It’s great when life gives you a little extra. Whether it’s the unexpected sale at your favourite shop or the five-pound note hidden in an old coat; sometimes it’s the simple things that bring that tiny but precious bit of joy.
HMRC isn’t often linked with joy, but for many smaller service businesses, the flat rate VAT scheme was their little bit extra.
For those not familiar with the flat rate VAT scheme, this was set up by HMRC to reduce the admin burden for businesses with a turnover below £150,000. Instead of completing a VAT Return by adding up the VAT on sales and deducting the VAT on purchases you simply multiplied your gross sales by a percentage set by HMRC for your industry.
While the scheme wasn’t always financially beneficial it was a real gem for service industries who had very low vatable expenses and whose customers were either VAT registered or who you could charge VAT to without losing a competitive advantage.
As an example, HMRC gave Computer and IT consultancy a flat rate percentage of 14.5%. Under the scheme, you would still charge your customer £100 plus VAT, but instead of paying the £20 over to HMRC, you would multiply £120 by 14.5% and therefore pay just £17.40 over to HMRC. This would give you a saving of £2.60 – your little bit of joy.
As of 1 April 2017, for many of these small service businesses, the joy is about to end.
HMRC has reached the conclusion that businesses have been voluntarily registering for VAT to take advantage of the scheme. This is of course, correct. For most, taking advantage of a tax saving that is there for the taking, is a wise business decision.
From 1 April 2017, HMRC will be introducing a new Flat Rate Scheme category called “Limited Cost Trader” and any business who falls under this banner must use the percentage of 16.5%.
You may feel that using 16.5% is still a tax saving, which it possibly is, but at best it’s nominal. To demonstrate, a £100 net sale would see you pay £20 over to HMRC. A £120 gross sale multiplied by 16.5% would see you pay £19.80 over to HMRC. That’s a VAT saving of 20p however in this instance you haven’t got the benefit of being able to offset VAT incurred on any of your purchases. So as a summary, if you have no Vatable purchases then you are 20p better off.
For almost all businesses considered a Limited Cost Trader currently on the Flat Rate Scheme it is worth reviewing whether this is still the best option.
So, would you be considered a Limited Cost Trader?
HMRC’s guidance says a limited cost trader will be defined as one whose VAT inclusive expenditure on goods is either less than 2% of their VAT inclusive turnover in a prescribed accounting period; or greater than 2% of their VAT inclusive turnover but less than £1,000 per annum if the prescribed accounting period is one year (if it is not one year, the figure is the relevant proportion of £1,000).
Aside from the 2% threshold, it’s HMRC’s conclusion of what is a good and what constitutes a service which will make the biggest difference and really highlights what type of businesses they wish to remove from the scheme.
Effectively, if a purchase is tangible (you can kick it) then it’s classed as a goods and if it’s intangible (you can’t kick it) then it’s a service.
So, things like rent, software subscriptions and licences (such as Xero), telephone expenses and subcontractors are all classes as services. HMRC also include your motor expenses, unless you run a garage as these are your cost of sales, as a service. Any kind of food or drink and capital expenditure is also classed as a service under the revised categories.
Goods are purchases that you resale, or non-capital repairs and renewals and stationery. If you hire equipment, then HMRC has said that they would treat this as goods.
As HMRC move rapidly towards their Making Tax Digital deadline, the changes to the Flat Rate Scheme contradict this slightly. For example, if you purchased any desktop software that comes in the post with a disc that you need to install it – that would be classified as a good. However, if you have a Xero subscription for instance, because you can’t kick Xero, that would be a service.
In short, if you run a cloud based, paperless business then the benefits of the Flat Rate Scheme will end for you on 1 April 2017.
So, what can you do?
If your turnover is under £83,000 then you may decide to deregister for VAT. If your turnover is over the VAT threshold, then it may be beneficial to move to the standard VAT scheme. This can either be on the accrual basis (VAT is calculated when an invoice is raised) or the cash basis (VAT is calculated when an invoice is paid).
Either way, we highly recommend that you contact us and we’ll help you to review your current position and what course of action will be beneficial to you and your business. It will also be worth thinking about any possible changes that may happen within your business over the next year or two. Once you deregister from the Flat Rate Scheme, you will have to wait a year
before you can re-join. So if you are thinking about bringing in a new product line, selling more goods or refreshing the office decor in the near future, it is important that this is considered.