Changes to the VAT flat-rate scheme

A look at how the changes may affect users

One of the major changes announced in the Chancellor’s 2016 Autumn statement was to introduce the concept of a ‘limited cost business.’ 

This is relevant from 1 April 2017 and has a direct effect on small businesses including many ACCA members. It is important that you are clear on the changes and the potential effect on your VAT returns.

If affected, ACCA members in practice will need to apply a new, higher flat rate percentage. This could potentially make the FRS much more expensive and may even mean a switch to another method of VAT calculation.

Legislation explains a limited cost business (LCB) is ‘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 £1000 per year (pro-rata for a quarter ie £250).

If doing quarterly VAT returns, this test has to be done each quarter if the value of goods is close to the 2% rule. If the above test is failed, accountants may need to pay the new rate of 16.5% instead of the normal 14.5% (ignoring first year discount).

So the key is to establish what are the ‘relevant goods’. VAT notice 733 defines these as goods that are used exclusively for the purposes of your business.  However these specifically do not 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
  • 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 (ie rent for instance).

At a recent HMRC webinar on the subject, accountants had the following important questions which are worth reproducing along with our opinion:

Q 1: In theory, in one year could you have to switch between the 16.5% if costs fall below the £250 in two out of the four quarters?
A:  Yes, each quarter the business has to check the criteria if they are still ok to use the lower rate applicable to the trade sector. It is important as the spent on relevant goods may change each quarter.

Q 2: If a business is within the first year in the FRS, will they have the option to leave? (Normally you have to stay in for one year)
A: If you wish to leave the scheme you must write and tell HMRC. It would expect that most businesses will leave at the end of an accounting period. However, you may leave voluntarily at any time during an accounting period. 

Q 3: Are exempt and zero rate supplies included in flat rate turnover?
A: Yes, exempt supplies i.e. rent are the part of your FRS turnover. You may pay more VAT by being on the scheme if these supplies are a larger proportion of your business turnover than the average for your trade sector. You do not have to make any partial exemption calculations. 

Q 4: Is my software cost part of ‘relevant goods’?
A:   Strangely, it depends! If it is standard software, which is provided on a disk, then it falls in the relevant goods category. But if it is software that you ‘download’ or ‘designed specifically for you’- it is a service and not part of relevant goods. The distinction between these two is not very clear especially where software providers may give the accountant the choice of how to obtain the goods. 

ACCA members now have little time to decide where their business stands but it is anticipated that many will be affected as they may have few relevant goods as determined above. 

You will need to weigh up the alternative VAT options as the increase in the rate coupled with the extra corporation/income tax on the excess produced by the FRS may well mean that a standard rate approach is equally or more profitable.  However the ease and convenience of the FRS cannot be easily dismissed.

On a positive note, HMRC has issued an online tool for businesses to use to help calculate what rate of flat rate vat should be paid in the relevant period.