From 1st April 2017, changes to the Flat Rate VAT Scheme were implemented. We detail how these new flat rate changes affect contractors running their own limited company.
Background on the Flat Rate VAT Scheme
The Flat Rate VAT Scheme is a simplified method for eligible businesses to work out their VAT liability by applying a fixed percentage, based on the trade or profession to the VAT inclusive turnover. Under this method, any VAT reclaimable is restricted. This does not include the purchase of capital goods such as new equipment, food and drink and vehicles, parts of vehicles or other capital equipment greater than £2000.
For example, if you are an IT contractor, your fixed percentage would typically be 14.5%. If you invoice a client for £2,500 plus VAT you will pay HMRC £435 (£3,000 x 14.5%). The standard rated method involves calculating the VAT liability based on VAT charged on sales less VAT incurred on purchases.
Flat Rate VAT changes from April 2017
From April 2017, changes affecting businesses with a very low-cost basis have been implemented. These businesses will now be classed as “limited cost traders” if they spend:
- less than 2% of their VAT inclusive turnover on goods in an accounting period; or
- more than 2% of their VAT inclusive turnover but less than £1000 a year.
Goods do not include:
- any services – which is anything that isn’t goods
- expenses like travel and accommodation
- food and drink ate by yourself or your employee(s)
- vehicle costs including fuel unless you are in the transport business using your own, or a leased vehicle
- rent, internet, phone bills and accountancy fees
- gifts, promotional items and donations
- goods you will resell or hire out unless this is your main business activity
- training and memberships
- capital items for example office equipment, laptops, mobile phones and tablets
The government has published a tool to find out whether you meet the “limited cost trader” criteria. Click here to access this tool currently published on gov.uk.
A business that is deemed as a “limited cost trader”, should apply a new rate of 16.5% to their VAT inclusive turnover to calculate their VAT liability, instead of applying the fixed percentage based on their trade or profession. For example, a typical IT contractor, currently on a fixed flat rate of 14.5%, this means an increase of 2%. Note that if you are in the first year of the Flat Rate Scheme a further 1% discount still applies.
Who is affected by Flat Rate Scheme changes?
The measure will increase the VAT bill of businesses that are labour-intensive but spend little on goods.
Examples of the kind of entities that may be affected are IT contractors, consultants and construction workers who supply their labour but are not responsible for purchasing the raw materials.
How will the new Flat Rate transition to the new rate?
To ensure the transition of the new VAT rate of 16.5% where applicable, legislation was published on 23 November 2016 to prevent businesses from issuing invoices or receiving payments prior to 1 April 2017 for services provided post 1 April. Effectively, any such supply will be deemed to have taken place on 1 April 2017 and therefore subject (if applicable) to the new flat rate percentage of 16.5%.
What to do about the new Flat Rate scheme changes
If you are still within the first 12 months of VAT registration, you will still be eligible for the 1% first-year discount. This would mean that you are still on the most tax-efficient and simplistic scheme to calculate your VAT liability.
If you have been a user of the Flat Rate Scheme for more than one year and are deemed as a “limited cost trader”, leaving the scheme and accounting for VAT under the standard calculation method can produce a relatively insignificant sum of between £78 – £128 per annum (based on turnover of between £60k – £90K per annum and reclaiming input VAT on accountancy fees alone).
To reclaim input VAT on eligible purchases under this method, you are required to analyse and provide VAT receipts to support each purchase. This, of course, requires additional time for a potentially minimal benefit, dependent upon your level of expenditure eligible for reclaim.
The choice of whether to remain on the Flat Rate Scheme or move to a Standard VAT Scheme will be unique to each individual business circumstances depending on their capital expenditure. We recommend speaking to your accountant before making a decision.
Contact SJD Accountancy
If you require further help or support in making this decision please contact your accountant, or our SJD Accountancy experts on:
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