Flat Rate Scheme changes - Limited Cost Traders

Changes are being made to the Flat Rate Scheme (FRS) which may mean that the scheme is less attractive to some businesses and this may result in these businesses deciding to no longer operate under the FRS. It is important to understand these changes especially if you already operate the scheme or are considering using the FRS.

Background to the Flat Rate Scheme

Under the FRS a set percentage, determined by the business trade sector, is applied to the VAT inclusive turnover of the business as a one-off calculation instead of having to identify and record the VAT on each sale and purchase the business makes. Turnover will include any exempt supplies and it is therefore not generally beneficial to join the scheme where there are significant exempt supplies.

The aim of the FRS for small businesses is to reduce the administrative burden imposed when operating VAT, however many small businesses who use the scheme are also better off as they are effectively able to keep some of the VAT charged to customers.

Flat Rate benefits for those trading below the VAT registration scheme

For some very small businesses including those trading below the annual VAT registration threshold of £83,000, it has been worthwhile registering for VAT and operating the FRS. Effectively these traders charge their customers VAT at 20% on the services they supply but only pay over VAT at an effective maximum rate of 17.4%. They are therefore able to keep a minimum of 2.6% of the VAT paid by their customers.

Where the relevant FRS percentage is lower than 14.5% the effective percentage of VAT which can be retained could be significantly more.

The change to the Flat Rate Scheme

The change, described as an anti-avoidance measure, introduces a new 16.5% rate from 1 April 2017. This rate will be applicable for businesses with limited costs, such as many labour-only businesses. Businesses using the scheme, or considering joining the scheme, will need to decide if they are 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 £1,000 per annum if the prescribed accounting period is one year (if it is not one year, the figure is the relevant proportion of £1,000 so for someone who completes their VAT return quarterly the limit is £250).

Businesses using the FRS will be expected to ensure that, for each VAT return period, they use the appropriate flat rate percentage, so the check to see whether a business is a limited cost trader will have to be carried out for each VAT return.

What happens now?

The introduction of the 16.5% rate for limited cost traders will result in affected businesses having to reconsider their position and may result in different outcomes. Some businesses will:

• continue to use the flat rate scheme, checking for each VAT return period, whether they are affected by the 16.5% limited cost trader percentage and paying VAT at the 16.5% rate if appropriate
• decide to leave the FRS. In order to leave the FRS you must write and let HMRC know. Generally businesses choose to leave at the end of an accounting period. However, you may leave voluntarily at any time during an accounting period. HMRC will confirm the date you left the scheme in writing. If you are considering this option we can advise the most appropriate time to leave the scheme but this will generally be before 1 April 2017
• decide to deregister for VAT where the business turnover is below the VAT deregistration threshold. A business effectively leaves the FRS the day before they deregister for VAT.

We can advise you of the best course of action for you and your business.