April 2017 sees the introduction of changes to the VAT flat rate scheme, which are likely to have a significant impact on certain small businesses. We consider the changes below.
Understanding the flat rate scheme
The VAT flat rate scheme was designed to reduce the administrative burden on small businesses operating VAT. Under the scheme, instead of having to identify and record the VAT on each and every sale and purchase made, a business can apply a flat rate percentage to its turnover as a one-off calculation.
Businesses can opt into the scheme, but only if they do not exceed the relevant limits. Businesses must leave the scheme once income in the last 12 months exceeds £230,000, unless this is as a result of a one-off transaction and income will fall below £191,500 in the upcoming year. Businesses are required to also leave the scheme if there are grounds to believe that total income is likely to exceed £230,000 in the next 30 days.
In the 2016 Autumn Statement, Chancellor Philip Hammond announced the introduction of a new 16.5% rate for 'limited cost traders'. This type of trader is defined as one that spends less than 2% of its VAT-inclusive turnover on goods in the accounting period. Businesses whose VAT inclusive expenditure on goods is greater than 2% of their VAT inclusive turnover, but less than £1,000 per year (providing the prescribed accounting period is one year) may also be defined as a 'limited cost trader'.
The new rate will be introduced from 1 April 2017 for those firms with limited costs, such as many labour-only businesses, including hairdressers and IT consultants, amongst other professions. Any business wishing to make use of the scheme will be required to determine whether or not it meets the definition of a 'limited cost trader'.
The regulations outline that the goods must be used exclusively for the purpose of the business. Expenditure on the following items is excluded:
- capital expenditure
- food or drink for consumption by the flat rate business or its employees
- vehicles, vehicle parts and fuel (excluding businesses that provide transport services, such as taxi firms, and which use their own or a leased vehicle to carry out such services).
These are excluded as part of the test to prevent traders from attempting to inflate their costs above 2%.
The government hopes that the introduction of the new rate will help to 'level the playing field' and maintain the accounting simplification for the small businesses that make use of the scheme as it is intended to be used.
The government has issued anti-forestalling provisions which are designed to prevent a business defined as a limited cost trader from continuing to use a lower flat rate beyond 1 April 2017. Businesses which provide a service on or after 1 April 2017 but either issue an invoice or receive a payment for that service before 1 April 2017 will be affected by the new provisions.
How will I know if my business is affected?
HMRC is set to introduce a new online tool to help businesses decide whether or not they should use the new 16.5% rate. It has also pledged to begin communicating with those businesses which will be affected, ahead of the 1 April 2017 implementation date.
If you believe that you will be affected by the new rules, or for more information on the flat rate scheme, please contact us today. We would be delighted to assist you.