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Small businesses may suffer from VAT abuse crackdown

17th Feb 2017
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Walnuts and hammer on the table

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.”

Administrative problems

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

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.”

Replies (18)

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Chris M
By mr. mischief
18th Feb 2017 11:49

The Numpty Department came up with this one, and predictably so far its impact on my 50 or so affected clients has probably been nothing like what HMRC expects.

10 or so have discussed it with me. 3 are de-registering, the benefit to them of FRS was small beer. 4 are taking the hit on 16.5% or going to standard VAT.

Of the rest, some new sectors are being attacked: trading in computer parts, stationery, walking poles and farming implements. I expect to see a diverse range of trades going through the accounts in the coming year.

Idiots at HMRC! You really despair of them.

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Replying to mr. mischief:
By Ruddles
18th Feb 2017 12:38

I'd be wary about setting up new 'trades'. HMRC have hinted that they are aware of some of the 'solutions' doing the rounds and have said that the legislation will need to be tweaked to take care of them. Don't be surprised if different FRS rates have to be applied to different income streams, with cost of goods also being streamed.

But you're right - the whole thing is idiotic. FRS was set up to simplify matters for small traders. In theory, EVERY FRS user will now need to keep a detailed track of their expense categories and perform the quarterly (or annual) calculations to check whether or not they are a low-cost trader for the period. In one fell swoop, HMRC have effectively removed the very simplification that FRS was supposed to bring, so they may as well scrap the Scheme.

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Chris M
By mr. mischief
18th Feb 2017 14:55

Don't worry I'll be looking closely at exactly how the final legislation is worded.

Thanks (1)
By Paul Scholes
19th Feb 2017 17:54

Expanding on the Admin problems above, as discussed on the thread below, this is going to be a nightmare for some accounting systems, especially those that record the FRS VAT liability as each invoice is raised, with the worst scenario occurring under the cash basis, where an invoice is paid in a quarter with a different FRS rate to the one in which the invoice was raised.

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By free-rider
20th Feb 2017 09:00

You can`t deny that some agencies and financial service businesses have abused FRS for years and it was mainly these agencies who got the most financial benefit of FRS and not the actual small businesses they represented.

HMRC needed to do something about this - “limited cost trader” category should actually hit the abusers, but it will also inevitably bite some other small businesses too. Collateral damage.

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Replying to free-rider:
By johnacarpenter
02nd Mar 2017 16:41

The excess of VAT will be taxed as profit at 20% corporation tax.
All that's happening is that Corporation tax is being renamed VAT.
Total waste of time, make things simpler for the trader and the tax man.

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By ireallyshouldknowthisbut
20th Feb 2017 15:52

As I have been posting for several months, virtually every one of our FRS clients will be coming out as it hits every small service business and we don't do "stuff" businesses.

It hits every single service business on our books, including us unless there is a proper redraft.

I have already booked the last week in March just to deal with all the paperwork of pulling all our clients out, on the assumption HMRC don't budge on the issue.

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Replying to ireallyshouldknowthisbut:
By eppingaccountant
24th Feb 2017 11:30

Zero chance of HMRC budging on this issue.

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Andy Cliff
By AndySCL
24th Feb 2017 10:41

In our business, we use the FRS scheme and I have worked out that we spend around £7K/annum on VAT-able supplies which cover a myriad of things but are mainly services (eg accountant, IT support, phone and web related) and what puzzled me is that the website says there would be an 8 week consultation period for businesses to provide feedback but there was no detail on process/contact info. Can anyone also advise why only "goods" are allowed in the limited cost trader calculation and what is actually meant by "goods" within the new rules for FRS? I called VAT helpline in Dec and put these questions to them, they knew nothing about FRS changes and said to send written (no phone number offered) feedback to:-
HM Revenue and Customs - National Registration Unit
Imperial House
77 Victoria Street
DN31 1DB
United Kingdom
I can understand why HMRC would want to exclude ultra-low cost businesses from the FRS however I don't understand why VAT-able services aren't seen as true costs to a business. Furthermore, this is going to add more complexity and work to the tasks we all face when running our SMEs. We will either jump in and out of the FRS quarter by quarter or have to do a more involved VAT standard return. What was it David Cameron said about reducing red tape....? Why can't government target the abusers as mentioned above rather than cause the 90+ percent of compliant businesses who use the scheme as intended? The answer is, few people in government have ever run a business.

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By lavalamp
24th Feb 2017 10:42

This is going to affect me as well as some of my clients - can anyone tell me when we will know for sure that it's definitely happening from 1st April - I need to deregister some and move to standard vat for others, but have been holding off

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By RogerMT
24th Feb 2017 11:03

The article says "if the changes go ahead" - is it still a possibility it will not go ahead?

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By [email protected]
24th Feb 2017 11:14

Most of my clients pay for services, rather than goods, and thus will be caught by this new rule. They weren't 'abusing' the scheme, they were using it as it was laid out in law.

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By david wilks
24th Feb 2017 11:22

How can MTD work with the less detailed records for FRS? This is a nail in the coffin for FRS. Whilst there can be benefits for FRS users on a proper basis at the end of the day 20% is collected on sales and detailed records maintained to claim 20% input tax. The difference is paid over to HMRC. No fiddling about amending turnover. Am I missing something?

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By sallyrichardson
24th Feb 2017 12:11

For clients that can, and that purchase goods but with major peaks and troughs through the year, we have suggested the annual accounting scheme, so that as long as their goods % is OK across the whole year they will be OK. Surely there is a better way to identify these 2 man companies that are profiting from the FRS? Could they not disallow them from using the FRS if they get any more than 60% of their income from one company? We all know these companies are usually invoicing 1 or 2 clients all year...??? Yes this could still be worked around, but not as easily...

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By kevinringer
24th Feb 2017 13:00

It hits all my FRS clients. I don't expect to have any in FRS after 01/04/17.

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By raybackler
24th Feb 2017 13:53

We have 14 FRS clients and my best guess is that only 2 will stay in the scheme after 1st April. I have yet to agree with each of the affected 12 how we will process the VAT on their costs. As most are consultants it will inevitably relate to travel expenses. If we have to process a myriad of small subsistence bills each month, then it will cost more money. I think I am going to recommend that they use the Flat Rate Expenses allowance and we just have to determine the level. That way I can keep my fees at the same level. Just needs an exercise for each client to determine the level of the Flat Rate claim, if they habitually spend less than £10 per day.

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By RobertD
25th Feb 2017 10:54

The FRS scheme was one of the reasons put forward for difficulties with MTD. After these changes HMRC will defend this argument by saying there are only X businesses still in the scheme. Am I being cynical but all roads appear to point towards digital.

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By trecar
25th Feb 2017 15:34

If I remember correctly when self assessment was introduced the claim from HMRC was that most small businesses would be able to manage without an accountant. We are also told that IT changes would make accountants superfluous. Perhaps, and I may be incorrect here, HMRC are actually making the system more complex in order to safeguard the existence of the accountancy profession!!

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