I am writing to make you aware of the new rules set out by HMRC which were announced by the Chancellor of the Exchequer on 23rd November 2016 regarding a new 16.5% VAT flat rate scheme for businesses with limited costs. This change will come into effect from 1st April 2017.
Background
The VAT Flat Rate Scheme (FRS) is a simplified accounting scheme for small businesses. Currently, businesses determine which flat rate percentage to use by reference to their trade sector. From 1 April 2017, FRS businesses must also determine whether they meet the definition of a limited cost trader, which will be included in new legislation. For some businesses - for example, those who purchase no goods, or who make significant purchases of goods - this will be obvious. Other businesses will need to complete a simple test, using information they already hold, to work out whether they should use the new 16.5% rate.
Businesses using the FRS will be expected to ensure that, for each accounting period, they use the appropriate flat rate percentage.
How does the VAT FRS work?
Under the FRS, an invoice for £2,000 would have 20% VAT added - £400. Under current rates, many contractors would then deduct VAT at 14.5% from the £2,400 received; meaning £348 is paid to HMRC.
With the new rate at 16.5%, a limited cost trader would pay £396 to the taxman, an almost identical fee to that charged to the client. "The key point is you are paying over the large majority of the VAT that you are collecting,”
“Most contractors will have made a subsidy out of the flat rate scheme, so they benefit from having simplicity and a surplus. But because 16.5% is so close to the amount of VAT you are collecting, contractors will definitely be worse off than they were under the old rules.”
What is a limited cost trader?
A limited cost trader will be defined as one whose VAT inclusive expenditure on goods is either:
- Less than 2% of their VAT inclusive turnover in a prescribed accounting period
- 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)
Goods, for the purposes of this measure, must be used exclusively for the purpose of the business but exclude the following items:
- Capital expenditure
- Food or drink for consumption by the flat rate business or its employees
- 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)
Examples
Goods must be used exclusively for the purpose of the business - this means that you must not include the cost of any goods that are used in full or in part for your own private use. For example, printer ink and stationery that are used for both your office and your home would not be included. It would also exclude goods acquired with the intention of giving them away or donating them to a third party.
Capital expenditure - is the cost of any goods which are bought to be used in the business over a period of time (for example, longer than a year). Examples include equipment such as a computer, mobile phone, office furniture, a tablet or a printer, even if they are not necessarily treated as capital assets for accounting purposes. The legislation that describes capital expenditure goods can be found in VAT Regulations 1995, 55A (1).
These exclusions are part of the test to prevent traders buying either low value everyday items or one off purchases in order to inflate their costs beyond 2%.
How contractors can plan for the VAT FRS changes
The most suitable approach will depend on your current spend on VAT-able goods.
However, making additional purchases simply to clear the 2% mark won’t necessarily benefit your business.
“If you already spend 1.9% of your turnover on stationary, for example, it would be worth spending a bit more – providing it’s genuine – to then make significant savings.
“It’s unlikely those very short of the 2% will find increasing their spend on goods to be worthwhile. Each cost has to be a genuine business expense, and what’s not yet clear is whether benefits in kind will count. HMRC is due to consult on the measures in before April 2017 where there will be some clarity.”
Anti-forestalling provisions
Paying or invoicing in advance to avoid an increase in tax is known as forestalling. Anti-forestalling legislation was published on 23 November 2016. It is designed to prevent any business defined as a limited cost trader from continuing to use a lower flat rate beyond 1 April 2017.
This will affect a business that supplies a service on or after 1 April 2017 but either issues an invoice or receives a payment for that supply before 1 April 2017.
When considering the limited cost trader definition, any such supply must be treated, for VAT purposes, as taking place on 1 April 2017. Any invoice or payment that covers continuous supplies of services that cross this date must be apportioned.
Example of affect after FRS scheme changes
How to respond to the VAT FRS changes
If your business generates less than £83,000 per year and you are voluntarily VAT registered, de-registering is a potential option, however, we advise communicating with your contracted agencies to ensure they are aware of your intentions and such decision complies with their contractual requirements with you. If you must remain VAT registered, after assessing the expenses which your company incurs, you do not expect to claim more than £226 in VAT then it will be advisable to remain in the flat rate scheme.
Alternatively, another option is to revert to the traditional method of calculating VAT, but recording VAT collected and paid out, then paying the difference on a quarterly basis on the assumption that the VAT to be claimed from your expenses exceed the flat rate saving of £226.
Effect on your business
We have analysed your income and expenditure information which we have on file from production of previous VAT returns and have reached the conclusion that the changes in rules relating to the flat rate scheme will affect your business and cause the VAT rate payable to HMRC each quarter to increase to 16.5%.
This is because, from the total annual expenses which you incur normally, your quarterly expenses which are exclusively for the purpose of your trade, is less than the required 2% of your VAT inclusive turnover.
This change will substantially reduce your flat rate scheme savings. If you have regular VAT inclusive expenditures that are paid each month or quarterly, then please provide us with this information to allow us to reassess your VAT position.
Following review of this letter, please can you provide us with your feedback regarding your choice of action following implementation of this new VAT rule.
Changes by HMRC in VAT Flat Rate Scheme
We are writing to make you aware of the new rules set out by HMRC which were announced by the Chancellor of the Exchequer on 23rd November 2016 regarding a new 16.5% VAT flat rate for businesses with limited costs. This change will come into effect from 1st April 2017.
Background
The VAT Flat Rate Scheme (FRS) is a simplified accounting scheme for small businesses. Currently businesses determine which flat rate percentage to use by reference to their trade sector. From 1 April 2017, FRS businesses must also determine whether they meet the definition of a limited cost trader, which will be included in new legislation. For some businesses - for example, those who purchase no goods, or who make significant purchases of goods - this will be obvious. Other businesses will need to complete a simple test, using information they already hold, to work out whether they should use the new 16.5% rate.
Businesses using the FRS will be expected to ensure that, for each accounting period, they use the appropriate flat rate percentage.
How does the VAT FRS work?
Under the FRS, an invoice for £2,000 would have 20% VAT added - £400. Under current rates, many contractors would then deduct VAT at 14.5% from the £2,400 received; meaning £348 is paid to HMRC.
With the new rate at 16.5%, a limited cost trader would pay £396 to the taxman, an almost identical fee to that charged to the client. "The key point is you are paying over the large majority of the VAT that you are collecting,”
“Most contractors will have made a subsidy out of the flat rate scheme, so they benefit from having simplicity and a surplus. But because 16.5% is so close to the amount of VAT you are collecting, contractors will definitely be worse off than they were under the old rules.”
What is a limited cost trader?
A limited cost trader will be defined as one whose VAT inclusive expenditure on goods is either:
- Less than 2% of their VAT inclusive turnover in a prescribed accounting period
- 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)
Goods, for the purposes of this measure, must be used exclusively for the purpose of the business but exclude the following items:
- Capital expenditure
- Food or drink for consumption by the flat rate business or its employees
- 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)
Examples
Goods must be used exclusively for the purpose of the business - this means that you must not include the cost of any goods that are used in full or in part for your own private use. For example, printer ink and stationery that are used for both your office and your home would not be included. It would also exclude goods acquired with the intention of giving them away or donating them to a third party.
Capital expenditure - is the cost of any goods which are bought to be used in the business over a period of time (for example, longer than a year). Examples include equipment such as a computer, mobile phone, office furniture, a tablet or a printer, even if they are not necessarily treated as capital assets for accounting purposes. The legislation that describes capital expenditure goods can be found in VAT Regulations 1995, 55A (1).
These exclusions are part of the test to prevent traders buying either low value everyday items or one off purchases in order to inflate their costs beyond 2%.
How contractors can plan for the VAT FRS changes
The most suitable approach will depend on your current spend on VAT-able goods.
However, making additional purchases simply to clear the 2% mark won’t necessarily benefit your business.
“If you already spend 1.9% of your turnover on stationary, for example, it would be worth spending a bit more – providing it’s genuine – to then make significant savings.
“It’s unlikely those very short of the 2% will find increasing their spend on goods to be worthwhile. Each cost has to be a genuine business expense, and what’s not yet clear is whether benefits in kind will count. HMRC is due to consult on the measures in before April 2017 where there will be some clarity.”
Anti-forestalling provisions
Paying or invoicing in advance to avoid an increase in tax is known as forestalling. Anti-forestalling legislation was published on 23 November 2016. It is designed to prevent any business defined as a limited cost trader from continuing to use a lower flat rate beyond 1 April 2017.
This will affect a business that supplies a service on or after 1 April 2017 but either issues an invoice or receives a payment for that supply before 1 April 2017.
When considering the limited cost trader definition, any such supply must be treated, for VAT purposes, as taking place on 1 April 2017. Any invoice or payment that covers continuous supplies of services that cross this date must be apportioned.
How to respond to the VAT FRS changes
If your business generates less than £83,000 per year and you are voluntarily VAT registered, de-registering is a potential option, however, we advise communicating with your contracted agencies to ensure they are aware of your intentions and such decision complies with their contractual requirements with you. If you must remain VAT registered, after assessing the expenses which your company incurs, you do not expect to claim more than £226 in VAT then it will be advisable to remain in the flat rate scheme.
Alternatively, another option is to revert to the traditional method of calculating VAT, but recording VAT collected and paid out, then paying the difference on a quarterly basis on the assumption that the VAT to be claimed from your expenses exceed the flat rate saving of £226.
Effect on your business
We have analysed your income and expenditure information which we have on file from production of previous VAT returns and have reached the conclusion that the changes in rules relating to the flat rate scheme will affect your business and cause the VAT rate payable to HMRC each quarter to increase to 16.5%.
This is because, from the total annual expenses which you incur normally, your quarterly expenses which are exclusively for the purpose of your trade, is less than the required 2% of your VAT inclusive turnover.
This change will substantially reduce your flat rate scheme savings. If you have regular VAT inclusive expenditures that are paid each month or quarterly, then please provide us with this information to allow us to carry on a free reassessment of your VAT position.