Although changes to VAT is generally only water cooler chat within accountants offices, the announcement by Chancellor of the Exchequer Philip Hammond of changes to the Flat Rate Scheme should be essential reading this week for all VAT registered sole traders and small businesses.
Below we have set out some key information about these changes and how they may affect your business.
What is the VAT Flat Rate Scheme (FRS)?
Normally, the amount of VAT a business pays over to HMRC is VAT charged on sales less VAT reclaimed on expenses. However, businesses with a VAT exclusive turnover of £150,000 or less have the option to apply to join the Flat Rate Scheme.
A benefit of this scheme is simplified tax management for sole traders and small businesses who, rather than calculating their VAT liability as mentioned above, instead pay a fixed percentage of sales.
E.g. A hairdresser on the FRS at 13% charging a customer £10 including VAT would be liable to pay HMRC £1.30.
Although tax savings were not intended as a benefit of the scheme, many sole traders and small businesses who’s expenses consisted significantly of labour costs, for example, could end up reaping such a reward. Although this is about to change…
What is changing?
The Chancellor of the Exchequer has announced a significant change to the Flat Rate Scheme for what will now be called ‘limited cost traders’ who will have to use a rate of 16.5%.
According to HMRC’s website, businesses using the FRS will be defined as a limited cost trader if:
- VAT inclusive expenditure on goods is less that 2% of VAT inclusive turnover
- Greater than 2% but less than £1000 per annum.
This expenditure on goods will exclude capital expenditure, food and drink used by the business and it’s employees or vehicles (including vehicle parts and fuel – except for transport service businesses). The purpose of the exclusions being ‘to prevent traders buying either low-value everyday items or one-off purchases in order to inflate their costs beyond 2%’
Will This Affect Me?
Labour intensive businesses (e.g graphic designers, accountants, IT contractors, consultants, hairdressers, etc) who spend very little on goods will end up paying more VAT over to HMRC. This will be due to the increased flat rate percentage of 16.5% which is higher than any of the current FRS percentages currently used (a list can be found here).
What Should I Do?
The new changes come into force on 1 April 2017. If you are already registered on the FRS or are currently considering doing so, you should analyse your sales and costs to determine whether being registered on the FRS will be beneficial to your business in line with HMRC’s definitions in their technical note on the change .
We will continue to update this post as further details and guidance are released by HMRC, but in the meantime if you seek assistance in understanding the changes or working out how they might affect you, do not hesitate to contact us.