The Chartered Institute of Taxation (CIOT) has expressed concern that HMRC’s new measure to crackdown on abuse of the VAT Flat Rate Scheme (FRS) simplification may be ineffective, and bring unwelcome consequences for tax-compliant small businesses.
The FRS, which enables small businesses to pay HMRC a fixed rate of VAT determined by their type of business rather than keep detailed records, has come under fire following allegations of widespread abuse by some employment agencies and similar businesses, which set up thousands of two-employee companies to both benefit from a favourable FRS percentage and NIC employment allowance,
To tackle this issue, during last year’s Autumn Statement the Chancellor announced changes which mean a business that falls into a new definition of a ‘limited cost trader’ during an accounting period will pay a higher 16.5% rate.
If the changes go ahead, businesses using or considering joining the FRS will need to determine, typically quarterly, whether they are also a limited cost trader and, if they are, will pay HMRC 16.5% of their gross sales, rather than a potentially lower percentage applicable to their activity.
Because of the way the limited cost trader is defined, most businesses in the FRS will need to consider whether they fall into its definition during a particular accounting period, and could be caught by fluctuating in and out of the 16.5% rate.
HMRC estimates that 411,000 businesses use FRS, and that approximately 4,000 businesses will move back into standard VAT accounting following the change. However, the CIOT believes far more business will be affected, and that the costs of doing this could be significantly higher than the £180 per annum suggested by HMRC. The proposed changes are also complicated, and could negate the simplification aims of the FRS.
Targeted action – not wholesale changes
While the CIOT accepted that the government must tackle abuse, it believes that the current proposals must be changed to avoid collateral damage to the majority of small traders who do not abuse the system.
Commenting on the changes Peter Dylewski, chairman of the CIOT’s indirect taxes sub-committee, said that targeted action against abuse of the FRS is preferable to wholesale changes.
“We are concerned that HMRC has significantly underestimated the collateral impact of these changes, both in terms of the number of businesses affected and the financial impact”, said Dylewski.
The CIOT has urged HMRC to rethink its view that existing legislation and legal principles cannot be used to tackle abuse of the measure, and suggested that HMRC further investigate alternative approaches, such as to restrict the FRS to businesses required (rather than eligible) to be registered for VAT, or tighten up the associated business rule.
“HMRC will face difficulties building in effective anti-tax avoidance measures to prevent traders side-stepping the new measure, for instance by buying and selling small amounts of goods to take them over the limited cost trader thresholds”, said Dylewski. “We strongly suspect gaps will remain in the legislation and will be exploited, and we are also concerned that some users might simply ignore the changes, and just liquidate any businesses subsequently assessed by HMRC.”
The CIOT also believes that the changes are likely to cause administrative problems for FRS users. Any business which might fall within the definition of a limited cost trader will need to check its position for each VAT accounting period using a planned online tool on Gov.uk.
To effectively use the online tool, the business will need to know the value of its purchases of goods during that period, effectively meaning that the business will need to have recorded most of its transactions during that period anyway, thus negating some of the simplification elements of the FRS.
“The proposed changes add a significant level of complexity on small business owners who will need considerable guidance from HMRC”, said Dylewski. “Many will have to pay for additional accounting advice. One of the main challenges will be for businesses to understand whether they have acquired goods or services, which is often unclear for expenses such as computer software, electricity and gas and professional subscriptions.”
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