Flat rate VAT changes may impact your small business

The Flat Rate Scheme for VAT was designed to simply administration for VAT registered businesses with a turnover under £150,000.  In his Autumn Statement earlier this week, the Chancellor Philip Hammond announced some significant changes to the scheme designed to stamp out misuse.  However these changes may also adversely impact other companies who are using the scheme for its intended purpose.

What is the Flat Rate VAT Scheme?

The normal method of accounting for VAT is for a business to pay over to HMRC the difference between the VAT on invoices it sends to its customers (output VAT) and the VAT it incurs itself on invoices it receives from its suppliers (input VAT).  The Flat Rate VAT Scheme aims to simply this, by allowing eligible businesses to calculate the VAT payable as a flat percentage of their sales figure, including the VAT.

The applicable percentage differs by type of business – for example, an accountant would pay 14.5%.  A full list of the percentages by type of business can be found on the GOV.UK website.  If in a quarter an accountant billed clients for work amounting to £10,000 and added VAT of 20%, or £2,000 on those invoices, then the VAT payable for that quarter would be £1,740 (£14.5% of £12,000).

The Flat Rate Scheme was designed to generate VAT receipts for the government of roughly the same amount as would be the case under the standard VAT arrangements.  Some businesses would pay slightly more and some would pay slightly less.  The government’s concern has been that certain businesses have been using the scheme to pay much less VAT than it deems appropriate.

What is changing?

The main issue for the government was in respect of businesses with a very low cost base, particularly those costs attracting input VAT.  The Autumn Statement introduced the concept of ‘limited cost traders’ to deal with this.  These businesses may still use the Flat Rate Scheme, but irrespective of the type of business they are, they will have to apply a flat rate of 16.5% to their sales.  For the accountant in the example above, their VAT bill will increase to £1,980 – only £20 less than the full amount of VAT charged on the invoice – meaning that if that company incurred more than £20 of input VAT during the same quarter, they would be worse off under the Flat Rate Scheme.

The proposals define a ‘limited cost trader’ as one that spends less than 2% of its sales on goods (not services, even if those services carry input VAT).  Even if the 2% threshold is exceeded the business will also fall within the definition if it spends less than £1,000 a year.  The goods figure cannot include the following:

  • food and drink
  • capital goods
  • vehicles or parts for vehicles

Which type of businesses will be impacted?

The main type of businesses that will be worse off following these changes are labour-intensive ones, that typically will spend very little on goods.  This will include activities such as accountancy, consultancy, hairdressing as well as companies that sub-contract their labour into otherwise material-rich activities (e.g. construction).

When do the changes take effect?

The measures are due to come into force on 1 April 2017.  HMRC VAT Notice 733 which deals with the Flat Rate Scheme rules has also been updated to include ‘anti-forestalling’ measures to stop businesses avoiding the impact of the changes by raising invoices earlier than they should.

Whilst these comments are designed to explain the Flat Rate Scheme in outline as well as the changes, the rules of the Scheme contained in Notice 733 are detailed in several aspects and should be read in their entirety before any decisions are taken.  If you wish to discuss the impact of these changes on your own business in more detail please contact us.