VAT Director Rayner Essex
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VAT Flat Rate: Not so simple simplification

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As all VAT registered businesses will soon have to keep digital records under the MTD regulations, is it now time to put the VAT flat rate scheme (FRS) out to pasture?

3rd Dec 2021
VAT Director Rayner Essex
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When it was introduced, the FRS was designed to simplify the VAT accounting for small businesses.  But with the limited cost trader rules and the domestic reverse charge for the construction industry have added complexities which are arguable made worse when using the FRS.

Simple but with complexity

The case of Swiss Dawn Consultants Ltd (TC08311A/V), is an example of how a simple misunderstanding on how the FRS works can lead to VAT liabilities

The taxpayer had used the correct flat rate percentage (which is often the first issue for traders using the scheme) but the misunderstanding arose in applying that percentage to the net, rather than the gross value of sales. In addition, the taxpayer had reclaimed input tax on purchases which were not capital items, although the taxpayer had recognised this and had written to HMRC to correct this.

An example period (04/15), the taxpayer had gross sales of £60,444. Applying 13% (the flat rate for the sector) produces an output tax liability of £7,857 but the net value of sales was used for the calculation, so £50,370 x 13% = £6,548, producing an under declaration of £1,309. The overall liability over all returns was £8,474

Is it still a simplification?

This case highlights how easy it is to make errors using the flat rate scheme. Often taxpayers will forget to apply the 1% discount or forget to disapply it after 12 months.

Other issues include limited cost trader rules, and what purchases can go into calculating whether to use the normal or higher flat rate percentage. Then there is regular issue of whether something is a capital item or not. The question is usually framed around website design or bespoke software, but these are not capital items, they are services.

Way forward

As a VAT practitioner, I feel there is still a home for the FRS, but its scope and benefits are now limited to specific sectors or business models. There is still potential for certain trade sectors to make a little extra “profit” on each transaction. 

On the basis the FRS was intended to be a simplification, however, with the various rules now in play, its not really simple. Using the scheme requires some knowledge about VAT and accounting procedures and this can often trick taxpayers into thinking it’s easy, which it is, as long as the taxpayer correctly reads and implements the rules.

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Replies (9)

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By Paul Crowley
03rd Dec 2021 16:20

Zero justification for continued existence
Same could really be said for annual accounting scheme

The claimed purpose for Flat Rate was to make keeping records easy for the simple trader
Only ever used to make a buck from the taxpayer
Outlived its purpose
Totally agree

Thanks (4)
By jon_griffey
03rd Dec 2021 17:02

For a simplification measure it does seem surprisingly full of mantraps.

Thanks (2)
Replying to jon_griffey:
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By Paul Crowley
03rd Dec 2021 20:00

The calculating on Net was very common.
Had a couple myself. None were people trying it on, genuinely thought that HMRC liked to give away money.

Thanks (0)
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By Roland195
04th Dec 2021 09:28

Never claimed to understand the rationale behind it - before the limit cost trader rules came in, it was predominantly used by consultantcy businesses to write off substantial amounts of VAT and who likely had simple calculations anyway. Then you have the nonsense of trying to fit the business into the categories - half of the listed ones couldn't be viable with turnover low enough to qualify for the scheme.

Thanks (0)
Replying to Roland195:
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By Paul Crowley
04th Dec 2021 16:01

Even worse
Almost no identifiable actual real trades for traders that were likely to want simple records
HMRC take was if you made too much VAT profit you misunderstood the category

Publican that sold food being an example
No you are a restaurant

Thanks (3)
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By BIGWAL
04th Dec 2021 19:29

Tend to disagree with various comments, as for some clients the FR scheme is highly relevant.
Take my catering client (please !). Has lots of zero rate purchases but it' s impossible to plough through every receipt - if not lost or illegible - to correctly record input Vat - and that's using bank feeds. But I know income is properly recorded as very little room for wrong postings. Plus a couple of others where it's use is very appropriate.
Those incorrectly using FR without professional advice deserve all they get if they end up getting penalised.

Thanks (1)
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By MattS
05th Dec 2021 17:03

I see it used fair less that it used to be, and I cant remember the last time I seriously considered advising a client to use it.

Thanks (0)
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By adam.arca
06th Dec 2021 14:16

Yes, please, let the FRS kick the bucket and at least MTD will be good for something.

It was always a politician's sound bite and an added complication more than a genuine simplification.

Notwithstanding the strength of Bigwal's point above, we shouldn't let the tiny tail of businesses which find the FRS helpful wag the dog on this one as 99% of traders using this scheme do so because they see it as a profit centre rather than an administrative easing.

I could never get my head round the fact that FRS traders were effectively ripping off their customers by charging them "tax" which they then pocketed rather than paid over to the taxman; and all completely legitimately.

Thanks (1)
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By Ben Alligin
06th Dec 2021 14:18

I think you will find HMRC re-defined the purpose of FRS when they re-designated it as tax evasion and changed all the % rates for any individual who had signed up to the scheme or voluntarily registered for VAT when there was a margin to be made!

Thanks (1)