Important changes to the VAT Flat Rate Scheme were phased in on 1 April 2017, and could have far-reaching implications for small and medium-sized enterprises (SMEs).
Many small business users of the Scheme who have low costs will see the rate they pay drastically increase under the reforms.
The VAT Flat Rate Scheme was originally created to simplify businesses’ record keeping, by making it easier for smaller companies to figure out their bills.
VAT is usually calculated via a two stage process, where VAT-registered businesses are required to deduct the VAT on their inputs, from their outputs.
In comparison, the Flat Rate Scheme used a simplified single step process, whereby they only paid VAT on the sale at a rate determined by their business’ type.
However, HM Revenue & Customs (HMRC) noted that the scheme led to some businesses effectively paying less or more than they would do under the ‘typical’ two stage VAT regime.
HMRC has been aware of this inconsistency for some time and has long suspected some businesses of using the rules to their advantage.
With this in mind, the Government has now introduced changes to the Scheme, which will see the rate of low cost businesses, referred to as ‘limited cost traders’, increase.
‘Limited cost traders’ can still use the Scheme, but their percentage will increase to 16.5 per cent. This means that if they sell £240 of work, including £40 of VAT, the flat rate amount payable is £39.60 or £240 x 16.5 per cent.
Under the new rules, Businesses that spend less than two per cent of their sales on goods (not services) in an accounting period are now automatically considered ‘limited cost traders’, as are those who spend less than £1,000 a year on goods – even if this is more than two per cent of the firm’s turnover.
When working out the amount spent on goods, this cannot include purchases of capital goods, food and drink, vehicles, or parts for vehicles.
IT contractors, consultants, hairdressers and accountancy firms, which heavily rely on labour, with very little other costs, are most likely to be affected.
Whilst construction workers who supply their labour, but are provided with their raw materials by a main contractor, are also likely to be hit hard by the new changes.