There was very little in the 2016 Autumn Statement which directly affected small business, but one measure caught our eye; HMRC are changing the VAT Flat Rate Scheme.
The VAT Flat Rate Scheme is a simplified scheme for accounting for VAT. If you are VAT registered and on the scheme, you forego the ability to reclaim input VAT on your costs. Instead, you account for VAT on your gross sales, at a predefined percentage which is dependent upon your business type.
For example, a consultant may use a rate of 14.5%. Therefore, if they issue an invoice for £1,000 plus VAT (= £1,200), they will account for VAT of 14.5% on £1,200 = £174. The difference in VAT between what they charge (£200) and what they pay over to HMRC (£174) is supposed to represent the loss of input VAT which they can reclaim.
This element of the scheme has made it popular, as it has reduced the need to split out input VAT on purchases, which can be time consuming and difficult.
However, this is changing.
With effect from 1 April 2017, the change affects businesses with a very low cost base. These businesses are called “limited cost traders”. They can still use the Flat Rate Scheme, but their percentage will be 16.5%, so in the example above, the VAT they will pay over is £198.
What is a limited cost trader?
A business is a limited cost trader if its VAT inclusive expenditure on goods is:
- Less than 2% of VAT inclusive turnover, or
- More than 2% of VAT inclusive turnover, but less than £1,000 per year.
Goods are those used exclusively for business purposes, excluding:
- Capital expenditure,
- Food & drink for consumption by the Flat Rate business or its employees, and
- Vehicles, vehicle parts and fuel, unless the business is one which supplies transport services such as a taxi business
HMRC have introduced anti-forestalling measures to prevent businesses from reducing their post April 2017 turnover by issuing invoices early. If a business supplies a service on or after 1 April 2017, but issues an invoice or receives payment before 1 April 2017, then those supplies are treated as being made on 1 April 2017 for the purposes of considering whether the limited cost trade definition is met. More information in respect of the anti-forestalling measures can be found in the updated VAT Flat Rate Scheme guidance (sections 8.2 and 9.7).
Draft legislation will be published on 5 December 2016 for an 8 week period of consultation. HMRC have promised businesses an ‘Easy-to-use online tool’ to help them work out whether or not they are limited cost traders and should use the new rate of 16.5%.
HMRC have taken a simplification process and made it more complicated! It now offers very little incentive to use the Flat Rate Scheme if you are a service business, as you would presumably be better off operating VAT under the normal method and reclaiming input VAT on your costs. It would probably have been easier to raise the Flat Rate Scheme percentages all round – or perhaps that will happen next year!