vat small business pointers

Flat Rate VAT changes for small business

 

INVOICE/CASH ACCOUNTING

FLAT RATE

REGISTRATION & RECORD KEEPING

INVOICE/CASH ACCOUNTING

FLAT RATE

REGISTRATION & RECORD KEEPING

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Changes were announced in the 2016 Autumn Statement to the amount of VAT that many small businesses will have to pay.  This will affect businesses that use the VAT Flat Rate Scheme but which spend very little on raw materials - such as firms providing services.

How does it work? - Normally a business deducts the VAT on its inputs from the VAT charged on what they sell. Under the Flat Rate Scheme, that two stage process is simplified to one step.

The percentages for each type of business vary.  The flat rate scheme is designed to give the government roughly the same amount of VAT, but is easier to work out.  Because it is an approximation, some businesses will pay more, and some less. The government is concerned that some businesses are using the Flat Rate Scheme to pay less VAT than is appropriate.

What is changing? - In the Autumn Statement the Chancellor announced changes which affect businesses which have a very low cost base. These businesses are now called "limited cost businesses". Limited cost businesses can still use the Flat Rate Scheme, but their percentage will be 16.5%.

Limited cost business

From 1 April 2017, a flat rate percentage of 16.5% applies in place of the business specific percentage to any business which meets the definition of a `limited cost business’. This is a business which spends less than 2% of its VAT-inclusive turnover on ’relevant goods’ or one which spends more than 2% of its turnover but less than £1,000 a year on relevant goods. The figure of £1,000 is reduced proportionately for periods of less than one year, and as such equates to £250 a quarter.

This test is applied each time that the business completes its VAT return. Consequently, it is possible that a business may be a limited cost business in one VAT quarter, but not another. Where the position is marginal, it may be necessary to do the sums each time a VAT return is completed to check which percentage – limited cost business or sector specific – should be applied.

If you're not using the VAT Flat Rate Scheme, the limited cost trader rules don't apply to you.

How do you know if you're a limited cost trader?

HMRC says that a limited cost trader is a business that buys only a few goods. More specifically, a limited cost trader's spend on goods, including VAT, in a quarter is:

  • less than 2% of its VAT-inclusive sales for that quarter, or
  • more than 2% of its VAT-inclusive sales for that quarter, but less than £250

This figure should exclude the cost of the following items:

Examples of supplies that are not relevant goods. (Relevant goods are defined as goods that are used exclusively for the purposes of your business)

This is not an exhaustive list:

  • accountancy fees, these are services
  • advertising costs, these are services
  • an item leased or hired to your business, this counts as services, as ownership will never transfer to your business
  • goods not used exclusively for the purposes of your business, for example electricity to supply a home and an office located in the home
  • food and drink for you or your staff, these are excluded goods
  • fuel for a car this is excluded unless operating in the transport sector using your own, or a leased vehicle
  • electronic devices, such as a laptop or mobile phone for use by the business, this is excluded as it is capital expenditure, see paragraph 15.1
  • anything provided electronically, for example, a downloaded magazine, these are services
  • rent, this is a service
  • software you download, this is a service
  • software designed specifically for you (bespoke software), this is a service even if it is not supplied electronically
  • goods which are bought solely to meet the test, as these would not be used exclusively for the purposes of your business, for example, if the quantity of goods being bought cannot reasonably be used by the business and are simply ‘stockpiled’ or thrown away, even if the business may normally use those items is smaller quantities such as office materials
  • stamps and other postage costs, these are payments for services
  • capital expenditure goods of any value

 

Examples of relevant goods - This is not an exhaustive list:

  • stationery and other office supplies to be used exclusively for the business
  • gas and electricity used exclusively for your business
  • fuel for a taxi owned by a taxi firm
  • stock for a shop
  • cleaning products to be used exclusively for the business
  • hair products to use to provide hairdressing services
  • standard software, provided on a disk
  • food to be used in meals for customers
  • goods provided by a subcontractor and itemised separately
  • goods brought into the UK if they are not otherwise excluded
  • goods bought without VAT being charged, if they are not otherwise excluded

 

What you need to do if you're a limited cost trader

If you're a limited cost trader, you'll need to check how much you've spent on goods each quarter and see how this figure compares to the specifications above.

If it turns out that you are a limited cost trader, you need to apply the 16.5% limited cost trader percentage to your VAT-inclusive sales for that quarter when you're working out how much to pay HMRC - don't use the usual rate for your trade.

Who will this affect? - It will increase the VAT paid by labour-intensive businesses where very little is spent on goods. For example, this may affect IT contractors, consultants and hairdressers.

 

Do I still get the 1% discount in the first year of VAT registration when on the Flat Rate scheme? – Yes, HMRC have confirmed this is still available.

 

How often do you have to apply the limited cost trader test? - When on the flat rate scheme you need to apply the limited cost trader test every VAT period.

 

The limited cost trader rules generally affect contractors with low outgoings. How can contractors avoid being classified as such and keep the flat rate VAT rates? -  This depends on whether you have any goods purchased in the relevant VAT period. If the total of goods bought is less than 2% of turnover in the same period, or less than £1,000 a year, then you’ll have to use the limited cost trader rate.

 

Currently, my trade sector falls under printing, which is set at a flat rate of 8.5%. Can you tell me will these rules apply? - If you meet the criteria for a Limited Cost Trader, the rate would be 16.5%. However, for the printing industry, we expect this type of trade to have quite a lot of ‘applicable goods’. This could include the ink or paper for printing. So for most printers, this would mean the cost of goods would be more than 2% of turnover, meaning the rules would not apply.

 

As a limited cost trader will you be able to claim VAT back on goods costing over £2,000. I’m thinking of purchasing a new Mac. - The rules state that a business on the flat rate scheme can reclaim VAT on goods that cost more than £2,000.

 

Does the cost of a subcontractor count as a capital good when applying the Limited cost trader test? - Unfortunately not – services are not included.

 

My company expenses consist of salary, accountancy, some travel costs, the odd subsistence expense, software rental, and telephone costs. How would I see if I currently meet or fall foul of this test? - It’s likely you’ll be affected. Ultimately, the majority of service-based companies are likely to be affected. Here are some examples of items that won’t be included as relevant goods:

This is not an exhaustive list:

  • accountancy fees, these are services
  • advertising costs, these are services
  • an item leased or hired to your business, this counts as services, as ownership will never transfer to your business
  • goods not used exclusively for the purposes of your business, for example electricity to supply a home and an office located in the home
  • food and drink for you or your staff, these are excluded goods
  • fuel for a car this is excluded unless operating in the transport sector using your own, or a leased vehicle
  • electronic devices, such as a laptop or mobile phone for use by the business, this is excluded as it is capital expenditure, see paragraph 15.1
  • anything provided electronically, for example, a downloaded magazine, these are services
  • rent, this is a service
  • software you download, this is a service
  • software designed specifically for you (bespoke software), this is a service even if it is not supplied electronically
  • goods which are bought solely to meet the test, as these would not be used exclusively for the purposes of your business, for example, if the quantity of goods being bought cannot reasonably be used by the business and are simply ‘stockpiled’ or thrown away, even if the business may normally use those items is smaller quantities such as office materials
  • stamps and other postage costs, these are payments for services
  • capital expenditure goods of any value

 

It the scheme still worthwhile?

The flat rate percentage for limited cost businesses is 16.5% of VAT-inclusive turnover. This equates to 19.8% of VAT-exclusive turnover, which means that virtually all the VAT charged to customers is paid over to HMRC, with very little allowance to cover input VAT. A business is a limited cost business if the cost of its relevant goods is less than 2% of its turnover. However, the list of relevant goods excludes all service and fuel. Consequently, a business that has significant expenditure on non-relevant goods, may not recover the associated input VAT in full. In this situation, the trader may be better off using traditional VAT accounting and opt leave the flat rate scheme voluntarily.

 

Beware of trying to beat the system by buying goods specifically to escape the definition of a limited cost trader, where the quantities are such that they cannot reasonably be used by the business and would be stockpiled or thrown away. HMRC are wise to this, and there is a specific exclusion to counter this practice.

 

Better out than in

Many service sector businesses may now be better off out of the flat rate scheme. A business may incur significant amounts of VAT on items that are used exclusively for the business, but which are not taken into account in determining whether the business is a limited cost business. Consequently, virtually all VAT charged to customers will, under the flat rate scheme, be paid over to HMRC, allowing no relief for input VAT suffered.

 

Example: Limited cost business

Holly has a business providing management consultancy. In a particular VAT quarter, she invoices clients £30,000 plus VAT (£36,000). Prior to 1 April 2017, her flat rate percentage was 14%.

 

Her expenditure on relevant goods is £120 plus VAT (which is both less than 2% of turnover and £250 a quarter). Consequently, she is a limited cost business and her VAT percentage is 16.5%.

 

However, Holly also pays rent of £500 plus VAT for her office and incurs £1,000 plus VAT on accountancy fees. She also spends a further £3,000 plus VAT during the quarter on goods that are not relevant goods.

 

Her total input VAT in the quarter is £924 (£24 (relevant goods) + £100 (rent) + £200 (accountancy) + £600 (other)).

 

Under the flat rate scheme, Holly must pay VAT of £5,940 (16.5% of £36,000) over to HMRC. She has charged VAT of £6,000, leaving her with only £60 to cover the input VAT suffered of £924.

 

By contrast, under the standard VAT scheme, Holly would only pay £5,076 (£6,000 - £924) over to HMRC – a saving of £864. Interestingly, using the trade specific percentage of 14%, Holly would pay £5,040 to HMRC.

 

Leaving the scheme

While the flat rate scheme is administratively simple (depending on the nature of the business) this may come at a cost. Traders wishing to leave the scheme and revert back to the standard scheme must tell HMRC in writing. It is usual to leave at the end of a VAT period. However, once a trader has left, they cannot rejoin for a year.

 

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