The VAT Flat Rate Scheme changes from 1 Apr 2017 when new rules come into force in a heavy handed attempt to combat abuse of the system. The FRS differs from standard VAT accounting because you pay a percentage of your business turnover rather than paying the actual VAT arising on the difference between sales and purchases.
You continue to charge clients the headline rate of 20% VAT and you can potentially benefit by remitting a smaller percentage to the taxman. The FRS rates differ from sector to sector, but for IT contractors the norm used to be a rate of 14.5%. That’s changing to 16.5%.
Generally speaking, the new rules are awful! If you want to see what HMRC said about this (in Nov 2016) the press release and draft legislation are here.
Let’s consider three examples of a software developer with net annual sales of £50,000 and net VATable costs of £5,000.
| Standard VAT accounting |
Old FRS Rules 2002 – 2017 |
New FRS Rules 2017 et seq |
|
| Sales | 50,000.00 | 50,000.00 | 50,000.00 |
| VAT | 10,000.00 | 10,000.00 | 10,000.00 |
| Total | 60,000.00 | 60,000.00 | 60,000.00 |
| Gross sales | 60,000.00 | 60,000.00 | |
| VAT Flat rate | 14.5% | 16.5% | |
| VATable costs | 5,000.00 | ||
| VAT | 1,000.00 | ||
| Total | 6,000.00 | ||
| VAT in | 10,000.00 | ||
| VAT out | (1,000.00) | ||
| HMRC remittance | 9,000.00 | 8,700.00 | 9,900.00 |
| “Standard” variation | NIL | £300 better off | £900 worse off |
Double those annual sales to £100,000 (some of our clients operate at that level) and you can see that the difference could be either £600 better off or £1,800 worse off.
And do the sums the other way around, under the new FRS rules the VAT of £9,900 represents a rate of 19.8% on the sales of £50,000. That’s a bit like saying “pay all the VAT to HMRC and claim back practically nothing”. This makes the new Flat Rate Scheme nigh on useless!
You may suggest that the software developer in the example should simply deregister because the sales of £50,000 are below the VAT registration threshold of £83,000. Yes, that’s true. And then the VAT recovered would be NIL (instead of getting £1,000 back) and so the business would still be worse off, but to a greater extent!
Wiggle Room
There is not much wiggle room, unless you incur a reasonable amount of cost on “relevant goods”. The new rules are designed to impair only “limited costs” traders. That’s nearly everyone! However, try out the formula below to see if you can escape being labelled as a “limited costs” trader. This calculation has to be done every VAT quarter (so you may find that you alternate between FRS Old Rules and FRS New Rules).
The Formula
Work out your total for VAT inclusive sales.
Calculate a figure for 2% of your VAT inclusive sales.
Work out your total for VAT inclusive costs on “relevant goods”. Goods are tangible things, so be sure to ignore costs for services like office rent, freelance workers, accountants, insurance, travel, telephone calls, etc.
For the purposes of the VAT FRS rules (unless you’re a retailer of these goods) the expression “relevant goods” excludes the following:
- Items of a capital nature
- Cars
- Computers
- Printers
- Scanners
- Mobile phones
- Furniture, etc
- Fuel for motor vehicles
- Spare parts for motor vehicles
- Food
- Drink
- Anything which has a dual personal/business use (like bicycles and parts for their upkeep)
Question 1
Is your expenditure on “relevant goods” less than £250?
Yes > the new FRS rules apply > use a rate of 16.5%
No > go to Question 2
Question 2
Is your expenditure on “relevant goods” less than 2% of your VAT inclusive sales?
Yes > the new FRS rules apply > use a rate of 16.5%
No > the old FRS rules apply > use the old rate from the table of approved rates
Conclusion
If you spend more than £250 (or more than 2% of your VAT inclusive sales – whichever is the greater) every quarter, on . . .
- pencils
- envelopes
- toner cartridges
- traditional books and magazines
. . . then you may be in with a chance. In any case, you will have to give your bookkeeper a full analysis of all the goods you buy as “stuff from Amazon for £39” is not enough to tell us if these are “relevant goods”.
In a few cases, where you’re on a really low flat rate (teachers and trainers are on a 12% flat rate under the old rules) it might be worthwhile buying a few toner cartridges every quarter and then chucking them in a cupboard until you retire from business. You might then pass the test “more than 2% of your VAT inclusive sales” and you would still get your old flat rate. This has to be assessed on a case by case basis, but I have at least one lecturer who makes so much bounty on the 12% flat rate that it’s worth his while using some of that bounty to buy “relevant goods” which will languish unused, and he will still win overall!
In all other cases, we recommend leaving the Flat Rate Scheme on 31 Mar 2017 and adopting the standard approach to VAT from 1 Apr 2017. We are writing to all affected clients with a proforma letter which needs a real ink signature and which needs to be returned to us by 28 Feb 2017 so that we can get it submitted, agreed by HMRC, and implemented at midnight on 31 Mar 2017.
A withdrawal from the Flat Rate Scheme does not change the way that you bill your clients. If you’re company is VAT regsitered then it will still be VAT registered, and we will look after your VAT for you using the standard method and not the flat rate method.
Lastly
Beware of trying to fiddle the system. Any attempt to invoice in advance for services to be provided on or after 1 April 2017, to capture that invoice within the old FRS rates, will be treated as if the invoice was issued on 1 April 2017 (paras 8.2 and 9.7 of VAT notice 733).