VAT: Flat rate scheme saves the dayby
The VAT savings were largely eroded when the FRS rules were changed in 2017, but it can still produce some winning outcomes. Neil Warren explains how the scheme has solved a big VAT challenge.
Limited cost trader category
Like many accountants, I saw the introduction of the ‘limited cost trader’ category on 1 April 2017 as the death knell for the flat rate scheme (FRS). The draconian rate of 16.5% and the complicated rules about what is classed as ‘relevant goods’ were a winning combination to deter users and end the VAT windfalls that had been enjoyed by many service-related businesses since 2003 when it was first introduced (VAT Notice 733, para 4.4.)
But the scheme is a bit like an aging cricketer whose best days are behind him – it can sometimes produce a spectacular innings to revive a flagging career.
My private client Sue has a dilemma: her limited company has two sources of income and is not VAT registered:
- Rental income from letting out a holiday cottage in the Lake District – £30,000 a year;
- Management consultancy income for business clients.
Sue was persuaded to take on a lucrative consultancy contract back in February and the company’s rolling 12-month sales have now exceeded the £85,000 VAT registration threshold. There will be no problem charging 20% VAT on her consultancy work because her client can claim input tax. But she doesn’t want to lose one sixth of her rental income by paying VAT, an annual bill of £5,000. Neither activity has much input tax to claim.
Flat rate scheme to the rescue
The best solution is for Sue to register her company for VAT - she has no choice - but also apply to join the FRS from her first day of registration.
The company will charge her consultancy clients £24,000 VAT each year because her annual fees will be about £120,000. If she applies to join the FRS, her company’s relevant flat rate percentage will be 14% for ‘management consultants’. This rate will also apply to the rental income because the rate for a business is wholly based on the activity with the greater or greatest percentage of turnover.
The day-to-day spending on the cottage means the company has no risk of falling into the limited cost trader category of 16.5%.
To summaries the numbers are:
- £120,000 fees + £24,000 VAT + £30,000 letting income = £174,000 gross income x 14% flat rate = £24,360 annual VAT payment to HMRC;
Sue’s company has only lost £360 by being VAT registered; £24,360 paid to HMRC less £24,000 collected from her consultancy client. This is a much better result than the £5,000 annual VAT loss she feared.
Two FRS bonuses
But the situation gets even better:
First year discount
In its first year of VAT registration, Sue’s company will get 1% discount on its flat rate percentage i.e., 13%. This saves an extra £1,740 of VAT for 12 months.
Pre-registration input tax
The company purchased the holiday cottage in 2018 and spent about £20,000 plus VAT on fixtures, fittings and furniture. These items are still owned and because they were purchased less than four years ago, it can claim £4,000 input tax under the pre-registration rules on its first VAT return. A quirk of the FRS is that users can claim pre-registration input tax in the same way as a non-scheme user.
There is no good news for Sue about the extensive building work the company paid for in 2018: pre-registration input tax claims for services are capped at six months before the registration date and building work (including building materials) is a service.
The flat rate scheme has solved Sue’s dilemma. The numbers have worked out well and her company will actually be better off being VAT registered because of the £5,740 windfall with the two scheme bonuses.
The key message is that the FRS can still produce some winning outcomes, although I still believe it should be abolished!