Changes to VAT Flat Rate Scheme for business who do not purchase goods
HMRC are making an alteration to the VAT flat rate scheme (FRS) categories to include a new ‘limited cost trader’. Businesses that fall within this category will be required to use a new FRS percentage of 16.5% from 1st April 2017. HMRC say the new limited cost trader category will increase the annual tax yield by £130m.
The changes will affect businesses who supply services the most, including IT professionals, Consultants, Architects, Legal advisors and Labour only builders.
What the changes mean and working out if you are a limited cost trader
From the 1 April 2017, you will need to work out if you are a limited cost trader. To do that you need to know two items of information for each VAT return you complete:
- Your turnover
- The cost of goods purchased (see below “what are relevant goods”?)
You’re a limited cost business if the amount you spend on relevant goods including VAT is either:
- Less than 2% of your VAT flat rate turnover
- greater than 2% of your VAT flat rate turnover but less than £1,000 per year or £250 a quarter
This test will need to be completed each time you complete a VAT return. This is because you can move from a limited cost rate of 16.5% in one period to your relevant sector rate in another. This would happen if your costs fluctuate above and below 2%.
An IT consultant business has a FRS turnover of £10,000 a quarter including VAT. The business spends £240 on relevant goods. This is more that 2% (£200) of the flat rate turnover and less than £250. The rate the business must use is the 16.5% limited cost trader rate for the business. The business will pay £1,650 at 16.5% to HMRC. Before the 1st April 2017 the business would have used a rate of 14.5% for a busines in the computer and IT consultancy or data processing category and paid £1,450 to HMRC. The business is £200 worse off as a limited cost trader for the quarter and possibly £800 (4 quarters VAT returns at £200) worse off for the year.
What are relevant goods?
Goods are tangible physical items, think bricks for a builder or beer for a pub. Non-goods are services, think accountant’s fees or internet line charges.
Examples of relevant goods
This isn’t an exhaustive list:
- stationery and other office supplies to be used exclusively for the business
- gas and electricity used exclusively for your business
- fuel for a taxi owned by a taxi firm
- stock for a shop
- cleaning products to be used exclusively for the business
- hair products used to provide hairdressing services
- standard software, provided on a disk not as a download
Examples of supplies that aren’t relevant goods
This isn’t an exhaustive list:
- accountancy fees
- advertising costs
- an item leased/hired by your business, this counts as services, as ownership will never transfer to your business
- food and drink for you or your staff, these are excluded goods
- fuel for a car – this is excluded unless operating in the transport sector using your own, or a leased vehicle
- laptop or mobile phone for use by the business, this is excluded as it is capital expenditure
- anything provided electronically, for example a downloaded magazine
- software you download
- software designed specifically for you (bespoke software), this is a service even if it is not supplied electronically
What are the options to beat the effects of being classed as a “limited cost trader”?
If a business expects its taxable sales in the next 12 months to be less than £81,000 (the deregistration threshold) then it can deregister. This will avoid having to worry about limited cost trader calculations and might save some VAT for customers unable to reclaim input tax. Many businesses will decide to deregister if they are limited cost traders every quarter, because of the minimal input tax credit effectively given by the 16.5% rate and the administration time they can save by not having to account for VAT on VAT returns to HMRC.
An IT consultant business is on the FRS and has gross sales of £10,000. The VAT charged on those sales is £1,667. The business is a limited cost trader and will pay VAT of £1,650 at 16.5% to HMRC. It has retained a VAT FRS profit of just £17.
Leave the FRS and use the traditional method
An option is to revert to the traditional method of calculating VAT. Buy recording VAT collected and paid out and then paying the difference on a quarterly basis. Businesses with all standard rated sales only needs to have input tax of more than £10 per £1,000 of output tax to be better off with normal VAT accounting. This decision should consider the time saving benefits of the FRS – is it worth paying more tax to retain these benefits? A business must notify HMRC of its decision to leave the FRS. Once a business leaves, it cannot re-join for 12 months.
An IT consultant business has net sales of £8,333. The VAT charges in those sales is £1,667 the gross value of the sales is £10,000. The business purchases £500 of goods and services with £83 VAT charged. The business files a VAT return and pays HMRC £1,584. The business has managed to retain £83 of the VAT it has paid.
Revised buying strategy
The biggest spending of service businesses on ‘relevant goods’ will be on stationery items. A possibility is to spend 2% of gross sales each quarter on buying stationery. Print cartridges are the best option as they are expensive consumable goods. The cost of the stationery stock is a business expense, so is within the definition of ‘relevant goods’. Additionally, many service-related businesses buy a lot of expensive technical books. There is an argument that those businesses should always buy hard copy books (goods) in future, rather than subscribe online for the publications (services).
An IT consultant business has gross sales of £10,000. The VAT charged on those sales sales id £1,667. The business purchases £150 of books and £100 of printer cartridges. The business files a VAT return using the 14.5% flat rate used by businesses in the computer and IT consultancy or data processing category and pays HMRC £1,450. The business has managed to retain £217 of the VAT it has charged to it is customers.
Savvy VAT shopper
Note how the business on example 4 is a savvy VAT saver and ensures the £150 spent on books and £100 on printer cartridges are in the same VAT return period. This allows the 14.5% IT rate to be used. If the books and cartridges were purchased in different VAT quarters the 16.5% rate as a limited cost trader for the VAT quarter would have been used.
If a business likes to forward plan and can buy £250 of goods in different VAT quarters. It maybe be possible to adopt the 14.5% rate over 4 different quarters. If it is not possible to spread the £250 spent on goods evenly between the VAT quarters, but the business expects to spend £1,000 on goods over the year, an annual VAT return can be completed allowing the whole VAT year to benefit from the 14.5% available to IT consultancy.
Unless a FRS business is expected to spend £1,000 on relevant goods each year, such businesses trading under the VAT deregistration threshold of £81,000 may want to deregister from VAT with effect from 1 April 2017. Businesses who are trading over that threshold may need to withdraw from the FRS from the same date.