Now that the fine print of the Chancellor’s Autumn Statement has been published, it is clear that many small businesses will lose the cash benefit of the VAT Flat Rate Scheme from 1st April 2017,
VAT Flat Rate Scheme (FRS)
The FRS is used by thousands of small businesses to simplify their business bookkeeping and 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 April 2017. The FRS will continue, but many businesses will find it simply uneconomic to use.
When using the FRS the business ignores VAT incurred on purchases when reporting VAT payable, with the one exception of capital items costing £2,000 or more, the VAT on which they can reclaim. Typical capital item expenditure by a small business could be a new van or an expensive computer system. Business owners simply multiply their gross turnover (including VAT charged at the normal rates) by the FRS percentage set for the particular trade sector they operate in.
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 the most common service-related businesses are:
- Bookkeeping, accountancy and legal services: 14.5%
- Market researchers and debt collection services: 12%
- Journalism and entertainers including dance/exercise instructors: 12.5%
- Computer or IT consultancy: 14.5%
- Business services not listed elsewhere, such as advertising consultants: 12%
- Estate agents and property management: 12%
- Management consultancy: 14%
- Computer repair services: 10.5%
- Beauticians and hairdressers: 13%
- Political, professional and religious organisations & Trade Unions: 8%
- Portrait or other specialist photography: 11%
If the business incurs relatively few expenses, which applies pretty much to all the above categories and it operates in a sector with a relatively low FRS percentage, such as someone repairing computers from home, it will pay out significantly 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 not 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 sometimes significant cash advantage enjoyed by service-related businesses.
From 1st April 2017 a business will be required to use a FRS percentage of a whopping 16.5% if it is deemed to be a “low cost trader”. This will almost certainly adversely affect businesses in all of the trade sectors listed above and possible many other similar businesses. This is because 16.5% of a business’s gross turnover is equivalent to 19.8% of the net leaving virtually no credit for VAT incurred on purchases.
Low cost trader
HMRC/VAT define a ‘low cost trader’ as one 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
Firstly you will need to establish whether or not you are likely to be classified as a low cost trader and if you are, any business who is trading under the VAT threshold of £83,000 should seriously consider deregistering from VAT with effect from 1 April 2017.
Also, any businesses that are trading over that threshold will have to consider whether or not 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.
This petty measure seems to me to be a sledgehammer to crack a very small nut and clearly discriminates against small businesses, often sole traders, who are struggling as it is, in the present uncertain economic climate.
If you would like more detailed information on some aspect of UK Tax, send me an e-mail and I’ll be pleased to advise further.