NEW VAT Flat Rate Scheme Changes

The Flat Rate Scheme (FRS) was originally introduced as a simplification scheme to help reduce the administrative burden for smaller businesses. It is not a tax allowance and businesses using the scheme should broadly pay the same amount of VAT as they would on standard VAT accounting.

In the Autumn Statement the Chancellor of the Exchequer announced new legislation to come into effect from 1 April 2017 to tackle what HM Revenue & Customs believes is “aggressive abuse” of the FRS. This new legislation introduces a new test to undertake and a new flat rate for businesses with low costs.

On 28 February 2017 HMRC updated VAT Notice 733: Flat Rate Scheme for small businesses to include detailed legislation on “limited cost businesses”.

HMRC state that the legislation is aimed to level the playing field and tackle the abuse. In the past 12 months HMRC dealt with an additional 30,000 applications to join the FRS, the bulk of which were received from “unscrupulous employment agencies” who have transferred clients out of umbrella companies into single limited companies and then registered them for VAT and the FRS. In addition, it believes many businesses were registering to use the scheme for a cash benefit rather than for simplification purposes and that many advisors were marketing the scheme in this way.  HMRC believe that the solution published is resilient and should retain the simplification benefits for the majority of FRS users.

Limited cost business category

From 1 April 2017 businesses need to assess if they fall into the new limited cost businesses category for each VAT period, if they are not a limited cost business they will continue to use the sector appropriate percentage to calculate the VAT liability for that period. If the VAT period straddles the 1^st of April then split treatment is required. The appropriate sector percentage under the current FRS rules is used for months prior to 1 April, and the limited cost business test is completed for the months post 1 April, with appropriate limits being time apportioned.

A limited cost business is defined as a business whose expenditure on “relevant goods” (including VAT) is either:

• Less than 2% of their VAT flat rate turnover or
• Greater than 2% of their VAT flat rate turnover but less then £1,000 per year (£250 per quarter).

Unless it is clear that you are not a limited cost business you will have to complete the test each VAT period. You could be a limited cost business in one period but back to using your relevant sector percentage in another. In order to assist FRS users HMRC are releasing an online calculator. This is currently at beta testing stage and should be finalised in early April. The calculator can be found at:

https://www.tax.service.gov.uk/check-your-vat-flat-rate/vat-return-period

“Relevant goods”

The key to the test is the definition of “relevant goods”. After the draft legislation was released much commentary was published and potential work-arounds discussed. The final legislation has increased some of the complexity behind the definition but has removed what appeared to be some potential loopholes. The main definition for relevant goods as stated in VAT Notice 733 is:

“You receive a supply of goods (including by acquisition or import) if the exclusive ownership of moveable items is passed to you from another person.”

There is some further clarification on the supply of goods which includes receiving “water or any form of power, heat, refrigeration or ventilation”. The notice then details goods that are used for the purposes of your business but are specifically excluded from the “relevant goods” definition and these are:

• vehicle costs including fuel, unless you’re operating in the transport sector using your own, or a leased vehicle
• food or drink for you or your staff
• capital expenditure goods of any value
• goods for resale, leasing, letting or hiring out if your main business activity doesn’t ordinarily consist of selling, leasing, letting or hiring out such goods
• goods that you intend to re-sell or hire out, unless selling or hiring is your main business activity
• any services

It is also important to note that goods are only included if they are used exclusively for the purposes of the business. This means that if goods have a dual purpose such as some element of private use then it is excluded from the definition.

If you are using the FRS then HMRC are in the process of writing to you and the first round of letters will be received mid-March. HMRC are also looking to notify users via email. The communications from HMRC will outline the potential outcomes and options of this new test, which are:

1. No change – you are definitely not a limited cost business and can continue to use the relevant sector percentage.
2. You are a limited cost business:
   1. Use the limited cost business percentage for the periods in which your purchases of relevant goods are below the limits, or
   2. Leave the FRS and calculate VAT using the standard method, or
   3. If your turnover is below the VAT deregistration limit you can deregister from VAT.

Another option to consider if you are currently accounting for VAT on a quarterly basis is to apply to use the annual accounting scheme in conjunction with the FRS, which means you will only need to undertake the test once per year when you submit your annual VAT Return. This also allows you to spread the payments over 10 months and gives you 2 months after the end of the VAT year to complete and submit your return.

If you are currently using the FRS to calculate and administer your VAT then please discuss the various options with us. Please call your local office and ask to speak to a member of our VAT team – we would be delighted to advise you.