 2017 19:32

Is the main activity defined as the trade sector that the company is using? If so does the fact that the company is using "any other activity not listed elsewhere" mean they can buy and sell a small amount of goods and this constitutes part of their main activity? What a ridiculous mess.

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By Marion Hayes
05th Mar 2017 00:08

I have seen no commentary on the income tax/nic lost reducing the benefit of the legislation.
My client has withdrawn from FRS into standard VAT and his tax liability @ 40% will fall significantly. I have yet to quantify the overall impact but am surprised people have not commented that the so-called windfall was still taxable at potentially a higher level than VAT.

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Replying to Marion Hayes:
By JCresswellTax
06th Mar 2017 10:00

I think it is probably as you will find a lot of 40% taxpayers probably trade through limited companies, so tax reduction isn't as significant?

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By FrogHappy
06th Mar 2017 10:24

I watched the HMRC webinar and I too was shocked at the response regarding motor mechanics. However I don't think the person who answered this took enough time to understand the question or the reality of the situation and you would hope that in a tribunal it would be obvious that a mechanic needs to buy and sell motor parts as part of providing a service, just as a shop who only buys and sells motor parts needs to do the same. The legislation has been designed to stop business claiming their own motoring costs as relevant goods, rather than items traded in the normal course of business.

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Replying to FrogHappy:
Jonathan@Aiteo
By [email protected]
06th Mar 2017 10:49

You're probably right, but if senior people from HMRC are put on a webinar to answer questions like this, and get them wrong, then it just goes to show what a mess they've turned the FRS into.

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Replying to [email protected]:
Jonathan@Aiteo
By [email protected]
06th Mar 2017 10:52

Actually, I'm going to revise "you're probably right", because I've re-read the handout on exclusions relating to goods and it's pretty clear that the response given by HMRC is consistent with the handout. So in that scenario the parts couldn't be counted as goods.

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By FrogHappy
06th Mar 2017 10:32

But a another quandary that arose regarding closing the loopholes is this:

What if a trader buys £500 of stationery each quarter just to meet the 2% relevant goods threshold, but doesn't actually really need it for the business and so just stockpiles it or wastes it. Say they make £4,000 from the FRS in a year, then they have gained £2,000 from the exercise. This is quite clearly artificial abuse of the system but would it stand up?

My view is that this might fall foul of the provision "must be used wholly and exclusively or the purposes of the business" because it is not actually being used in the business and is not needed for the purpose of the business. What does anyone else think?

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Replying to FrogHappy:
Jonathan@Aiteo
By [email protected]
06th Mar 2017 10:54

Which part of

"just to meet the 2% relevant goods threshold"

do you think is consistent with

"must be used wholly and exclusively for the purposes of the business"?

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Replying to FrogHappy:
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By garethgreen
06th Mar 2017 11:36

I agree that purposely buying excessive amounts of stationery would be unlikely to count as "relevant goods".

This begs the question of what is excessive, however. A certain amount of stockpiling would seem OK, in my view, as long as it is reasonable to claim that the trader does eventually expect to consume the stockpile.

The mere fact that it will take, say, two years to consume the stockpile at the current rate of usage does not, IMHO, mean the goods are not used for the purpose of the business. Equally, I'm going to stick my neck out and say that a ten year stockpile is unlikely to be accepted as for business purposes.

The purpose test is a factual one: the purpose for which the goods are used or are to be used. Arguably, goods can still be used exclusively for the purpose of the business, notwithstanding that a motive for purchasing them was to avoid being an LCT.

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By Ian McTernan CTA
06th Mar 2017 10:49

After a review of my clients I'm advising them all to come out of the FRS scheme as it is no longer effective for them- as they now have to monitor all their VAT and costs anyway, to see whether they qualify, it's become useless as a method of cutting down on administration.

It's no longer fit for purpose- but then this move needs to be seen in conjunction with Making Tax Difficult and the reporting requirements there.

One has decided he's off to South Africa rather than stay here (not his only reason for going!).

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By Echo761
06th Mar 2017 11:14

I also listened to the webinar and they gave out "duff" advice about imports being liable to the reverse charge... no they are not. The import VAT comes in via the C79. Also it was shocking how many questions they got about ..so if I buy these goods.. are they qualifying goods... erm no they are actually services. Most people struggled with the concept of what are goods and what are services. A fundamental point if HMRC's tackling of the perceived abuse (where they clearly know who is doing the wrong) is to work.

Shambles and overkill in my opinion.

Then wait for the wailing as the latest task force is issued to have another bite at those using the "simplification" of FRS.

There are so many conflicting definitions of goods now it all gets very confusing, i.e. if they now treat certain purchases as capital items (and excluded) for the FRS and not for other tax purposes... danger ahead.

Finally... combine the changes on the FRS and IR35 and effectively "consultants" will become a rare breed.
.... breathe... breathe.... :)

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By QuentinPain
06th Mar 2017 11:20

First we have FRS as a way to simplify VAT for small businesses (at least that's how I remember it being "sold" to us when it first came out).

Then we have "Tax doesn't have to be taxing".

Then we have OTC ("Office of Tax Simplification").

And now we have even more complicated rules.

Does anyone in government have the slightest notion of what they're doing?

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By Taxbreak
06th Mar 2017 11:25

Of course, all of the LCT changes would not have been necessary if there had not been the blatant abuse of the FRS rules by the small minority of advisers in the first place. One can only hope that the new PCRT rules will result in less of the sort of behaviour that poisoned the well for those taxpayers who were using the FRS for the purposes for which it was designed.

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By Taxbreak
06th Mar 2017 11:25

Of course, all of the LCT changes would not have been necessary if there had not been the blatant abuse of the FRS rules by the small minority of advisers in the first place. One can only hope that the new PCRT rules will result in less of the sort of behaviour that poisoned the well for those taxpayers who were using the FRS for the purposes for which it was designed.

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Replying to Taxbreak:
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By NeilW
06th Mar 2017 11:28

It would have been far better if the FRS had never existed in the first place, and the VAT issue handled by automation and computerisation - not legislation.

Then we wouldn't need a registration level. Everybody could be required to charge VAT from the get go.

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Replying to Taxbreak:
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By Echo761
06th Mar 2017 15:53

But HMRC know who abused it... they said so in their webinar. Looks like they are afraid to confront them... so everyone has to stay behind after school.

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By NeilW
06th Mar 2017 11:26

What's funny is that if you're a consultant and the majority of your expenditure is zero rated or exempt (train travel, rent or work from home rebates), and you're billing large amounts then you'll still be making a few quid for filing four forms and paying direct debits.

0.2% return is better than a lot of business savings accounts

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Replying to NeilW:
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By raybackler
06th Mar 2017 13:06

A consultant billing £10000 net will hold on to £20 of VAT in a month at the 19.8% level. My monthly fees have £23 of VAT, so without looking at VAT Recovery on any other costs, they will be £3 per month better off. So it is not worth holding on to a 0.2% return.

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Replying to raybackler:
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By NeilW
06th Mar 2017 19:39

Perhaps then your fees are not worth paying, and you can be replaced with a computer.

You can do what is needed for £12 per month.

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By C Graham
06th Mar 2017 11:53

What about software licences - most are cloudbased and paid by monthly subscription but does that reclassify them since they are virtual goods?

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Replying to C Graham:
Jonathan@Aiteo
By [email protected]
06th Mar 2017 12:01

No, they are classified as services.

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Replying to C Graham:
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By dwaccounting
06th Mar 2017 13:50

In the Q&A section they differentiated between software supplied on a disk that does fall within the definition of goods; downloaded software that was regarded as a service; and depending on the length of the licence period some software could be regarded as capital.

So does this mean if we tick the box to also receive a hard copy of the software that the software would count as goods?

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By Watson Associates
06th Mar 2017 12:09

All is not lost! My understanding is that calculations will be looked at on a quarter by quarter basis. If a client only purchases 50% of goods required but purchases them in the correct quarters then his FRS 'profit' will only be halved or less.

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By mail.taxperfect.co.uk
06th Mar 2017 12:12

I buy an off-the-shelf company on behalf of one of my clients, then "sell" it to him as part of the service. Actually, I buy lots of off-the-shelf companies on behalf of lots of my clients, and "sell" to them as part of the service. Are these "goods" or "services" for the purposes of my own FRS calculations?

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Replying to mail.taxperfect.co.uk:
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By Echo761
06th Mar 2017 15:49

Services

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By nkwayne
06th Mar 2017 12:28

"In the HMRC webinar the following new exclusion from relevant goods was also listed:

goods for disposal as promotional items, gifts or donations
It is assumed that the above changes will be given force of law in the final regulations to be passed by Parliament before 1 April 2017."

I can't see this exclusion anywhere in the VAT Notice 733, so is that more legislation on the hoof, or is there anything anywhere else which actually backs that up?

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By Pavilionaire
06th Mar 2017 12:44

Did anyone else hear HMRC's comments about protective clothing? Unless my ears deceived me they said for the purposes of FRS work overalls were classed as goods but a CAPITAL item so not part of the 2%. Since when has anyone categorises overalls as capital?!?

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Replying to Pavilionaire:
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By dwaccounting
06th Mar 2017 13:25

Yes, I couldn't believe my ears when I heard that one!

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Replying to dwaccounting:
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By C Graham
06th Mar 2017 14:13

how do you depreciate that capex?

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Replying to Pavilionaire:
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By Echo761
06th Mar 2017 15:48

Yes... yet another howler from their "policy" peeps!... or wait... was he serious... oh... nooooo

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Replying to Pavilionaire:
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By Echo761
06th Mar 2017 15:48

Yes... yet another howler from their "policy" peeps!... or wait... was he serious... oh... nooooo

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By pauld
06th Mar 2017 13:46

In the example given on the printer which has both private and business use. Isn't a printer a capital expenditure good and therefore not a relevant good for FRS? so private use irrelevant?

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By mjaaccounting
06th Mar 2017 13:46

I have been discussing this with HMRC toady regarding a hairdressing client.

As the goods the buy to sell in the salon are not allowed to be included in the expenditure calculation they will have no option but to withdraw from the scheme.

The staff bonuses are based on sales less VAT so their salaries will go down.

My client will now have to keep detailed VAT records and pay £5-6k extra in VAT.

Well done HMRC, trebles all round!

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Replying to mjaaccounting:
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By sawebs
06th Mar 2017 18:10

mjaaccounting wrote:

I have been discussing this with HMRC toady regarding a hairdressing client.

As the goods the buy to sell in the salon are not allowed to be included in the expenditure calculation they will have no option but to withdraw from the scheme.

The staff bonuses are based on sales less VAT so their salaries will go down.

My client will now have to keep detailed VAT records and pay £5-6k extra in VAT.

Well done HMRC, trebles all round!

Surely this is a nonsense. So shampoo is not connected in any way with a hairdressers trade? I can't believe we are all letting this go through. Lots of letters to local MPs, numpty Hammond et al required.

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