What is the flat rate scheme?
The VAT flat rate scheme is a simplified accounting scheme for small businesses, designed to simplify your records of sales and purchases. It allows you to apply a fixed flat rate percentage to your gross turnover to arrive at the VAT due. You decide which flat rate percentage to use by reference to your trade sector.
However, the government is concerned that some businesses are using the Flat Rate Scheme to pay less VAT than is appropriate.
At the Autumn Statement on 23rd November 2016, the Chancellor of the Exchequer announced the introduction of a new 16.5% VAT flat rate for businesses with limited costs. This will take effect from 1 April 2017.
What is changing?
The new rate will affect businesses which have a very low base cost. These businesses will be called ‘limited cost businesses’. They will still be able to use the Flat Rate Scheme, but their percentage will be 16.5%.
A limited cost business will be defined as one whose VAT inclusive expenditure on relevant goods is less than 2% of its VAT inclusive turnover in a prescribed accounting period.
The relevant goods purchased must be used exclusively for the purpose of the business. When calculating the amount being spent on relevant goods, a business cannot include the purchase of the following:
- Capital expenditure (eg. plant, machinery and equipment, say a laptop or mobile phone)
- Vehicles, vehicle parts and fuel (unless it is a business that carries out transport services)
- Goods for resale, leasing, letting or hiring out if your main business activity doesn’t ordinarily consist of selling, leasing, letting or hiring out such goods
- Goods that you intend to re-sell or hire out, unless selling or hiring is your main activity
- Food and drink for you or your staff
- Any services (see list below for examples)
Examples of relevant goods are:
- Stationery and other office supplies
- Gas and electricity
- Fuel for a taxi owned by a taxi firm
- Stock for a shop
- Cleaning products
- Hair products to use to provide hairdressing services
- Standard software provided on a disk
Examples of supplies of services are:
- Accountancy fees
- Advertising costs
- An item leased or hired to your business, as ownership will never transfer to your business
- Anything provided electronically, for example a downloaded magazine
- Rent
- Software you download
- Bespoke software, even if it is not supplied electronically
The above services are not classed as relevant goods.
A business will also be classed as a limited cost business if it spends less than £1,000 on goods in an accounting period of one year (or £250 per VAT quarter), even if this is more than 2% of the business’s turnover on goods.
Which businesses are likely to be affected?
This will affect businesses that use the VAT Flat Rate Scheme but which spend very little on goods, eg. IT contractors; consultants; hairdressers and accountancy firms. It will also affect construction workers who supply their labour, but where the raw materials are provided by the main contractor.
When does this start?
The new rules start on 1st April 2017. However, the anti-forestalling provisions in place may affect invoices issued and goods bought from now on.
Vat returns which cover both before and after 1 April 2017
For VAT returns which cover both before and after 1 April 2017, you must split the return into 2 periods with the second period starting on 1 April 2017. For the first period you will calculate your VAT under the Flat Rate Scheme in the usual way. For the second period you must apply the test as above. The calculation for the second period must not include any turnover or supplies from the first period.
Putting the new scheme into practice
There is a government provided calculator available to help businesses work out if they are a limited cost business at www.gov.uk/vat-flat-rate-scheme/how-much-you-pay.
Before you use the calculator, you will need the following information relating to your most recent VAT return period:
- Your relevant turnover
- The cost of goods
You may need to complete this test each time you complete your VAT return as you can move from a limited cost rate of 16.5% in one period to your relevant sector rate in another. This would be the case if your costs fluctuate above and below 2%.
After doing this calculation you may find that you are paying more VAT than you would if you were not part of the Flat Rate Scheme. In this instance you may wish to move to the standard method of accounting for VAT.
Practical examples
Example 1
A business has a flat rate turnover of £10,000 a quarter. It spends £260 on relevant goods.
This is more than 2% of the flat rate turnover and more than £250 so the rate they need to use is the sector rate for their business.
Example 2
A business has a flat rate turnover of £20,000 a quarter. It spends £325 on relevant goods.
This is more than £250 but less than 2% of the flat rate turnover so the rate they need to use is 16.5%.
Example 3
A business has a flat rate turnover of £10,000 a quarter. It spends £225 on relevant goods.
This is more than 2% of the flat rate turnover but less than £250 so the rate they need to use is 16.5%.
For more information about what these changes mean for your business contact us on 01684 214900 or email enquiries@elizabetheyre.co.uk