There was a time when the VAT flat rate scheme (FRS) offered significant tax advantages to all businesses turning over less than £150,000 a year. Though the VAT deductions provided by the scheme varies by sector, all registered businesses were guaranteed to pay a maximum 14.5% VAT rate to HMRC. Some firms (for example, businesses working in the food retail sector) had a flat rate of just 4%.
However, the introduction of the new 16.5% flat rate for businesses with ‘limited costs’ has changed this. Affected businesses have been presented with a dilemma: should they stay inside the scheme or should they go?
Limited cost businesses
The new 16.5% flat rate was introduced in April 2017 and ostensibly aims to tackle what the government views as abuse of the scheme.
This rate will be applied to all businesses designated by HMRC has having ‘limited costs’. In practice, this means that if your annual expenditure on goods is less than 2% of your annual VAT-inclusive turnover you will be classified as a limited cost business.
You will also be seen as a limited cost business if you spend more than 2% of your turnover on goods but spend less than £1,000 each year.
Goods, for the purposes of this measure, must be used exclusively for the purpose of the business but exclude the following items:
- any services – which is anything that isn’t goods
- expenses like travel and accommodation
- food and drink eaten by yourself or your staff
- vehicle costs including fuel unless you’re in the transport business using your own, or a leased vehicle
- rent, internet, phone bills and accountancy fees
- gifts, promotional items and donations
- goods you will resell or hire out unless this is your main business activity
- training and memberships
- capital items for example office equipment, laptops, mobile phones and tablets
- any item that has a private use element.
Should I stay or should I go?
Businesses now designated as limited cost are now facing a significant reduction in the tax advantages offered by the flat rate scheme.
The FRS changes will have an impact on service oriented businesses and the options are:
- use the Limited Cost Trader flat rate
- move to the normal VAT return regime
- de-register if turnover is below £83,000.
However, here are some important things to consider before making your decision.
VAT reduction: The flat rate scheme continues to offer the 1% VAT reduction in the first year of registering.
Simplified accounting: The tax benefits may no longer be as attractive, but the flat rate scheme retains one of its key benefits: simplifying your VAT accounting.
If your business turns over between £85,000 and £150,000 and you not want the extra hassle of full VAT administration, the flat rate scheme remains a useful resource.
Standard VAT scheme: Leaving the flat rate scheme will mean paying the full 20% VAT rate. This, of course, can be offset by reclaiming VAT on your purchases which means you might be better off than staying on the FRS.
Affected businesses should seek professional advice before making a decision on either remaining inside or leaving the flat rate scheme.