Preparing for the changes to the VAT flat rate scheme

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Following the surprise announcement by Philip Hammond in the Autumn Statement, major changes to the flat rate scheme will come into effect from 1 April 2017.  It is therefore vitally important for any business currently using the flat rate scheme to review their position as soon as possible.

The changes have been announced as being an anti-avoidance measure and appear to be targeted at firms and agencies that make their workers self-employed and exploit the flat rate scheme rules.  The unfortunate consequence of these changes is that the impact is more widespread and could have a significant impact on many service based businesses currently using the flat rat scheme.

What are the new rules?

Currently the highest VAT percentage applicable for flat rate scheme users is 14.5%, but from 1 April 2017 this will increase to 16.5% for businesses deemed to be a ‘limited cost trader’.

HMRC define a ‘limited cost trader’ as being a business whose VAT inclusive expenditure on goods is either:

• Less than 2% of their VAT inclusive turnover in a prescribed accounting period; or

• Greater than 2% of their VAT inclusive turnover, but less than £1,000 per annum.

Therefore any business not spending at least £1,000 per year and in some cases much more than this will be deemed as a limited cost trader and will need to apply the new 16.5% rate were they to remain on the flat rate scheme.

Goods, for this purpose, must be genuine business expenditure and be used exclusively for the purpose of business, but exclude the following items:

• Capital expenditure

• Food or drink for consumption by the business or its employees

• Vehicles, vehicle part and fuel (except where the business is one that carries out transport services)

For many service based businesses it is unlikely that they will have expenditure on goods in excess of £1,000 per annum, with many likely to only to have stationery purchases that can qualify as goods with other purchases such as legal or accountancy fees, telephone costs and electricity all being the purchase of services, rather than goods.

The impact of these changes could be huge for many businesses using the flat rate scheme.  For example a consultancy business with a turnover of £100,000 plus VAT per annum and a 14.5% flat rate would previously have paid over £17,400 per year output VAT to HMRC.

Under the new rules they would pay £19,800 output VAT, just £200 less than they would pay under standard VAT accounting, but still without the ability to recover any input VAT incurred.  A £2,400 increase in VAT payable.

For businesses currently on a lower flat rate percentage than 14.5%, but who meet the definition of a ‘low cost trader’ the impact could be even more severe.

It should also be noted that anti-forestalling methods have been introduced to prevent the possibility of invoices being raised prior to 1 April 2017 and therefore having the VAT calculated at the previous lower rate, but actually being in relation to work to be performed after 1 April.  In such cases, the applicable percentage to apply to such income will be the higher rate of 16.5%.

What are the options?

• Some low cost businesses who are trading below the VAT registration threshold may only have registered due to the cash benefits of being on the flat rate scheme.  For these businesses, one of the best options may be to de-register for VAT.  If the benefit to being registered no longer exists, then the additional administrative costs of being VAT registered could then be eliminated

• For some businesses, switching to standard VAT accounting may be the best way to go, with the main benefit being that you could now recover the input VAT incurred on expenditure

• For others, especially those trading above the VAT registration threshold, it may be preferable to remain on the flat rate scheme, even though it would not be as cash beneficial as it once was.  The main reason for this would be the simplicity of the flat rate scheme calculations in comparison with standard VAT accounting and if the net VAT benefit of switching to standard VAT accounting is minimal then this could be suitable

• The final option would be to remain on the flat rate scheme and increase the expenditure on genuine business goods so as to no longer be considered a low cost trader, therefore retaining the existing percentage, but spending more than you would have previously

  This would work well for businesses that have been reluctant to purchase certain items in the past due to the cost of doing so.  Going forward, although the same cost will still be incurred the overall net position of the business may actually be improved from purchasing these items and therefore being able to remain on the current flat rate percentage

  It would be necessary for these purchases to be wholly and exclusively for the purpose of the business and purchased for a genuine commercial reason, so it may not be possible in all circumstances, but is certainly something worth considering.  As noted above capital items do not however count towards the 2% of turnover/ minimum of £1,000 low cost trader threshold.

Conclusion

Although these changes will generally impact upon service based businesses the most, I would encourage all current users of the flat rate scheme to have their position reviewed as a matter of urgency prior to the 1 April 2017 to ascertain what the most appropriate route forward is.