In the Autumn Statement last month the Chancellor announced a change to the Flat Rate Scheme that will have a big effect on contractors in yet another measure to reduce the earning power of those venturing out on their own. There’s a perceived abuse of the scheme and this measure seeks to reduce the benefit of using the scheme for certain types of business, particularly those that don’t have huge costs.
The FRS is a scheme for VAT registered businesses with annual income of less than £150,000, introduced to reduce the burden on small businesses. It simplifies the calculation of each VAT return and can give a bit of a benefit back to the company if they don’t have a huge amount of expenses that include VAT.
If you’re VAT registered, the traditional way to calculate the VAT payable each quarter is to take the VAT you’ve paid on your expenses from the VAT you’ve charged on your sales in that period. There are various costs that don’t include VAT and others that do but aren’t allowable. You need to keep VAT receipts to support the claim and all in all it can be quite complex and time consuming.
On the Flat Rate Scheme the VAT payable is calculated based on your sales in the quarter and a percentage defined by your trade sector. Whilst you still need receipts to support your expenses they don’t need to be VAT receipts.
A new percentage is being introduced from 01/04/2017 for ‘limited cost traders’ which significantly reduces the financial benefit of the scheme.
A ‘limited cost trader’ is a business that spends less than 2% of their gross turnover (including VAT) on goods OR spends more than 2% but the total is less than £1,000/year.
For this test, ‘goods’ exclude capital purchases, food, drink and vehicles and associated costs (allowed if you carry out transport services). Any items allowable must be used exclusively for the purpose of the business.
If you have an annual turnover of £100,000 including VAT you’ll need to spend more than £2,000 on applicable goods each year, to use your original trade sector percentage.
If your turnover is £40,000 inc VAT/year the 2% of turnover is £800, but unless you spend over £1,000 you’ll still be classed as a ‘limited cost trader’.
The technical note suggests this check should be done every quarter, so cash flow could be difficult to estimate. There may be some quarters that are more cost heavy, meaning you might flit between percentages throughout the year.
Currently your FRS percentage is defined by your trade sector, so an IT consultant would usually use ‘Computer and IT consultancy or data processing’ sector at 14.5%.
The new FRS percentage is 16.5% and overrides the trade sector - you’ll have to work out if you fall into the new ‘limited cost trader’ category first and then apply the correct percentage.
On an invoice of £1,000 net the VAT payable calculations would be:
|
FRS trade sector percentage |
14.5% |
16.5% |
|
|
Invoice Net |
£1,000 |
£1,000 |
|
|
Invoice VAT |
£200 |
£200 |
|
|
Invoice Gross |
£1,200 |
£1,200 |
|
|
VAT payable (gross x %) |
£174 |
£198 |
|
|
FRS ‘bonus’ the company keeps (VAT charged - VAT payable) |
£26 |
£2 |
|
A significant difference.
All businesses on the Flat Rate Scheme will need to check to see if they’re covered by this new definition.
HMRC will be releasing an online test to help you decide in due course, hopefully well in advance of the change coming in. In the meantime if you’re worried you can give us a call but we’ll be reaching out to those of our clients we think are affected in the New Year.
The change only takes effect from 1st April 2017, but you must continue to invoice as normal and not ‘bulk invoice’ around that date to avoid the higher tax on some invoices.
If you’re classed as a ‘limited cost’ trader there are a few options for you.
You may find that the other benefits of being on the Flat Rate Scheme (the simplified returns and not needing to obtain VAT receipts) are enough to stay on with the 16.5%, especially if you have very few expenses or they’re all travel expenses (which don’t contain VAT).
You could go back to standard VAT, deducting the VAT you incur from the VAT you’ve charged. You will need to ask for VAT receipts when purchasing anything and it may add some time to your bookkeeping.
Alternatively, if your sales each year are less than £83,000 you don’t need to be VAT registered, so it’s worth looking at deregistering. This won’t be right for everyone, so you need to talk to your accountant before deciding.
There is an eight week consultation period so there could yet be changes to come. Further clarity on how often the test is run would be welcome along with a little more guidance over how the FRS registration process will change.
Don’t forget we’re here to help you, from working out if you’re affected to deciding the best way forward for your company. We’ll be contacting you in the New Year to start this process and prepare for 1st April 2017.
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