Many contractors and other service providers will lose the cash benefit of the VAT flat rate scheme from April 2017, the chancellor announced in the Autumn Statement.
Flat rate
The flat rate scheme (FRS) is used by numerous small businesses to simplify their VAT reporting. Many businesses also gain a cash advantage by using the scheme, but this advantage is due to be cut back significantly from 1st April 2017. The FRS will continue but many businesses will not find it economical to use.
Cash advantage
When using the FRS, the business disregards VAT incurred on purchases when reporting VAT payable, except for capital items which cost £2,000 or more. The trader simply multiples his gross turnover (including VAT charged at the normal rates) by the FRS percentage set for his trade sector.
This FRS percentage is supposed to take account of the amount of VAT likely to be incurred on business expenses. Follow the link to see how much each type of business pays https://goo.gl/7XlCjY. If the business incurs few expenses, and it operates in a sector with a relatively low FRS percentage, it will pay out less VAT to HMRC under the FRS than it would outside the scheme. Numerous businesses register for VAT voluntarily before their turnover reaches the VAT registration threshold, so they can use the FRS and bank the cash advantage.
Abuse of FRS
The government believes small businesses have been abusing the FRS by using it as the law intended, so it is changing the terms of the scheme to make is less appealing to use, and to lower the cash advantage enjoyed by service-related businesses.
From 1 April 2017, a business will be required to use a FRS percentage of 16.5% if it is a “low cost trader”. This is likely to adversely affect businesses in all the trade sectors in the link above, and possible many other similar businesses, as 16.5% of the gross turnover is equivalent to 19.8% of the net leaving almost no credit for VAT incurred on purchases.
Low cost trader
This is a business whose expenditure on goods (not services) is less than 2% of its gross turnover, or if more than 2% of its turnover, the amount spent on goods is less than £1,000 per year. Any expenditure on; capital items, motor expenses, or food or drink for consumption by the business, is ignored when working out the 2% or £1,000 threshold.
This emphasis on ‘goods’ will discriminate against businesses who bring about VAT on services such as: rent, software licences, IT support, digital journals, sub-contractors, telecoms etc. In VAT terms a service is anything which is intangible, or where the cost relates to a tangible asset it is the temporary use of that asset – such as hiring.
Action to take
You must review the use of the FRS for every client who currently uses that scheme.
Businesses who are trading under the VAT threshold of £83,000 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.
Note that any attempt to invoice in advance for services to be provided on or after 1 April 2017, to capture that invoice within the FRS, will be treated as if the invoice was issued on 1 April 2017
If you are still unsure about the Flat Rate Scheme and would like some further hands on advice, feel free to call the offices on 0207 993 8661, email us on info@oswaldmurdock.com or alternately come down and visit the offices in Farringdon London.
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