Changes to the Flat Rate VAT Scheme

Changes to the Flat Rate VAT scheme, used by small businesses with an annual turnover less than £150,000, will come into effect from 1 April 2017.  The main change that interested us as contractor accountants is that the new rate will be a straight 16.5% regardless of your industry or type of work. Previously several different rates applied, some as low as 9%.

As it stands, the Flat Rate scheme simplifies record keeping for small businesses, by making it easier for them to work out the amount of VAT they must pay. It reduces the usual two-step process of deducting the VAT on what they buy, from the VAT on what they sell, down to just one step. So the firm just pays VAT on a flat rate percentage of turnover.

The changes have come about because government believes that some businesses are using the flat rate VAT scheme in a way which enables them to pay much less VAT than they should.

Flat rate VAT schemes have previously been quite lucrative to those small businesses who operate with a very low vatable cost base. While such businesses can still use the Flat Rate Scheme the increased percentage of 16.5% means there is very little financial incentive or advantage to the flat rate scheme. To illustrate: if they sell services of a value of £120 which includes £20 of VAT, then the flat rate of VAT they pay will be 16.5% of £120 so £19.80 – a 20 pence saving for every £100 pounds of sales, or £200 on every £100,000.

The new Chancellor Phillip Hammond has now termed such businesses “limited cost trader”, and defined them as those that spend less than 2% of their sales on goods in an accounting period. This spend on goods cannot include the purchase of capital goods, food and drink or vehicles and parts of vehicles. A firm will also be classed as a ‘limited cost trader’ if it spends less than £1,000 a year on goods, even if this is more than 2% of their turnover.

This change will impact most on businesses which are very labour-intensive and  which spend very little on goods particularly those individuals trading through limited companies as contractors, such as IT Contractors, Oil and Gas Contractors, Aerospace Contractors. It will also affect those contractors who work in construction where the materials they use are provided by the main contractor.

The new rules will be enforced from April 1st next year, but may start to affect things such as invoices issued and goods brought from now onwards. You can find out more information on the HMRC site, or just email us on ask or give us a call on 0161 456 9666.

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