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VAT flat rate scheme advantages restricted

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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 P&G
28th Nov 2016 10:57

Typical of HMRC, they create new laws, often with little or no consideration of any "consultation" responses and then when the accountancy profession finds perfectly legal ways to help taxpayers make positive use of the law, they cry foul and worse still they bamboozle the professional bodies into issuing missives as to how we should act responsibly and not help clients to avoid tax!

How ironic when the next article on the Accounting Web email is Rebecca Cave's book on how to extract profit from the family company. Surely if it has been written under the new responsible guidance it should be one simple sentence - All extractions should be under PAYE/NIC deduction.

Not only do we have an out of control HMRC we also have out of touch professional bodies, more intent on cosy lunches with HMRC than supporting and protecting members in their unequal fights against what is becoming an unelected dictatorship.

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By geoffmw1
28th Nov 2016 11:17

What will happen to VAT when Brexit operates in full. Surely best to await Brexit before changing any of the current rules

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By totallytopcat
28th Nov 2016 11:36

I wish the treasury would pay more attention to those causing abuse at higher ends of the tax brackets than on small businesses like this struggling to survive in a world where cashflow is imperative.
Many are not able to cover service costs as it is due to the increase in rents and light/heating bills plus rates. Travel costs are also high and very few have options other than to use their own vehicle. So why of all things take these huge elements out of the equation.
It will mean those businesses who need the cash most, won't have it. And this is a statement for working people!

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By dgowens
28th Nov 2016 11:54

With the proposal to make tax digital then the flat rate scheme had to go. Also by bringing in the change a year before MTD businesses will get used to writing up there books. The chancellor may make de-registering from VAT only allowable if the business is ceasing to trade.

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By michaelblake
28th Nov 2016 12:00

Are books purchased for a professional library "goods" and if the same books are taken not in a physical form but as an online subscription do they then become services?

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By fmuk
28th Nov 2016 14:56

I’m sorry Rebecca but I don’t agree with your article regarding the new Flat Rate scheme category regarding low cost traders.

‘A limited cost trader will be defined as one whose VAT inclusive expenditure on goods is either:
1 less than 2% of their VAT inclusive turnover in a prescribed accounting period
2 greater than 2% of their VAT inclusive turnover but less than £1000 per annum if the prescribed accounting period is one year (if it is not one year, the figure is the relevant proportion of £1000)’

There is no mention of (not services) on the 2% figure of turnover.

The legislation states that ‘Goods, for the purpose of this measure, must be used exclusively for the purpose of the business but exclude the following items:
1 Capital expenditure
2 Food or drink for consumption by the flat rate business or its employees
3 Vehicles, vehicle parts and fuel (except where the business is one that carries out transport services for example a taxi business and uses its own or a leased vehicle to carry out those services)
These exclusions are part of the test to prevent traders buying either low value everyday purchases in order to inflate their costs beyond 2%.’

This legalisation is to stop on the road salesmen who’s only expenses are fuel and food & drink. It’s not to stop Accountants, Estate agents etc.

This statement is not part of the legislation: (where did it come from?)
'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'

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Chris M
By mr. mischief
28th Nov 2016 13:22

The worst aspect of this thing, which I have had various clients complain about, is being labelled in some way as a tax dodger.

NONE OF THESE GUYS ARE TAX DODGERS, HMRC!

The fact that the FRS has produced good profits for many clients of mine is 100% down to HMRC incompetency and 0% down to tax dodging. I have posted on here and other sites over the years how easy it would be to define sectors properly. HMRC staff hang out on these sites, it all falls on deaf ears.

As a contractor accountant, my contract is with my clients. They are perfectly entitled to sue me for negligence if I do not advise them to set themselves up to get the most favourable VAT sector.

It so happens many of my clients are engineers. But none of them are in the specific flat rate sector that the numpties from HMRC have classed as engineers. It really beggars belief!

HMRC had no problem writing "accountancy 14.5%" WTF is so hard about writing "engineers 14.5%" ??

If they had simply done this, plus some other sectors where the problems have been, no-one would be moaning. No-one would be upset by totally unfairly being labelled as a tax dodger.

This whole shabby episode sums up exactly why the UK has the longest tax code in the UK. It's because HMRC are a bunch of duffers.

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By AndrewV12
28th Nov 2016 13:29

Pity, it was a great little scheme, it worked well for everybody, it was simple, it worked, why get rid off it...OOOhh forgot it was probably another one of George Osbornes cloak and dagger tax purges.

Relax HMRc hes long gone, and he does not cast a long shadow, hes a back bencher.

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Nigel Harris
By Nigel Harris
28th Nov 2016 13:47

This first comment here makes a valid point. This was a mean-spirited announcement, blaming taxpayers for following the law. OK, so there were unintended consequences, which HMRC should have been able to foresee by analysing VAT Returns submitted previously - i.e. small trader returns with neglible Input Tax claims.

I have no problem with the Government fine tuning tax law. I object most strongly to taxpayers being vilified for applying the law!

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By reilloc
28th Nov 2016 14:16

What about equipment leases?

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By noelable
28th Nov 2016 14:33

How about the £1200 worth of gift vouchers under the trivial benefit rules, 4 directors (£50 x 6) for birthday, anniversaries, Christmas etc

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By richardterhorst
28th Nov 2016 15:17

Making tax simpler. Hmm... how to do that? I know lets make the VAT FRS not worth it.

And then MTD.

I wonder when they will make tax difficult?

Idiots!

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By richardterhorst
28th Nov 2016 15:18

Making tax simpler. Hmm... how to do that? I know lets make the VAT FRS not worth it.

And then MTD.

I wonder when they will make tax difficult?

Idiots!

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By ringi
28th Nov 2016 18:36

Why did it take so many years for HMRC to work out why so many IT contractors where going on to the flat rate VAT…… (I could have told them when it first come out, and I worked out what it meant for me!)

Now how many people will start to buy £2K of items to sell on ebay…..

Until NI is combined with income tax, HMRC will just be going round circuits created by people very skilled in understanding complex systems, faster than HMRC can ever change the systems!

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By reilloc
29th Nov 2016 14:46

How do equipment leases fit into this?

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By Platta
29th Nov 2016 17:49

If HMRC think the % are wrong, why don't they just change them ? Why build in yet another check that has to be done, making more work.

Or - why not just rule that a business must go onto standard vat if they don't pass the test, why have another % ?

As we go into MTD, and wider use of software, vat is much easier to cope with, so we don't really need FRS anyway !

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Replying to Platta:
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By towat
06th Dec 2016 10:41

Platta wrote:

Or - why not just rule that a business must go onto standard vat if they don't pass the test, why have another % ?

Because HMRC want small businesses to be able benefit from the admin savings from using FRS.

Or perhaps more accurately they don't want to be accused of discriminating against small businesses.

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Replying to Platta:
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By ringi
07th Dec 2016 10:56

Platta wrote:

Or - why not just rule that a business must go onto standard vat if they don't pass the test, why have another % ?

Think of trying to sort out the mess of doing this 5 years after the fact when a HMRC audit is done (and there are no records of vat) ....

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By carnmores
06th Dec 2016 09:08

DNS stop trying to be clever and stop advertising

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By garethgreen
06th Dec 2016 10:08

Was the draft secondary legislation published on 5 Dec, as promised? I can only find an updated technical note, which makes clear that goods acquired for the purpose of giving them away will not count.

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Replying to garethgreen:
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By paulb
06th Dec 2016 11:08

I think that goods acquired for marketing & promotional gifts does not fit this - can you quote the technical notes, would be good to have a look.

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Replying to noelable:
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By paulb
06th Dec 2016 11:23

If for example you purchased two Ipad's and added marketing to the reverse and sold them for £1.00 to a children's hospital then would this not be okay? Don't see any mention of commercial selling price for goods.

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Replying to paulb:
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By garethgreen
06th Dec 2016 12:30

I think Sir Humphrey would describe relying on this sort of thing to avoid being a low cost trader as being "courageous".

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By garethgreen
06th Dec 2016 17:45

I managed to find the draft legislation:
www.gov.uk/government/publications/draft-legislation-vat-tackling-aggres...

I can’t see any information about how to make submissions under the consultation.

There’s also an Explanatory Memorandum, which explains more about why they felt these new rules were needed:

"Of the 411,000 businesses that use the FRS, we estimate that 123,000 have limited costs. There has been a significant growth in the number of self-employed people registering for and exploiting the FRS. We believe this is due to the aggressive marketing of the scheme by some agents. HMRC received 30,000 extra applications in bulk between January 2016 and August 2016.”

There is also a Policy Paper: www.gov.uk/government/publications/vat-tackling-aggressive-abuse-of-the-...

This says in the Policy Objective section:

"However, where the self-employed, labour only businesses or other businesses with limited costs - register for VAT and use the FRS, this results in a large cash advantage. This is because they use the flat rate appropriate to their trade sector but have significantly lower costs than most small businesses in that sector.”

This seems to suggest that in the various services sectors, most businesses will have lots of purchases of goods, so this new rule is just targeting the few that don’t. Rubbish.

Does anyone know of any firms of accountants, lawyers, IT advisers, engineers or management consultants that have turnover low enough to qualify for the FRS, yet manage to buy enough goods that they are not Limited Cost Traders? Given the turnover limits, we are talking about firms with a maximum of three fee earners. That's a hell of a lot of stationery!

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Replying to garethgreen:
By cfield
06th Dec 2016 18:25

I see they're banging on about so-called "level playing fields" again so it sounds like it's got the dead hand of David Gauke all over it. He always uses that expression when he wants his pronouncements to sound fair and reasonable.

Will HMRC be warning any "customers" who pay more VAT under the flat rate scheme that they are losing out or is it OK for HMRC to make a profit out of it?

What about stock? Does that count as goods for own use given that that stock is necessary to run the business or does the trader specifically have to consume the goods?

If so, are they seriously suggesting that a retailer with low overheads could be moved from their current low flat rate to the 16.5%? That would be perverse. It could easily double their VAT liability.

If not, does that mean we are at liberty to buy goods such as stationery and sell it on at cost or a small discount?

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Replying to cfield:
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By ringi
07th Dec 2016 11:09

cfield wrote:

If not, does that mean we are at liberty to buy goods such as stationery and sell it on at cost or a small discount?

Remember anything you do JUST to save tax can be ignored by the HMRC.
Therefore you would need to sell on the stationery to your clients at a small marginal profit,.

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By Mikolaj
07th Dec 2016 17:34

Why this nonsense from HMRC, if they want rid of the abuse of the flat rate system, then should just abolish it altogether. But for service companies and professionals too, locum doctors working via agencies for instance (12% FRV), they might buy a few hundred pounds worth of equipment/specialist clothing each year, but that's it, HMRC decided on 12% FRV?
Less than 0.01% of the vast majority of businesses from 1 April 2017 obliged to use the new flat rate @ 16.5% could benefit.
Mass and I mean mass vat de-registrations are about to hit HMRC, and the ones that are trading above the vat threshold will simply have to incur greater accountancy costs from full vat accounting. This is an extremely business unfriendly measure.
A better idea would be to change all labour only businesses regardless of business sector to the 14.5% (as in construction), this is not a flat rate that is greatly abused.
The results of this draconian measure will see a huge spike in black market activity and under the counter trading to ensure the vat threshold is not breached.
The exchequer will get less revenue, not more as he might have hoped, a step way too far in my opinion.
HMRC obviously relish shooting themselves in the foot!
Where was the consultation?

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Replying to Mikolaj:
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By garethgreen
08th Dec 2016 10:00

Mikolaj wrote:

Where was the consultation?

The consultation is now. I suggest that readers who have clients on the FRS should make clear to Treasury that this is going to penalise virtually all businesses in certain service company sectors, including businesses that were not making any profit from the FRS (compared with normal VAT accounting).
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Replying to garethgreen:
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By Mikolaj
08th Dec 2016 10:59

This is secondary legislation that comes into force 01/04/2017, regardless of what any of us feed back from this point in time, this legislation will take effect, I can't see them backtracking now.
Feedback is what is sought before forthcoming legislation is announced, and the idea being that such feedback is taken into account when forming the legislation.
I represent CIMA on the Treasury's JVCC in London (Joint Vat Consultative Committee), this issue has not once been mentioned in my time on JVCC.
I believe there is no real intention to consult on this issue from the Treasury or HMRC, just the real intention to 'impose' new rules... as I have said, they will reap what they sew and I shall stipulate this as powerfully as I can next JVCC!

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Replying to Mikolaj:
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By garethgreen
08th Dec 2016 17:49

You may be right that they won't listen, but if we all assume that making submissions is futile and make none, we are just making it easy for them. They can argue there were no objections, so they obviously successfully stopped the "abuse" with no collateral damage.

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By Mikolaj
07th Dec 2016 17:57

"Of the 411,000 businesses that use the FRS, we estimate that 123,000 have limited costs."

This is a woeful estimate by HMRC, I actually believe given many years of experience it is more like 300,000+ of the total of 411,000 which will qualify as limited cost traders. They are all to be shafted and treated like tax dodgers, MANY ARE NOT.

This will have a catastrophic and immediate effect on small businesses throughout the UK & NI.

More bankruptcies and less tax collected, thus more social benefits to pay out.

Change this now HMRC, while there is still time, or reap the business crashing whirlwind it will create, mark my words.

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