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VAT flat rate scheme advantages restricted

23rd Nov 2016
Tax Writer Taxwriter Ltd
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Many contractors and other service providers will lose the cash benefit of the VAT flat rate scheme from April 2017, the chancellor announced in the Autumn Statement

Flat rate

The flat rate scheme (FRS) is used by numerous small businesses to simplify their VAT reporting. Lots of those businesses also gain a cash advantaged from using the scheme, but this advantage is due to be cut back significantly from 1 April 2017. The FRS will continue but many businesses will not find it economical to use.

Cash advantage

When using the FRS the business ignores VAT incurred on purchases when reporting VAT payable, with the exception of capital items which cost £2,000 or more. The trader simply multiples his gross turnover (including VAT charged at the normal rates) by the FRS percentage set for his particular trade sector.

This FRS percentage is supposed to take account of the amount of VAT likely to be incurred on business expenses. The common percentages used by service-related businesses are:

  • Accountancy and legal services 14.5%
  • Journalism or entertaining 12.5%
  • Computer or IT consultancy 14.5%
  • Business services not listed elsewhere 12%
  • Estate agents and property management 12%
  • Management consultancy 14%

If the business incurs few expenses, and it operates in a sector with a relatively low FRS percentage, it will pay out less VAT to HMRC under the FRS than it would outside the scheme. Many businesses register for VAT voluntarily before their turnover reaches the VAT registration threshold, so they can use the FRS and bank the cash advantage.

Abuse of FRS   

The government believes small businesses have been abusing the FRS by using it as the law intended, so it is changing the terms of the scheme to make is less attractive to use, and to reduce the cash advantage enjoyed by service-related businesses.

From 1 April 2017 a business will be required to use a FRS percentage of 16.5% if it is a “low cost trader”. This likely to adversely affect businesses in all of the trade sectors listed above, and possible many other similar businesses, as 16.5% of the gross turnover is equivalent to 19.8% of the net leaving almost no credit for VAT incurred on purchases. 

Low cost trader

This is a business whose expenditure on goods (not services) is less than 2% of its gross turnover, or if more than 2% of its turnover, the amount spent on goods is less than £1,000 per year. Any expenditure on; capital items, motor expenses, or food or drink for consumption by the business, is ignored when working out the 2% or £1,000 threshold.

This emphasis on ‘goods’ will discriminate against businesses who incur VAT on services such as: rent, software licences, IT support, digital journals, sub-contractors, telecoms etc. In VAT terms a service is anything which is intangible, or where the cost relates to a tangible asset it is the temporary use of that asset – such as hiring.

Action to take

You will have to review the use of the FRS for every client who currently uses that scheme.

Businesses who are trading under the VAT threshold of £83,000 may want to deregister from VAT with effect from 1 April 2017. Businesses who are trading over that threshold may need to withdraw from the FRS from the same date.

Note that any attempt to invoice in advance for services to be provided on or after 1 April 2017, to capture that invoice within the FRS, will be treated as if the invoice was issued on 1 April 2017 (para 8.2 and 9.7 of VAT notice 733).

Replies (84)

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By NH
23rd Nov 2016 20:07

What a ridiculous thing, how can you possibly stay within the law but be penalised for abusing the law, it is either legal or not.
I can think of all kinds of issues with this, but the first one that springs to mind is how on earth will a business know in advance whether or not it is likely to spend more or less than 2% on goods.
It makes a complete nonsense of the scheme, why not just withdraw it?

Thanks (11)
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By NLB
23rd Nov 2016 22:18

I think there will be lots of de-registrations and also a fair few move to the standard scheme as even those businesses impacted are likely to buy services with vat from telecoms to accountancy and everything in between. As long as the business in question is selling to other businesses that are VAT registered there is no disadvantage to reclaiming full vat on purchases on the std scheme and get the cashflow advantage on invoices out other than the admin or cost of getting someone to do it for them.

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By cfield
24th Nov 2016 00:55

Wow, we never saw this one coming. What a shock. One immediate query is whether the 2% relates to real turnover or flat rate turnover.

Stationery firms must be rubbing their hands with glee. If you're going to pay an extra 2% anyway, you might as well spend it on goods you might have some use for one day. Shame they've disallowed capital goods. Looks like we'll have to stock up on paper and printer ink instead.

Come to think of it, this is extremely unfriendly to the environment. Just think of all those extra trees that will have to be cut down. Our carbon footprints will now get bigger and all because the Chancellor wanted to stop the little guys saving a few quid in VAT.

I bet that's not in their policy impact assessment.

What else can we spend 2% of our turnover on? Any ideas?

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Replying to cfield:
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By dburdon
24th Nov 2016 12:45

I've written my own rant below. But in answer to your request for ideas, my own purchases on (non-capital) goods include the following:
1. Promotional T shirts
2. Exhibition banner
3. Office chair
4. Print cartridges
6. Light bulbs
7. Batteries
8. Stationery
9. Office cables

I'm still below the £1,000 and/or 2% threshold.

Thanks (1)
Replying to dburdon:
jlsmith
By jlsmith
24th Nov 2016 12:52

HMRC will need a new analysis code in their MTD minimum reporting specification to cope with this.

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Replying to dburdon:
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By ComanCo
24th Nov 2016 23:03

I am not sure you could include office chair, as this would likely be a capital item:
https://comanandco.co.uk/autumn-statement-2016#Flat_rate_scheme_to_end_f...

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By jon_griffey
24th Nov 2016 09:13

Will there now be a procession of cases going to FTT on the capital v revenue issue? If a business just squeezes over the 2% will HMRC have a trawl through and argue that every hole punch or memory stick is a capital item?

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By ireallyshouldknowthisbut
24th Nov 2016 09:37

I have been through a sample of 10 of my clients files who are consultants, computer geeks and other similar service businesses, and not one of them spends 2% on goods.

Virtually all their spends are services, the biggest spends being being travel, their friendly accountant, computer kit and software.

I am not sure what clients on flat rate WOULD spend 2% on goods, and trading business are unlikely to be in the scheme in any case given the turnover limits.

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Jonathan@Aiteo
By [email protected]
24th Nov 2016 09:38

Is there any sense as to how often this will be assessed? I presume companies will have to estimate if they're subject to the 16.5%. What happens if a company estimates it should be at 14.5% and pays accordingly, but by the end of the year ends up under the 2% threshold?

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By cfield
24th Nov 2016 09:39

I note they haven't excluded stock purchases, so in theory you could buy a job lot each quarter and sell it on to other small firms so they can make their 2%. In fact, you could have a cartel of firms who all sell the same goods on to each other in never-ending circles so eventually you end up buying them again yourself. We could become a nation of second-hand stationery suppliers.

How are they going to police this thing given that boxes 4 and 7 are nil under the flat rate scheme? Will every trader on 12% or above be getting an enquiry letter if they don't pay the 16.5%?

Thanks (2)
Replying to cfield:
Jonathan@Aiteo
By [email protected]
24th Nov 2016 09:42

If we didn't know and trust HM Treasury any better, one would almost say this hasn't been very well thought through.

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By norstar
24th Nov 2016 10:10

"This emphasis on ‘goods’ will discriminate against businesses who incur VAT on services such as: sub-contractors, telecoms etc".

How on earth can this be legal? You can't describe a service business turning over £150k and hiring subbies costing £50k as "abusing the flat rate scheme".

You lot created the scheme and set the %s. Now this?!

Thanks (8)
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By RobertD
24th Nov 2016 11:32

..... and, AGAIN. the upshot is small businesses reverting to the standard scheme and having to extract vat from every little invoice. More time spent in admin.

When is it going to stop?

They wonder why productivity is less than other countries. It's because we have to spend so much time keeping the vat man, the tax man and the pensions man bloody happy.

I really am starting to despair. The Government tells the treasury to collect more tax, the Treasury tells HMRC and HMRC come out with a load of ill considered plans to which the simpleton MP's who don't understand it, agree.

How much more does this Tory government think businesses will stand of this rubbish?

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Replying to RobertD:
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By towat
24th Nov 2016 13:31

Low cost businesses can still use the FRS just with a rate of 16.5% equivalent to 19.8% of net, so they can still save on admin.

Thanks (2)
Replying to RobertD:
Should Be Working ... not playing with the car
By should_be_working
25th Nov 2016 17:49

I long came to the conclusion that it's not a Tory government, Coalition Government or Labour government that's at fault.

It's just 'government', and too much of it.

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Replying to RobertD:
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By ringi
28th Nov 2016 18:16

Most IT contractors etc only issue one invoice a week often for over £1K, hence there are not lots of small invoices.

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Chris M
By mr. mischief
24th Nov 2016 11:51

I have a feeling HMRC are going to get themselves in a mess over this. After all they have form, often manage to screw things up totally. In this case, over the last few years I have publicly stated that all they had to do was define the sectors better.

I mean, how hard is it to write "Engineer 14.5%" or "Project Manager 14.5%" FFS???

So instead of an easy peasy common sense change in the definition of the sectors, we get this extra layer of complexity. Yet again adding to the longest tax code in the EU and probably the world.

Not only that, given that it is probably a bunch of clueless wallies who'll be drafting the legislation, there is every chance they'll muck it up and some of my clients will carry on making up to £10,000 per year profit from VAT.

FOOLS!

Here is my prediction, in the hope that at least some of the HMRC numpties are reading this and will be able to make a commonsense sector change instead of yesterday's utter drivel:

If you go ahead with this nonsense, there will be a sudden increase in the number of businesses whose expenditure on goods is 2.01% each year.

Honestly you really despair at these wallies!

Thanks (4)
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By Factuary
24th Nov 2016 11:58

I probably spend around 1% of turnover on goods each year to support my consultancy business. So it seems to make sense to look how to spend another 1% (£500) to defend an annual VAT saving of £2,800 (5.6% x £50k) through the FRS. Looks like I'll be ordering those new business cards and personalised pens for marketing freebies after all!

Thanks (3)
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By dburdon
24th Nov 2016 12:31

This appears to me as an out an out attempt by HMRC to do away with the flat rate scheme within the services sector. Why set such a high default rate of 16.5%? Why otherwise discriminate against against expenditure on services?

Running a small service based business means that almost by definition, very few "goods" are purchased.
I've just checked my recent cost base. Rent, telecoms, software, hosting, exhibitions and outsourced expertise such as accountancy etc. My non-capital "goods" amount to a few £ hundred for print cartridges, light bulbs, batteries and some promotional T shirts.
I took up the FRS because of the aggravation of the quarterly return, not any potential margin.

Thanks (2)
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By silverghost
24th Nov 2016 12:49

We can have some fun with this. Firstly, what is a capital item? I tend to put anything under £100 under revenue; will HMRC make a categorical statement as to what is capital? If I buy anti-virus software that comes on a disc, surely that is a tangible item, ie a good rather than a service? If I have a webinar on in the background but print off the powerpoint pages to read later - I then have a tangible item. There are bound to be others.

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Chris M
By mr. mischief
24th Nov 2016 13:17

It never ceases to amaze me just how incompetent the people who make our tax laws are! Extra complexity which probably won't achieve it's goal, instead of just defining the sectors more accurately with zero extra complecity plus a much greater chance of success.

Incompetence beyond belief!

Thanks (4)
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By towat
24th Nov 2016 13:24

This is what happens when the government bases it's anti-tax avoidance policy on whatever was in the tabloid headlines that month.

Thanks (7)
Replying to towat:
By DotasScandalDotOrg
25th Nov 2016 12:10

Rather, this is what happens when the government bases it's anti-tax avoidance on whatever lies Mr Gauke sings into their ears. It's not the tabloids that define what government does, but government that defines what tabloids print.
And as it happens, Mr Gauke seems to have a personal vendetta going on against small business and imagined, non-corporate "tax avoiders".
Contrast that with his attitude when talking to the big boys (Google, Amazon, and the rest) - you can literally see his eyes glow with love.
As long as this man will have a say in policy, UK will be wide open for BIG business ONLY, and firmly shut for everyone else.

Thanks (9)
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By raybackler
24th Nov 2016 16:21

I have just carefully checked a consultant who is typical of the many who operate in the service sector in the 14.5% flat rate band. He makes about £2000 out of the Flat Rate Scheme on about £108000 turnover. £2750 Flat Rate again, but foregoing about £750 of VAT on mostly services.

He buys some goods, but will never get anywhere near 2% of turnover. To recover this Flat Rate gain, HMRC would
need to increase the percentage to 16% - simples.

However, if my consultancy clients come out of the Flat Rate Scheme, because of the 16.5% band, they will have additional costs associated with recovery of VAT on all of their travel bills etc.

The difference between 16% and 16.5% is £650 on this typical client. Whilst my fees won't go up by that much, say £25 per month = £300, the government have heaped a whole load of unproductive time on my clients, when they could have just realigned the percentages. Unbelievably stupid. There will be a mass exodus from the Flat Rate Scheme and a massive drop in productivity.

PS - I don't want this extra work - it will be at the wrong end of the type of work I want to do for clients.

Thanks (6)
Replying to raybackler:
Jonathan@Aiteo
By [email protected]
24th Nov 2016 16:23

Agreed. And to use my own 'typical 14.5%' client example, based on current run rate they would be marginally better off under the full scheme, so now have the impetus to move to the full scheme giving a net loss to the Exchequer. Genius!

Thanks (4)
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By bendybod
24th Nov 2016 16:26

Just when we didn't have any other changes to think about on our clients' behalf!

Thanks (2)
accountant in london
By Accountant in London
24th Nov 2016 17:10

so ridiculous these changes! - isnt't FRS supposed to simplify rather then complicate things?!

Thanks (4)
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By adam.arca
24th Nov 2016 19:30

I'll admit to an agenda here: I've never liked the FRS, it never sat well with me that traders profited from the scheme (a minority POV, granted), and the supposed admin saving was illusory.

I would prefer HMG was honest, admitted that the FRS was a bad idea always open to abuse and just abolished it forthwith. On the assumption that is somehow politically unacceptable, then I suppose making the scheme less attractive is the way to go.

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Chris M
By mr. mischief
24th Nov 2016 20:18

I totally agree with the previous poster that it's just ridiculous I have a £100k plus engineer who makes a clear £10k cash profit on VAT.

But that's only because HMRC hired an escaped lunatic for 1 day and let him or her define the various sectors. I have posted on public websites many times in the past 5 years that if they hired ME for a week to re-define the sectors properly then 90% of the tax take problem would be solved.

The problem with HMRC is that their solution to all problems is more red tape, more silly rules. No-one ever seems to ask "How can we solve this problem AND cut red tape?"

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By nogammonsinanundoubledgame
25th Nov 2016 07:40

This is all an inevitable consequence of a flaw in the RIA conducted when FRS was introduced.

They announced that FRS would be globally "revenue neutral" from the treasury viewpoint, but this was based on the flawed assumption that everyone who qualified for FRS would go onto it, conveniently overlooking the obvious fact that as it was voluntary no-one would go on to FRS unless it was economically beneficial for them, the taxpayers exercising that choice.

What amazes me is that it took them so long to wake up.

With kind regards

Clint Westwood

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Replying to nogammonsinanundoubledgame:
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By NH
25th Nov 2016 07:53

It all started with Gordon Browns 10k zero CT rate, how shocked HMT were a couple of years later when everyone had incorporated just so that they could save money!

And now once again, how shocking to realise that 99% of traders on FRS are only on it because it saves them money, what terrible abuse of the system this is!

As with Gordons [***] up (remember all the weird tax rates), rather than scrapping the whole thing we decide to introduce extra layers of complication.

Thanks (10)
Replying to NH:
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By towat
25th Nov 2016 13:05

Gordon Brown also abolished ACT in one of his first budgets that's when we realised he didn't understand tax at all, and HMRC had to create mutiple new tax rates and notional tax credits to compensate.

Thanks (3)
Should Be Working ... not playing with the car
By should_be_working
25th Nov 2016 11:32

So in doing what parliament encouraged us to do, we are now accused of 'abusing' the scheme. [Insert unprintable comment here.]

I always thought the small 'profit' element was a share of the administrative savings that accrue to HMRC from the FRS? At least that's how I explained it to incredulous (read 'worldly-wise') clients. Now I'll just have to explain that Mr Hammond-Osborne-Brown wants to screw them over as usual.

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Replying to should_be_working:
By DotasScandalDotOrg
25th Nov 2016 11:57

The great thing about "what Parliament intended" is that it can be revised retrospectively - or just simply made up depending on the Treasury's needs of the day.
https://www.dotas-scandal.org/how-often-does-your-government-lie-to-you/

Thanks (2)
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By Pavilionaire
25th Nov 2016 12:28

What I resent is that pretty much any service-based business that registered for the Flat Rate Scheme is now labelled as abusing the tax system and that I as an agent have aided that abuse.

We as accountants have a duty to our clients to work within the law to minimise their exposure to tax. The problem is HMRC coming up with ludicrous rules, then when the penny drops they blame businesses - these are the people that generate the tax for HMRC that makes the world go round!

Naughty business abusing the Employment Allowance, taking tax-free dividends, trousering money via the Flat Rate Scheme. Well here's the thing HMRC - stop coming up with [***] rules that are full of holes and work through your proposals before you put them out there!

Thanks (7)
Replying to Pavilionaire:
By DotasScandalDotOrg
25th Nov 2016 12:38

Try to imagine how contractors at the center of the DOTAS retrospective which-hunt feel.

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Replying to DotasScandalDotOrg:
By cfield
25th Nov 2016 13:16

This strand is about the flat rate scheme. Please don't try and compare it to the contrived and artificial schemes that the Government is quite rightly clamping down on.

Nobody abused the flat rate scheme, except possibly those who chose the 12% rate for "any other business" when they should have chosen a higher rate, but again that's the fault of HMRC for not having enough sectors and making them too specific. That meant many businesses didn't "fit in" to the narrow definitions and more or less encouraged them to try it on with the 12%.

Those contractors you constantly bang on about (or more pertinently the people who created and sold the schemes) definitely were abusing the tax system, and they knew it.

So please don't hijack this thread to bang your drum on this subject. There really is no comparison.

By the way, I think you mean a witch hunt, not a which hunt.

Thanks (4)
Replying to cfield:
By Ruddles
25th Nov 2016 23:12

Nobody abused the flat rate scheme? Ahem - certain recruitment businesses setting up multiple companies? Fairly well-known abuse of the Scheme, or so I thought.

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By towat
25th Nov 2016 13:11

And of course any businesses that have reclaimed VAT on assets over £2000 will have to account for Output Tax on the assets if they decide to deregister, so they will have to stay in the FRS and pay 19.8% Output Tax or come out of FRS and incur the extra admin costs.

Classic case of moving the goalposts.

Thanks (1)
Replying to towat:
Jonathan@Aiteo
By [email protected]
25th Nov 2016 13:24

Or move to the full scheme...

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By johnacarpenter
25th Nov 2016 14:09

Under the current system, the excess VAT benefit i.e. the difference between VAT charged in invoicing and the VAT reclaimed is subject to Corporation tax currently @ 20%
That is you either pay VAT or corporation tax.
All that's changed is there will be more VAT a less Corporation tax. I appreciate that CT is set to be reduced in the next few years.
The point of the flat rate was to reduce admin for both HMRC and the tax payer, all this does is to make it more expensive for both parties.
Complete waste of time and our money.

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By taxbakbristol
26th Nov 2016 02:53

Lunatics are now in charge of the asylum!
Why don't they consult before making these dreadful changes- Oh I forgot they are lunatics suffering from delusions of competence!

Thanks (1)
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By North East Accountant
26th Nov 2016 12:13

HMRC introduce FRS to simplify VAT, without any thought of consequences.

They then realise that people are using it and gaining, in their opinion at unfair advantage.

Rather than admitting it was stupid and scrapping FRS they introduce more complexity.

Of course it's our fault for advising client's that they may benefit from FRS VAT.

Scrap FRS and go back to VAT being VAT, end of story.

Thanks (1)
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By carnmores
26th Nov 2016 13:08

basic amount £100 vat due £20 inclusive figure £120

so 16.5% of £120 = £19.80, so 20p on every £100 , the point , we dont want you to use this scheme , then bloody say so

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By paulb
26th Nov 2016 22:18

The typical client for me is Social Worker at 11% FRS - average profit from scheme approx £3683 per year. If a client decides to purchase one or two ipads for a promotional gift to local children's hospital, therefore, meeting the 2% of turnover. They still benefit from the scheme around £2500.00. Any issues with that?

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By Malcolm McFarlin
27th Nov 2016 15:48

Presumably many accountants and book-keepers will be affected since many of their purchases will fall below the 2% threshold of turnover. While we are yet to see the finer details of this HMRC proposal -I can see that many other trade classes currently identified within the HMRC guidance will need to be reclassified as you state within your article. Many tax consultants are on 12.5% FRS percentage -so quite a hike.

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By moufflon
28th Nov 2016 10:34

You don't ever hear (non-accountants) talking about how great the FRS is as a way of reducing VAT admin - its only ever about how it saves cash compared to standard VAT. How hard is standard VAT accounting? With most small businesses moving to online accounting packages, sending, receiving and posting VAT invoices is very straightforward. Our tax system is now mindbogglingly complex, the need for simplification is urgent, yet every budget just seems to add more complexity. The FRS should just be scrapped, along with large parts of the rest of the tax system.

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By Ian McTernan CTA
28th Nov 2016 10:47

This looks like trying to shift more people in to using Cloud software before the introduction of MTD, as many using the flat rate scheme had no real need for an accounting package to track that pesky VAT.

I have a few clients on the scheme so I guess it's time to tell them they are getting hit again (dividend tax hike incoming too).

Thanks (1)
Anne Photo
By Annehthr
28th Nov 2016 10:50

I have a client who is on the retail flat rate scheme will this affect him I wonder? he pays 7% on all goods sold as he buy most of his purchases second hand. Also for those who are in the scheme will the rates change ? Or is it for new businesses?

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Replying to Annehthr:
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By RachelSA
28th Nov 2016 16:54

this change is for service businesses, though I doubt this would fall under the classification of goods purchased being less than 2% of turnover.

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