Following the Autumn Statement, the Government have issued their draft legislation detailing the proposed changes to the VAT Flat Rate Scheme (FRS). They’ll come into effect on 1 April 2017 but may impact invoices issued and goods purchased from now onwards. Here you’ll find our initial review of the legislation and the changes it brings for independent professionals.
What is the FRS?
The FRS was introduced by HMRC to simplify the process of paying and reclaiming VAT for small businesses. On the standard scheme, businesses need to add up the VAT they have charged to clients and deduct the VAT they have paid on goods and services purchased. The difference is then payable to HMRC.
With the FRS, businesses pay a fixed rate of VAT to HMRC. The business then keeps the difference between what they charge their customers and what they pay HMRC. Under the FRS, businesses do not reclaim VAT on their purchases (except certain capital assets). For many contractors, consultants and small businesses the FRS is a preferred and simplified method.
So, what’s changing?
The changes have been designed to restrict potential abuses of the FRS by ensuring all businesses are paying the appropriate VAT. At the heart of the reform is the introduction of a new flat rate category; the Limited Cost Trader. This new category introduces a 16.5% rate for businesses with limited costs.
A limited cost trader is a business whose VAT inclusive expenditure on goods is either:
- less than 2% of their VAT inclusive turnover
- less than £1,000 in total, per year
A key change here is the definition of goods. When working out the amount spent on goods, it cannot include purchases of any capital expenditure (i.e. asset purchases), food or drink, or vehicles and fuel. This definition also excludes the purchase of services such as hosting fees, subscriptions to online journals, phones, email, insurances, accountancy fees, associate fees.
HMRC will soon be releasing an online tool to help businesses see if they fall into the limited cost trader category.
Should I leave the FRS?
If you meet the definition of a limited cost trader, and staying on the flat rate scheme means an increase in your VAT bill, then now may be the time to consider moving to the standard VAT scheme.
If this sounds like extra hassle, consider this for a moment: the flat rate scheme was conceived in the accounting technology dark-ages, to simplify record keeping for small businesses. Today, keeping accurate records using an online accounting app is now a matter of routine for most business owners. Calculating for flat rate or standard VAT simply comes down to which button you (or your accountant) presses at the end of the quarter. This means that for most people the transition from the FRS to the standard scheme will be virtually painless. As for the practicalities of leaving the FRS: it’s straight forward. Simply ask your accountant to write to HMRC.