On 1st April 2017, changes to the Flat Rate Vat Scheme (FRS) will come into force.
The Flat Rate VAT Scheme was designed to relieve the administrative burden on small businesses (with a turnover excluding VAT of less than £150,000) of accounting for VAT on everything they buy and everything they sell. The scheme allows businesses to apply a fixed rate to their VAT inclusive turnover for the period (usually quarterly) and pay that amount to HMRC. This means that they don’t need to spend hours accounting for VAT on all of their purchases. The rate applicable depends on the type of business (e.g. accountancy / mechanical / retail etc).
Here is an example of how the scheme currently works for a business using a Flat Rate of 14.5%
Net Sales for the quarter: £10,000
VAT on sales for the quarter: £2,000
Gross Sales for the quarter: £12,000
VAT payable to HMRC for the quarter: £12,000 x 14.5% = £1,740
You can see here that the amount of VAT to pay to HMRC is less than the VAT charged to customers in the quarter. This is because HMRC assumes that if that type of business had been using the standard VAT scheme and had accounted for the VAT on all purchases as well as its sales, the resulting amount due to HMRC would have been approximately £1,740.
The problem arises where businesses who have very few outgoings when compared to their sales figures use the FRS to their advantage. This can be illustrated as follows, where the business in question made the same amount of sales as above (£12,000 including VAT) but its expenditure for the quarter was only £600 including VAT).
VAT on sales for the quarter: £2,000
VAT on purchases for the quarter: £100
VAT Payable to HMRC for the quarter (business using Standard Scheme): £1,900
VAT Payable to HMRC for the quarter (business using 14.5% FRS): £1,740
Here, it shows that the business in question would actually profit from using the FRS. The following changes are being put in place to prevent these situations and ensure that the FRS is used for its original purpose which is to reduce the administrative burden on businesses.
So, what’s changing?
From 1st April 2017, so called “Limited Cost Businesses” will need to apply the new Flat Rate of 16.5%.
What is a Limited Cost Business?
A business whose VAT inclusive expenditure on “goods” is;
Below 2% of their VAT inclusive turnover; or
More than 2% or their VAT inclusive turnover but less than £250 quarterly (£1,000 annually).
These are literally goods and not services. For example, for a hairdresser buying shampoo, colour, hairspray etc, these would be classed as goods. On the opposite side, software licenses bought buy an accountant would be classed as services and as such are excluded from the calculations.
What about Advertising costs – are they goods?
If goods are bought which will be given away – such as promotional pens – these are excluded from the calculations.
What about Stationery costs?
Items such as stationery, printed letterheads are classed as goods and are allowed within the calculations.
Are Postage costs allowed?
Postage stamps are a service and are exempt from VAT which means they are excluded from the calculations.
Can Vehicle Costs be included?
Except where the business is one that carries out transport services – e.g. a taxi business – and uses its own or a leased vehicle to carry out those services, costs of vehicles, vehicle parts and fuel are excluded from the calculations.
What if I buy new assets for the business?
Capital expenditure is excluded from the calculations.
I’m in my first year on the FRS – do I still get my 1% rate reduction?
Yes. Whether you are affected by the changes or not, your 1% reduction for the first year on the FRS still applies.
How do I find out if I’m affected?
1. Speak to your accountant.
2. If you don’t have an accountant, there is an online calculator on HMRC’s website which you can use to help you work out where you stand. You can find the calculator here.
HMRC have advised that they will be writing to businesses currently using the FRS, although if you believe you may be affected it may be prudent to approach your adviser or use the calculator before you receive the letter.
Ok, so I’m affected by the changes. What are my options?
1. Use the new Flat Rate of 16.5%
2. Apply to leave the FRS and use the standard scheme.
3. If you are below the compulsory registration threshold (currently £83,000), you may wish to de-register for VAT altogether.
How do I know which is the right option for me?
If you have an accountant, speak to them. It may be worth doing some calculations to help you decide the best course of action for you to take. It may be that you are no worse off by leaving the FRS and moving to standard scheme on paper BUT there will be additional time required for processing all of your purchase receipts each quarter. This may result in you needing to change software supplier / starting to use software. If you pay your accountant or bookkeeper to complete your VAT Returns for you, their fees will probably increase too. It’s important to take all of these issues into account when making your decision.
Where can I find more information on the changes?
VAT Notice 733 is available on HMRC’s website here.