Hi
The flat rate scheme (FRS) is used by numerous small businesses to simplify their VAT reporting. Lots of those businesses also gain a cash advantage from using the scheme, but this advantage is due to be cut back
significantly from 1 April 2017. The FRS will continue but many businesses will not find it economical to use.
Cash advantage
When using the FRS the business ignores VAT incurred on purchases when reporting VAT payable, with the exception of capital items which cost £2,000 or more. The trader
simply multiples his gross turnover (including VAT charged at the normal rates) by the FRS percentage set for his particular trade sector.
This FRS percentage is supposed to take account of the amount of VAT likely to be incurred on business expenses. The common percentages used by service-related businesses are:
- Accountancy and legal services 14.5%
- Journalism or entertaining 12.5%
- Computer or IT consultancy 14.5%
- Business services not listed elsewhere 12%
- Estate agents and property management 12%
- Management consultancy 14%
If the business incurs few expenses, and it operates in a sector with a relatively low FRS percentage, it will pay out less VAT to HMRC under the FRS than it would outside the scheme. Many businesses register for VAT voluntarily
before their turnover reaches the VAT registration threshold, so they can use the FRS and bank the cash advantage.
Abuse of FRS
The government believes small businesses have been abusing the FRS by using it as the law intended, so it is changing the terms of the scheme to make is less
attractive to use, and to reduce the cash advantage enjoyed by service-related businesses.
From 1 April 2017 a business will be required to use a FRS percentage of 16.5% if it is a ‘low cost trader’. This is likely to adversely affect businesses in all of the sectors listed above, and possibly many other similar businesses, as 16.5% of the gross turnover is equivalent to
19.8% of the net leaving almost no credit for VAT incurred on purchases.
Low cost trader
A ‘low cost trader’ is a business whose expenditure on goods (not services) is less than 2% of its gross turnover, or if more than 2% of its turnover, the amount spent on goods is less than £1,000
per year. Any expenditure on capital items, motor expenses, or food or drink for consumption by the business, is ignored when working out the 2% or £1,000 threshold.
This emphasis on ‘goods’ will discriminate against businesses who incur VAT on services such as rent, software licences, IT support, digital journals,
sub-contractors, telecoms etc. In VAT terms a service is anything which is intangible, or where the cost relates to a tangible asset it is the temporary use of that asset – such as hiring.
Action to take
Businesses that are trading under the VAT threshold of £83,000 may want to deregister from VAT
with effect from 1 April 2017. Businesses that are trading over that threshold may need to withdraw from the FRS from the same date.
Note that any attempt to invoice in advance for services to be provided on or after 1 April 2017, to capture that invoice within the FRS, will be treated as if the invoice was issued on 1 April 2017 (para 8.2 and 9.7 of VAT notice 733).
This change will inevitably put an additional tax burden on numerous small businesses. Aren’t they the group the Government is supposed to be helping?
Noel Guilford