Important Changes to the VAT Flat Rate Scheme (updated version)

In the November 2016 Autumn Statement the Chancellor announced the introduction of a new 16.5% VAT flat rate from 1 April 2017 which will apply to certain ‘limited cost’ businesses registered under the Flat Rate Scheme (FRS). The current maximum flat rate for such businesses is 14.5%.

Traders who are registered under the FRS will need to determine whether they fall within the definition of a ‘limited cost trader’ and take appropriate action by 1 April 2017.

Current System

Since the introduction of the FRS in 2002 it has proved very popular with small businesses as it provides a simplified way of calculating their VAT liability by applying a fixed-rate to their VAT inclusive turnover.

The current rates apply across a complete range of trade sectors from grocers (who use 4%) to accountancy and legal services (who use 14.5%) with most input tax on costs and expenses ignored for VAT purposes.

For a business to be eligible to join the FRS ‘taxable turnover’ (the value of zero rated and standard rated supplies excluding VAT) for the next year must be £150,000 or less.

Reason for the Change

HMRC has determined that a number of service-related businesses are exploiting the rules by gaining an unfair cash advantage from using the scheme given that in many cases their costs and expenses are minimal.

Therefore from 1 April 2017 a business that is regarded as a ‘limited cost trader’ will be required to apply a fixed rate of 16.5% to their VAT inclusive turnover. Given that the standard rate of VAT is 20% and that a new fixed rate of 16.5% equates to 19.8% of net turnover, this will result in virtually no credit being given for input tax on any purchases and expenses.

Definition of a ‘Limited Cost Trader’

A limited cost trader will be defined as one whose VAT inclusive expenditure on goods (but NOT services) is either:

  1. less than 2% of their VAT inclusive turnover for a prescribed period; or
  2. greater than 2% of their VAT inclusive turnover but less than £1,000 per annum.

It should be noted however that any expenditure on the following items is ignored:

  • capital expenditure
  • food or drink for consumption by the business or its employees
  • cost of goods used in full or part for private use
  • motoring expenses (except for transport businesses)
  • goods acquired with the intention of giving them away or donating them to a third party.

Anti-forestalling rules

Paying or invoicing in advance to avoid an increase in tax is known as forestalling

A business that supplies a service on or after 1 April 2017 but who issues an invoice or collects payment for that supply before that date will be treated as if the invoice was issued on 1 April 2017.

Any invoice or payment that covers continuous supplies of services that cross this date must be apportioned.

What action should be taken?

All service-related businesses currently using the Flat Rate Scheme should now carefully review their situation to determine whether they are regarded as a ‘limited cost trader’.

Where they conclude that they will be at a disadvantage by using the new 16.5% flat rate they should consider taking the following action with effect from 1 April 2017: 

  • Deregister from the Flat Rate Scheme for businesses whose turnover is above £83,000, the current mandatory registration threshold.
  • Deregister from VAT completely where they are still trading below the £83,000 threshold where they have registered voluntarily in the past in order to register under the FRS.

Further information and updated guidance from HMRC

HM Revenue & Customs will be communicating with all affected businesses regularly up to 1 April 2017. 

In order to support businesses HMRC have recently introduced an ‘easy-to-use’ online calculator that will help determine whether a business currently registered under the Flat Rate Scheme will need to use the new 16.5% flat rate. Here is a link to the on-line calculator which became available from 28 February 2017:

Here is a link to the revised HMRC VAT Notice 733 ‘Flat Rate Scheme for small businesses’ which was also issued on 28 February 2017.

Traders should pay particular attention to the following paragraphs of Notice 733:

4.4 – Determining whether you are a limited cost business

4.5 – VAT returns that straddle the 1 April 2017

4.6 – Definition and examples of ‘relevant goods’

Support for Marsh Vision clients

If you are a client of Marsh Vision and are registered under the Flat Rate Scheme then please make contact with us as we will be offering full support and advice to all affected businesses regarding this very important development. or telephone: 01633 215544