As usual we have the government throwing the baby out with the bathwater. There's a loophole being abused by a certain group of people, so the government's solution is to impose a bureaucratic nightmare.
Many contractors, micro-business consultancies and other small businesses
will be affected by the government’s planned changes to the VAT Flat Rate Scheme (FRS), which were signalled last autumn without fanfare and are being brought in from 1 April 2017.
The cash benefit offered by the flat-rate scheme has provided a lifeline to many small businesses, as well as simplifying their VAT
treatment. It is used by many small businesses to simplify VAT reporting. Lots also gain a cash advantage from using the scheme, but this advantage is being all but removed from 1 April 2017. The FRS will continue, but many businesses will not find it economical to use.
How does it work now?
When using the FRS the business ignores VAT incurred on purchases when reporting VAT payable, with the exception of capital items that cost £2,000 or more. The trader simply multiples gross turnover (including VAT charged at the normal rates) by the FRS percentage set for the relevant 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:
- Journalism or entertaining 12.5%
- Accountancy and legal services 14.5%
- Computer or IT consultancy 14.5%
- Business services not listed elsewhere 12%
- Estate agents and property management 12%
- Management consultancy 14%
What this means is that service businesses with few expenses, and that operate
in a sector with a relatively low FRS percentage, pay out less VAT to HMRC than they would outside the scheme. Many businesses register for VAT voluntarily before turnover reaches the VAT registration threshold, so they can use the FRS and bank the cash advantage.
Here’s an example. A business services company invoices a client £1,000 plus VAT at 20%., so £1,200 in all. When it comes to passing
the VAT charged to the government the FRS calculation is 12% of the gross billing of £1,200 – £144 in this case. The business can bank the difference of £56.
How will it work from 1 April 2017?
From 1 April 2017, a business will be required to use a FRS percentage of 16.5% if it is
a “low cost trader” (see below). This is likely to adversely affect businesses in all of the trade sectors listed above and possible 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.
What is a low cost trader?
A low cost trader, in the government’s newly minted definition for the FRS, is a business with expenditure on goods (not services) of less than 2% of its gross turnover or, if more than 2% of its turnover, where the amount spent on goods is less than £1,000 per year. Any expenditure on capital items, motor expenses or food and drink for consumption by the business is ignored when working out the 2% or £1,000
threshold.
This emphasis on goods discriminates against businesses that incur VAT on services such as rent, software licences, IT support, digital journals, sub-contractors, telecoms and so on.
Defining goods to work out qualifying criteria
The question of whether a company can stay in the scheme because it buys enough goods of a sufficient value to avoid the low-cost-trader designation is something that many are pondering. It’s been near-impossible to find useful guidance from HMRC so far, so this guidance, while useful, may not be exhaustive:
What counts as ‘goods’ in assessing
low-cost-trader status:
- Stationery and other office supplies to be used exclusively for the business
- Gas and electricity used exclusively for the 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
Some supplies that aren’t good include:
- Accountancy fees (these are services)
- Advertising costs (services)
- An item leased/hired to your business (this
counts as services, as ownership will never transfer to your business)
- Food and drink for you or your staff (excluded)
- Fuel for a car (excluded unless operating in the transport sector using your own, or a leased vehicle)
- Laptop or mobile phone for
use by the business (capital expense)
- Anything provided electronically, like a downloaded magazine (services)
- Rent (services)
- Software you download (services)
- Bespoke
software (service, however supplied)
The FRS is supposed to be revenue neutral. But to achieve the simplification objective the government had to make it generous. Worse, not merely is it now having to remove that generosity but it must reverse it, which will make the simplification objective unattractive for many of the businesses that have grown used to both of the
benefits.
What now?
The 1 April 2017 deadline will roll around within hours. This is an important change for many small businesses because it is not something that is looming in the middle distance - like Making Tax Digital – it is happening
now.
There have been consultations to find an alternative, but HMRC sees no way of separating out the users of the system from those trying to play it, so everyone suffers.
The message to small-business owners now is to look again at the scheme and how it works, and decide in advance what you need
to do. Do you need to adopt standard VAT accounting – or is deregistration the best option if it’s available to you? At Guilford Accounting we’ve written to all our clients who are affected advising them on their best course of action.
If you – or someone you know - is on the FRS and their accountant hasn’t advised them what to do please get in touch for a complimentary no obligation call with me
at www.calendly.com/noelguilford.
Noel Guilford