The Flat Rate Scheme (FRS) for VAT was introduced to address concerns about the complexity and compliance costs of VAT for small businesses. It aimed to reduce the cost of complying with VAT obligations by simplifying the way that VAT due to HMRC was calculated. However, HMRC now believes that the scheme is being used by some businesses to avoid paying the correct amount of VAT and has take steps to prevent this.
Essentially under the FRS a business:
- charges VAT in the normal way, typically 20%
- does not reclaim VAT on expenditure
- having charged and collected 20% VAT, actually pays HMRC a lower rate of VAT
The difference between the rate charged to customers and the rate paid to HMRC is intended to compensate the business for the VAT on expenditure that it has not claimed. For this reason different rates of “payment VAT” apply for differing types of business. This is because there is a correlation between business types and the likely sums of VAT on expenditure that they are forgoing a recovery of.
The Chancellor announced in his recent Autumn Statement that the government will be introducing a new 16.5% rate with effect from 1 April 2017 for ‘limited cost traders’, such as many labour-only businesses.
Currently the lowest rate applicable for users of the FRS is 14.5%. This applies to businesses in sectors where there is little VAT incurred on costs, such as consultancy, legal and accounting services and labour only building services. The proposed change could impact on many of these businesses.
HMRC have stated in a technical note, issued at the time of the announcement, that a ‘limited cost trader’ is a business whose VAT inclusive expenditure on goods is either:
(a) less than 2% of their VAT inclusive turnover in a prescribed accounting period
(b) greater than 2% of their VAT inclusive turnover but less than £1,000 per annum if the prescribed accounting period is one year (if it is not one year, the figure is the relevant proportion of £1,000)
‘Goods’ excludes items of capital expenditure, food and drink that is consumed by the business, vehicles, vehicle parts and fuel for businesses not involved in the transport service sector.
It is important that all businesses with low (or no) input costs beyond labour that are currently on the FRS review their position. They will need to establish if the new rate will apply to them and to determine whether it would be beneficial to leave the FRS on 31 March 2017.
Anti-forestalling provisions have been introduced which are designed to prevent any business that is a limited cost trader from using another rate beyond 1 April 2017. This means that it will not be possible to, for example, invoice in advance of the date of the introduction of the new rate to bring a supply within a lower rate of VAT.
The anti-forestalling measures will affect businesses that provide a service on or after 1 April 2017 but issued an invoice or received payment for that supply before 1 April 2017. The supply will be treated as taking place on 1 April 2017 and the 16.5% flat rate will apply.
A revised edition of Notice 733 has been published on the HMRC website. Draft legislation has also been published and affected parties will be able to comment until 1 February 2017.
If you would like to discuss this further please contact Helen Carey or one of our consultants on 01206 321029.
This blog is intended as a general guide to current VAT issues and is not intended to be a comprehensive statement of the law. No liability is accepted for the opinions it contains or for any errors or omissions. CVC cannot accept responsibility for loss incurred by any person, company or entity as a result of acting, or failing to act, on any material in this blog. Specialist VAT advice should always be sought in relation to your particular circumstance.