VAT Flat Rate Scheme Changes 2017 – Limited Cost Traders

On 23rd November 2016, as part of the Autumn Statement, HMRC announced that they would be bringing in changes to the VAT flat rate scheme from April 2017.

This article is to update you of the changes which will come in to affect from 1 April 2017 and they will likely affect a lot of contractors, freelancers and small businesses.

This article assumes you are aware of what the VAT flat rate scheme is, if not then we have a detailed article: VAT flat rate scheme vs standard scheme.

VAT Flat Rate Scheme Changes 2017

Changes to the flat rate scheme from April 2017

HMRC have announced changes to the VAT flat rate scheme in order to counter what they see as abuse of the scheme.

The flat rate scheme was brought in as a simplified way of dealing with VAT, however many businesses were able to make additional profit by being on the VAT flat rate scheme which HMRC are now closing out.

From April 2017 HMRC have introduced a new category of trader, a ‘limited cost trader’, with a VAT flat rate scheme percentage of 16.5%

Currently under the flat rate scheme a business chooses the appropriate flat rate percentage according to its sector, however under the new rules from April 2017 you will have to consider whether you will meet the conditions for a ‘limited cost trader’ and if you do you will have to use the 16.5% flat rate percentage.

 

What is a limited cost trader?

A business is a limited cost trader if its VAT inclusive expenditure on relevant goods is either:

  • less than 2% of the VAT flat rate turnover
  • greater than 2% of the VAT flat rate turnover but less than £1000 per year

If your VAT return period is less than one year the figure is the relevant proportion of £1000, for example for a quarterly VAT return this would be £250.

One thing to be really careful of is that you have to check each VAT return to see if you are categorised as a limited cost trader or not – you could be a limited cost trader for one VAT period, and then back to your usual flat rate category for another.

HMRC have an online tool that you can use to check your status for each VAT return, see below for link:

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

 

What counts as relevant goods?

With regards to what counts as relevant goods you can read HMRC’s guidance, section 4.6, HERE

In summary, relevant goods are used exclusively for the purposes of your business, but don’t include:

  • 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, see HERE
  • 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

HMRC have given the below examples of relevant goods, this is not 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 to use to provide hairdressing services
  • standard software, provided on a disk

 

HMRC have also given the below examples of items that are NOT relevant goods:

  • accountancy fees, these are services
  • advertising costs, these are services
  • an item leased/hired to 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, these are services
  • rent, this is a service
  • software you download, this is a service
  • software designed specifically for you (bespoke software), this is a service even if it is not supplied electronically

 

So what does all this mean?

As you will see from the above examples of costs , the majority of freelancers and contractors, as well as service based businesses, are likely to not have much in the way of relevant goods, so are likely to be categorised as limited cost traders.

If you are categorised as a limited cost trader it means that you may end up paying more VAT than if you were on the standard VAT scheme instead, so you should check your circumstances to see if you would be better off either leaving the flat rate scheme, or de-registering for VAT if you are below the de-registration threshold which is £83,000 from 1 April 2017 (rolling 12 months turnover pre VAT).

Example

Here is an example of the calculations for the new limited cost trader flat rate scheme category:

Lets consider a limited company contractor on the flat rate scheme, with income of £80,000 per year before VAT, who is classed under the new limited cost trader category.

£80,000 + VAT of £16,000 (20%) = £96,000 invoiced to clients

Flat rate scheme calculation 16.5% x £96,000 = £15,840

So of the £16,000 of VAT you have charged to your clients, you have to pay £15,840 of this to HMRC, leaving only £160 VAT gained.

This means that if you were on the standard scheme instead you would only need to claim back £161 of VAT on your costs over the year to be better off.

The 16.5% figure confuses many people as they assume this is compared against 20%, so the gain is 3.5%. This is not the case, the 16.5% is applied to total income including VAT, so the effective comparison of the new flat rate limited cost trader category for most people is 19.8% vs 20.0%, so only 0.2% gain.

Although you may be paying some more VAT if you stay on the flat rate scheme, you should also consider the simplification that the flat rate scheme offers – to move to the standard VAT scheme which allows you to reclaim VAT on eligible costs you will have to analyse and keep VAT receipts, for this reason you may still wish to remain on the flat rate scheme.

 

How to leave the flat rate scheme

If you want to leave the VAT flat rate scheme you need to send a letter to HMRC, see HERE for more information.

 

You can read HMRC’s full guidance on the flat rate scheme HERE.

 

Disclaimer