Changes to the VAT Flat Rate Scheme (FRS) effective 1 April 2017

In News, Tax Updates by Jawaid Yakoob0 Comments

The Flat Rate Scheme (FRS) was introduced to reduce the administrative burden on smaller businesses and reduce record keeping requirements. Businesses would pay VAT based on their VAT inclusive turnover at a rate specified by HMRC for their industry sector which would be below the normal 20% rate of VAT. In exchange for this businesses would not be able to claim VAT on expenses unless they were classified as capital goods and cost over £2,000. Many businesses who have little vatable expenses gained a cash advantage by using the scheme which has led the government to introduce new legislation to reduce this advantage.

Limited Cost Businesses

From 1 April 2017 any businesses classed as a limited cost business will have to use a standard FRS rate of 16.5% irrespective of their usual rate. A business will be classed as a limited cost business if the amount spent on relevant goods including VAT is either:

  • Less than 2% of VAT flat rate turnover (gross sales including VAT)
  • Greater than 2% of VAT flat rate turnover but less than £1,000 per year

The above test is applied for each VAT period e.g. if VAT returns are completed quarterly then the test is applied each quarter.

See appendix for examples of new rules and comparison against previous rules.

Note that relevant goods are any goods bought entirely for the purpose of the business and not capital in nature, so a laptop or mobile phone irrespective of their value will not be a relevant good. Examples of relevant goods include:

  • Stationery & other office supplies
  • Gas & electricity used exclusively for business
  • Software provided on a disk NOT downloaded

Next Steps

Broadly speaking there are four options available to those caught by the above change in legislation:

  1. Do nothing – the test will need to be applied each quarter and may result in you being worse off. Historical VAT returns will need to be analysed to ensure that the general trend going forward will not leave the business worse off.
  2. Deregister from VAT – if turnover is below £81,000pa (or likely to fall below this) you can deregister from VAT all together. This will save having to apply the above tests and other record keeping requirements for what may now be a small, if any, advantage. Do note that deregistrations cannot be backdated.
  3.  Leave FRS – you can leave the FRS at any time however this will mean taking on the administrative burden of computing VAT on the standard method that carries many more record keeping obligations. This should leave you better off than if caught by the new FRS rules however further analysis can be done using historical VAT returns.
  4. Other options – a number of other options have been mentioned to circumvent the new rules however these require careful planning and consideration. One of which is to plan the expenditure of relevant goods so that they fall within one quarter, this would mean for that quarter the tests are met even if for the remaining three quarters they are not. The saving from the one quarter may justify remaining on FRS. Another option may be if a second trade was incorporated within the same entity which required the purchase of relevant goods, this would mean the tests are met however VAT would be paid on sales of the second trade under the normal rules as well.

We will need to carefully judge the position on a case by case basis, please get in touch to discuss your individual circumstances. However, it can be said that the most beneficial of the options for the majority of clients will be to either deregister from VAT if possible or leave the FRS.

For further information contact us on 0121 783 5392 or email Jawaid@sigmatax.co.uk

Appendix

Example 1

Turnover per quarter: £10,000
Spend on relevant goods: £260
More than 2% of turnover: Yes
More than £250 per quarter: Yes
VAT FRS rate: 14% (management consultancy)
VAT payable under new rules: £1,400
VAT payable under old rules: £1,400
VAT payable under normal accounting: £1,623

Example 2

Turnover per quarter: £20,000
Spend on relevant goods: £325
More than 2% of turnover: No
More than £250 per quarter: Yes
VAT FRS rate: 16.5% (limited cost business)
VAT payable under new rules: £3,300
VAT payable under old rules: £2,800 (14% management consultancy)
VAT payable under normal accounting: £3,279

Example 3

Turnover per quarter: £10,000
Spend on relevant goods: £225
More than 2% of turnover: Yes
More than £250 per quarter: No
VAT FRS rate: 16.5% (limited cost business)
VAT payable under new rules: £1,650
VAT payable under old rules: £1,400 (14% management consultancy)
VAT payable under normal accounting: £1,629

Example 4 – planned expenditure

Turnover per quarter: £20,000
Usual FRS rate assumed 14% (management consultancy)

 

Quarter 1 2 3 4 Total
Spend on relevant goods £2,000 £0 £0 £0
More than 2% Yes No No No
More than £250 Yes No No No
VAT payable new rules £2,800 £3,300 £3,300 £3,300 £12,700
VAT payable old rules £2,800 £2,800 £2,800 £2,800 £11,200
VAT payable normal £3,000 £3,333 £3,333 £3,333 £12,999

 

From the above example it can be seen that if all expenditure on relevant goods can be made in one quarter then there is a possible saving, however this may be minimal compared to the extra time cost of achieving this.

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