VAT flat rate scheme: End of an era

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Neil Warren shares his thoughts on the new category of “limited cost traders” who will use FRS percentage of 16.5% from 1 April 2017.

Shock announcement

The alteration of the VAT flat rate scheme (FRS) categories to include a ‘limited cost trader’ has been widely criticised by advisers. Those businesses will be required to use the FRS percentage of 16.5%, which will affect a large number of honest traders, although the aim of the new rate is to supposedly tackle aggressive abuse of the scheme by labour-only agency workers.

The new category will be introduced by secondary legislation and will represent a major change to 123,000 FRS users, according to HMRC.

The impact

HMRC issued a policy paper on the proposed changes titled “VAT: tackling aggressive abuse of the Flat Rate Scheme”. This paper recognises that the new rate “will remove the cash advantage for those businesses with limited costs”, i.e. all businesses are affected and not just the supposed tax avoiders.

It also revealed some interesting statistics:

  • The new limited cost trader category will increase the annual tax yield by £130m
  • Two thirds of FRS users are registered for VAT on a voluntary basis (annual taxable sales are less than £83,000) and HMRC anticipate that the new category will mean that “many of them may decide to deregister”
  • The limited credit for input tax that is evident with the 16.5% rate means that an estimated 4,000 FRS users will revert to normal VAT accounting, i.e. output tax less input tax
  • HMRC quote an average figure of £390 in cost savings for a business that chooses to deregister after 1 April 2017

What does the change mean?

Everyone agrees that the new 16.5% category will not assist the ‘simplification’ aims of the FRS. Life will definitely get more complicated.

A business will check its actual spending on goods each quarter and identify whether it can submit the return based on its normal trade sector category (e.g. accountant 14.5%, other services 12%) or whether its VAT inclusive expenditure on ‘goods’ is less than 2% of its gross sales or £250, and the 16.5% rate will therefore apply.

For the definition of goods; vehicles, road fuel and motor parts are excluded (unless the expense relates to a transport business such as a taxi firm), as well as food, drink and capital goods. Supplies of gas and electricity are classed as goods and included in the calculation, whereas rent, telephone and Internet charges are services, and so are excluded.

Example 1

For VAT quarter ending 30 June 2017, an accountant had gross sales of £10,000 including VAT. His VAT inclusive spending on qualifying goods for the same period was £240. The business must adopt the 16.5% rate and pay £1,650 of VAT if the £240 spending on goods is:

  • Less than 2% of sales (£10,000 in my example ie £200)
  • Less than £1,000 a year i.e. £250 in a quarter

So a total goods figure of £240 including VAT passes the first bullet test but not the second – so the 16.5% rate must be adopted.

Quarterly review?

A question I have been asked is whether a business must review its actual spending on goods for each VAT quarter after April 2017, as in my example, or whether it only reviews the relevant rate on an annual basis. The answer is that it must be reviewed at the time each VAT return is completed; ie on a period by period basis.

The technical guidance was updated on 5 December 2016. This guidance (which is not law) adds an extra layer of complexity by saying that only goods with 100% business use can be included in the 2% calculation. So an electricity bill with part business and part private use is excluded completely. This is supported by the draft legislation, which refers to an expense being "used by a flat rate trader exclusively for the purpose of the trader's business."

What about builders?

The FRS already has a ‘goods’ twist for builders (or building materials to be precise). If a builder spends more than 10% of his gross turnover on materials, he can use a lower FRS rate of 9.5%. If the material purchases are less than this figure, the FRS rate is 14.5%.

The new 16.5% rate means that if the material purchases (plus spending on other goods) are also less than 2% of total sales or more than 2% of total sales but less than £1,000 a year, the builder must apply the 16.5% rate. Of course a newly VAT registered builder will also get a 1% discount on his relevant category in his first year of registration.

If my calculations are correct, a builder might end up with one of six different FRS rates: 8.5%, 9.5%, 13.5%, 14.5%, 15.5% or 16.5%. So much for simplification.

Example 2

Bob the builder registered for VAT on 1 January 2017 and joined the FRS on 1 April 2017. So he qualifies for a 1% discount on his chosen FRS category until 31 December 2017, i.e. his first year of VAT registration.

The only goods Bob buys in his business are building materials. In the VAT quarter ended 30 June 2017, his material purchases were 15% of his gross sales so he used the FRS rate of 8.5%, i.e. 9.5% less 1% discount.

In the following quarter, his material purchases were only 8% of total sales, so he used the rate of 13.5% i.e. 14.5% less 1%. But in the quarter ended 31 December 2017, he only supplied labour (0% material purchases) so he applied the rate of 15.5% ie the new rate for limited cost traders less his 1% discount.

In 2018, his material purchases were again 15%, 8% and 0% of total sales in the first three VAT periods of the year, so he applied FRS rates of 9.5%, 14.5% and 16.5% in these periods.

Bob has been required to use six different FRS rates in his first six quarters of VAT registration.

Conclusion

HMRC’s policy paper confirms that an online tool will enable current and prospective FRS users to determine whether they must use the new rate, which is very welcome. But I suspect that many current users will either deregister or revert to normal VAT accounting.

On refection, I have the same thoughts regarding FRS as fellow Manchester United supporters did when Sir Alex Ferguson retired as manager in 2013: “We’ve had a good run… but nothing lasts forever.”

This article has been amended following the release of the draft VAT regulations and explanitory notes.

About Neil Warren

Neil Warren

Neil Warren is an independent VAT consultant and author who worked for Customs and Excise for 14 years until 1997.

Replies

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07th Dec 2016 17:22
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to garethgreen
08th Dec 2016 09:38

Did you find the draft legislation on 5th Dec? I looked very hard and couldn't find it anywhere. I have a sneekign suspicion it wasn't posted on Gov.uk until 6th or 7th

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to Rebecca Cave
08th Dec 2016 09:52

taxwriter wrote:

Did you find the draft legislation on 5th Dec? I looked very hard and couldn't find it anywhere. I have a sneekign suspicion it wasn't posted on Gov.uk until 6th or 7th

I found it on the 6th, but this was not because it suddenly sprung up where I had previously looked. I decided it must have been released, so I hunted round the nooks and crannies of the gov.uk website til I found it. One would almost think that they did not want it to be spotted!

It is dated 5 Dec, so I assume that's when they published it, but I can't say for sure.

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to Rebecca Cave
08th Dec 2016 10:34

I can confirm that the draft legislation was available on 5th December. I viewed it at around 2.30pm on Monday. I found it using Google, so it must have been posted some time before that.

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to Tim Vane
08th Dec 2016 11:17

Neil Warren has now amended his article above having read the draft regs. We do apologise for not finding the draft legislation before today. I restorted to asking HMRC.
The HMRC policy team replied saying " Thank you for highlighting the difficulty in finding the information, we are working with gov.uk to improve the signposting."

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to Rebecca Cave
08th Dec 2016 11:29

All they had to do is include it in the package of other documents linked on the Autumn Statement webpage.

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By RobertD
07th Dec 2016 17:42

4,000 is a gross underestimate made by some herbert analyst at HMRC who has no real clue of the real world. Just the same as the rest of HMRC and the government for that matter.
Again, businesses will be the losers in this.
MTD, AE, dividends tax and now FRS.
I as an accountant must stop using the scheme so by that rational I must be one of the aggressive abusers.
I think I make £26 per £1,000 from FRS. I have telephone, £6k of software, stationery and equipment to pay for.
How on Gods earth am I abusing this scheme.

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to RobertD
07th Dec 2016 19:02

Lay off those herberts RobertD!

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By RobertD
to TomHerbert
08th Dec 2016 07:08

TomHerbert wrote:

Lay off those herberts RobertD!

Sorry Tom, I should have gone with the expletive I first thought of.

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to RobertD
08th Dec 2016 08:44

Herberts?

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to RobertD
08th Dec 2016 09:22

Not a problem :-) Growing up in an era where the Beano used my surname as an insult on a weekly basis I got used to it fair quickly. In a strange way it's nice to see it back.

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to TomHerbert
12th Dec 2016 11:38

I worked for Herbert Refrigeration for 8 years and used to mutter it under my breath when people asked me where I worked!

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to RobertD
12th Dec 2016 11:15

"estimated 4,000 FRS users will revert to normal VAT accounting?"

I have 40 on my books alone, and I have already told them to revert as at 1 Apr 2017! Most of those 40 are over 83K and have to be VAT registered. So just one practice already represents 1% of that HMRC estimate!!

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to proactivepaul
12th Dec 2016 11:37

I have 15 Flat Rate clients and I estimate only two will stay in the scheme, so that is 13 for me. I can't see the figure being as low as 4000 - more like 40000 - and that is likely to be understated.

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07th Dec 2016 18:02

I'd be surprised if there are any businesses that are currently using the flat rates for sectors like accountants, lawyers, IT consultants, and management consultants that will be able to continue doing so. A handful, at most.

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07th Dec 2016 20:02

My own view is that HMRC have a Numpty Department. To make the cut in the recruitment process, you must be assessed with an IQ less than 100.

In my view, the Numpty department brought us false self-employment, the pasty tax and now the FRS nonsense.

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to mr. mischief
12th Dec 2016 11:45

I find that comment quite offensive.

Best,

Dave Numpty

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08th Dec 2016 10:49

Can't say I'm impressed by this idea. I market to my clients that they can make money by using the flat rate scheme and then charge them for doing the VAT returns so I get most of that extra money.....

Now its just not worth doing with the new 16.5% rate.

Bill a customer £1,000 + VAT and pay over £198 instead of £200 using the new rates and forego the input VAT, no thanks......

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08th Dec 2016 12:28

(a) “relevant goods” are goods used or to be used by a flat-rate trader exclusively for the purposes of the trader’s business".

What does it mean 'used'? This suggests that the goods need to be consumed by the trader. If I am a retailer, the goods I buy as stock are sold to the customer as new, not used. Even worse if I am a retailer of vehicle parts as I am not within one of the exceptions in (3)(a)(i).

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to jon_griffey
08th Dec 2016 14:14

jon_griffey wrote:

(a) “relevant goods” are goods used or to be used by a flat-rate trader exclusively for the purposes of the trader’s business".

What does it mean 'used'? This suggests that the goods need to be consumed by the trader. If I am a retailer, the goods I buy as stock are sold to the customer as new, not used. Even worse if I am a retailer of vehicle parts as I am not within one of the exceptions in (3)(a)(i).

It means "take, hold, or deploy (something) as a means of accomplishing or achieving something" So, it must be goods that you use by reselling them or by employing them to carry out the business activity (eg, paper to write on)
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08th Dec 2016 14:34

Am I missing something here? HMRC call use of "other business" category of 12.5% FRS rate as "abuse" but it was just a very poorly drawn up proposal, not fraud by those that use it.

Also, I was under the obviously disingenuous impression that FRS was about simplification?!. How will MTD cope with this change?

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to rockallj
08th Dec 2016 18:03

The "abusers" are the businesses that simply bill 40 hours a week to the same client and who have no virtually no costs, so would have virtually no input VAT. They have apparently been registering voluntarily, just so they can use the FRS to make a profit on VAT.

Whether this is abuse is a matter of opinion, but it was not the intended use of FRS, so it is difficult to object to HM Gov putting a stop to it. The problem is that by basing the test around purchases of goods, they are penalising service businesses that do have a whole range of costs, albeit not in relation to goods. I encourage everyone to make submissions saying the test should be redesigned to minimise the collateral damage.

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08th Dec 2016 21:05

So what about an accountant that uses the scheme he pays xero and receipt bank subscriptions on behalf of his clients then recharges them as part of his fixed fee proposal.

Are they classed as goods that are been resold to your clients and form part of the calculations.

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to Glennzy
09th Dec 2016 08:34

Glennzy wrote:

Are they classed as goods that are been resold to your clients and form part of the calculations.

Things that are not tangible are not goods.
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By NH
to Glennzy
13th Dec 2016 08:34

Surely as a cost of sale, that would be goods, but that would be too simple

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to NH
13th Dec 2016 09:26

It is nothing to do with cost of sale. If I buy writing pads to take notes, they are not a cost of sale, but they are goods.

If an accountant pays a tax adviser for specialist advice in relation to a client and rebills the client as a disbursement, the fees paid to that tax adviser would be a cost of sale for the accountant. That does not mean the tax advice is goods. It is a service.

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By NH
to garethgreen
13th Dec 2016 09:35

but we are talking about buying software and then reselling it, we are not talking about buying in a service (but then SAAS - is it software or a service)

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to NH
13th Dec 2016 10:50

Software is sometimes a service and sometimes goods. But what determines this is not whether it is a cost of sale.
http://www.taxadvisermagazine.com/article/goods-or-services

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09th Dec 2016 11:15

"If a builder spends more than 10% of his gross turnover on materials, he can use a lower FRS rate of 9.5%" in the main article.
Is this legislated somewhere or are there guidance notes? I hadn't spotted this as a rule before. I think most of my clients are clearly subbies with no costs (caught by new rules) or builders spending lots (well over 10%) on materials but I'd like to make sure I have this right if anyone can point me to more info please.

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By mumpin
to accountantccole
09th Dec 2016 14:36

Look at FRS7300:
General building vs Labour only building.

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By cfield
to fawltybasil2575
12th Dec 2016 10:47

The FRS has been around since 2002 and it was common knowledge even then that it was a money-spinner for firms with low overheads. Has it really taken the Government 14 years to cotton on to this fact? Why are they only doing this now? Is it all part of their obsession with so-called level playing fields?

They're the ones who set the rules. Everybody else has played to those rules without doing anything dodgy (except maybe choosing 12% when they shouldn't have but that was their own fault for not having enough categories) and now they cry foul and accuse anyone who was better off under the scheme of aggressive abuse. Did they really think people would join the scheme if it cost them more money?

It's the typical reaction of incompetent bureaucrats who try to blame everyone else instead of admitting to their own mistakes. It's also a typical sledgehammer to crack a nut.

Stationery firms must be rubbing their hands with glee, as their products are pretty much all that qualify for the 2% under these rules for most non-retail firms.

In fact, you are better off stocking up on stationery you will never use as the cost will be outweighed by the VAT saved (assuming you can find somewhere to put the ever-growing piles of boxes). Doesn't sound too good for the environment, does it, when we're all supposed to be going paperless. I bet they didn't mention that in the impact assessment.

So stock counts so long as it is for running a business. I wonder how they will judge that. Does it have to be your principal activity or can you have a nice little sideline selling all the spare stationery at a small margin? Do we have to advertise it as an ongoing activity? I can see a few disputes on the horizon on those lines.

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12th Dec 2016 10:43

Having done the sums myself I agree with Basil's point, if a business is currently on the 12% rate, as so many are, then it is more efficient to buy £250 worth of, say, stationery and remain on that rate than to switch to the 16.5% rate.

What an odd bit of legislation. I suppose it means there'll be contractors everywhere stockpiling paper, pens and buying a new laptop every nine months.

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By cfield
to Duggimon
12th Dec 2016 10:53

Duggimon wrote:

What an odd bit of legislation. I suppose it means there'll be contractors everywhere stockpiling paper, pens and buying a new laptop every nine months.


Laptops won't count. They are capital goods as they last more than a year (unless you go to a "world" famous firm where you are almost guaranteed having to take it back after a few months, and then wait another few months for your money back).
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12th Dec 2016 11:11

The Scheme was total madness anyway, a bit like the 0% corporation tax rate. If HMRC psychos stopped implementing hair brain ideas they wouldn't have to keep patching before complete abolition. No body enters the VAT flat rate scheme because it's simple.

Does anyone know how I get a spell check thingy to work on this page?

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to The Black Knight
12th Dec 2016 13:48

Type it in an offline medium that supports a spell-checker eg Word/email system/Notepad and then cut and paste into this website. This method also avoids frustration if, having been typing for some time, the internet connection breaks and you lose your post text.

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By cfield
to The Black Knight
12th Dec 2016 16:36

The Black Knight wrote:

The Scheme was total madness anyway, a bit like the 0% corporation tax rate. If HMRC psychos stopped implementing hair brain ideas they wouldn't have to keep patching before complete abolition. No body enters the VAT flat rate scheme because it's simple.

Does anyone know how I get a spell check thingy to work on this page?


Unfortunately the Word spellchecker isn't going to alert you that it's hare-brained, not hair-brained. Something to do with mad March hares I guess. Mind you, you could have got away with hair-brained once, back in the 1500s, when hair was an alternative spelling for hare.
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to cfield
12th Dec 2016 16:48

ha ha . I never even knew the origin of the expression so will have to claim complete ignorance. I always pictured Ken Dod's hair

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By cfield
to The Black Knight
13th Dec 2016 09:45

The Black Knight wrote:

ha ha . I never even knew the origin of the expression so will have to claim complete ignorance. I always pictured Ken Dod's hair


No, you're thinking of bad hair day.
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12th Dec 2016 11:30

How is it abuse to use rates that HMRC has set and to use a scheme that HMRC has encouraged?

It's gone from one extreme to the other, most of HMRC's 'customers' will getting 0.5% VAT benefit (less any actual input VAT they incur) if they continue to use FRS and will face additional accountancy costs if they don't.

As usual it is Britain's small businesses that are getting screwed, being squeezed until the pips squeak. Never mind, they only support the economy and they have the big savings MTF to look forward to (Freudian slip, I meant Making Tax Digital, not Making Tax Farcical, easy mistake to make).

Then to cap it all they will be paying more tax on dividends and if there is anything left to save they can opt for near zero savings rates or can be screwed again on alternative investments such as BTL, losing wear and tear allowance and mortgage interest relief if they have the misfortune of being in the artificial situation of having their rental income before interest being added to other income, making them 'higher rate taxpayers' for property income purposes and then losing tax relief on their mortgage interest. It's probably making them wonder if it is worthwhile doing all the unpaid administration of VAT, PAYE, etc for the Government, in addition to often working 40+ hours a week to try and make ends meet. Maybe the Dole is the way to go.....

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12th Dec 2016 11:31

I sure hope everyone uses bookkeeping software that can cope with your flat rate percentage changing each quarter!

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12th Dec 2016 11:36

Am I missing something? If an accountant with £100,000 of gross turnover was to buy a posh handbag (say for £2,500) and then resell to his partner for say £2,600 (£100 handling charge), that would satisfy the 2% rule. I know it's a bit of sham, but ...... it satisfying the rule. Doesn't it?

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to paulinleeds
12th Dec 2016 11:57

paulinleeds wrote:

Am I missing something? If an accountant with £100,000 of gross turnover was to buy a posh handbag (say for £2,500) and then resell to his partner for say £2,600 (£100 handling charge), that would satisfy the 2% rule. I know it's a bit of sham, but ...... it satisfying the rule. Doesn't it?

The point you are missing there is getting a woman to pay you will have to bill her husband. Ha and HMRC thought they had thought of everything.

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12th Dec 2016 12:01

Why don't they just get rid of the flat rate scheme?

Vat would then work how it was supposed to. doh

It's as if HMRC has ego issues.

In fact why don't we return to a system before they broke it.

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12th Dec 2016 12:07

So what about HMRC compliance check costs.

Checking a client is using the correct FRS rate is quite simple, if everyone reverts to standard VAT calculations how will they police this, or do they aim to recover the costs through fines, penalties and interest for wrongly reclaimed input VAT?

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By fmuk
12th Dec 2016 12:12

The secondary legislation reads:
‘relevant goods’ are goods used or to be used by a flat rate trader exclusively for the purposes of the trader’s business but excluding the following:
1 vehicles ,vehicle parts and fuel
2 food and beverages
3 capital expenditure goods

Where does it mention that supplies of gas and electric are classed as goods, whereas rent, telephone and internet are excluded. What about software, advertising (in the paper), professional subscriptions, insurance, CPD costs etc?

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By masont
12th Dec 2016 12:14

given the reaction to this "simplification", why do HMRC not just cancel FRS altogether? you are then either caught by VAT or not, depending upon turnover

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12th Dec 2016 12:58

The main problem for all the so called fiddling (not that most are) is that not all business have to be vat registered. In my opinion, all self employed should be , people fiddle their turnover, take cash to avoid the vat limits , this is what needs changing. We are just running a so called simple business, and are now going to probably revert back to standard vat, with more accountancy fees! or i start spending more.............. and therefore reduce my profit hmmm......

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12th Dec 2016 15:34

"HMRC regrets to announce the cancellation of the VAT Flat Rate Scheme Gravy Train service"...

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13th Dec 2016 10:10

Politicians have yet proven again they have no clue what's however of the real work. As for HMRC? Expletives are not allowed on this forum.

I joined the FRS scheme because it was simple and I could procrastinate entering my little expenditure slips. Now with MTD and FRS gone I must act like a corporate again when doing VAT. Grrrr....!

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By fmuk
13th Dec 2016 10:13

Accountant/Architect/Lawyer or Legal Services plus many other trades:
Costs include Rent/Rates/Insurance/Professional subs/Software/Telephone & internet/Stationery & Printing/Advertising/Staff etc etc
Hardly a limited ‘cost’ trader.

Self Employed salesperson:
Costs, Fuel and subsistence and mobile phone
This is a limited ‘cost’ trader.

I believe any fair-minded layperson would assume the above to be true.

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