Flat Rate VAT has been an asset to many small businesses by simplifying their administration and usually turning a small profit on the VAT charged to customers. However, HMRC have decided that the scheme is being ‘aggressively abused’ and they’ve put their foot down to try to stop this abuse by bringing in new legislation from April 2017.
The new legislation groups many types of small businesses as ‘limited cost traders’ and sets their flat rate at 16.5% of gross turnover. This effectively means that if your business falls into this category then you pay the equivalent of 19.8% VAT over to HMRC without the ability to offset VATable expenses as you would if you were registered for standard VAT at 20%. This change is likely to make de-registering from VAT or switching to standard VAT a better option for most limited cost traders.
Are you a ‘limited cost trader’?
A limited cost trader according to HMRC is any business where the VAT inclusive expenditure on goods is less than 2% of VAT inclusive turnover or less than £1000 in total. Goods in this circumstance excludes capital expenditure, food or drink consumption or vehicle expenses. So for a business turning over £100k (inc VAT) they would need to spend over £2k on goods that meet HMRC’s fairly limited definition to exclude themselves from the new limited cost trader category. This will mean that almost all contractors and consultants will fall into the new category and will almost certainly loose out as a result.
What are the consequences?
For a small business on the 14.5% flat rate VAT scheme with £50k net turnover they will get a £1,300 profit on VAT but under the new scheme they will get just £100. Turnover of £120k would yield a £3,120 profit on the 14.5% rate but this will be reduced to £240 from April. When you consider that standard VAT would allow you to claim back the VAT on many of your expenses if you left the scheme the very small profits are quickly eroded and the once very attractive Flat Rate VAT scheme becomes redundant.
What to do now?
Before taking any action it’s best to discuss this with your accountant. The 0.2% saving over standard VAT is almost negligible so from a purely monetary sense it will almost certainly be a better option to de-register or switch to standard rate VAT. The extra admin involved in preparing VAT returns on standard VAT may be off-putting for some but for those using good accounting software, the transition should be fairly painless.