What is the Flat Rate VAT Scheme?
The Flat Rate Vat Scheme (FRS) is an alternative to standard VAT registration, open to businesses with an expected turnover of less than £150,000 (£180,000 including VAT).
Under the scheme, you charge VAT to your clients at the standard rate of 20% and you pay HMRC a lower percentage of your VAT inclusive turnover. Unlike standard registration, you do not offset VAT paid by your business. The percentage used depends on your business activity and the corresponding FRS category.
Recent changes to the scheme
In April 2017, the government introduced a new flat rate category of 16.5% for businesses who fall into the definition of a "limited cost trader".
The government made this change because they believe that the Flat Rate VAT scheme has been abused in certain sectors where a limited company is used solely for the purpose of accessing the Flat Rate VAT benefit for a worker who is caught by IR35. However, genuine contractors across all market sectors will be impacted by the changes.
Who is classed as a Limited Cost Trader?
The new Flat Rate percentage applies to “limited cost traders”. HMRC guidance defines a business as a “limited cost trader” (LCT) if thier VAT inclusive expenditure on relevant goods is either:-
Less than 2% of their VAT inclusive turnover in a prescribed accounting period
Greater than 2% of their VAT inclusive turnover but less than £1,000 per annum if the prescribed period is one year (if not the £1,000 is pro –rated)
The meaning of relevant goods in this context is not defined in the legislation and therefore takes its everyday meaning and generally covers tangible items.
The legislation specifically excludes the following from the definition of “relevant goods”:-
Capital expenditure on equipment
Food and drink
Vehicles, vehicle parts and fuel
This affects a large number of contractors and freelancers as many of you have minimal vatable expenses, certainly in relation to the purchase of goods.
What impact does the change have on your income?
For many contractors this change meant a reduction in company profits and therefore take home pay. For example:
John is an IT Consultant. He is registered for Flat Rate VAT and is in his second year of trading so under the old rules he applied the rate of 14.5%
John made a surplus on the Flat Rate VAT scheme of £3,000
Post April 2017, John is classed as a “limited cost trader”
His expenditure on “goods” is £600 including VAT and as this is less than 2% of the £140,000 VAT inclusive turnover he falls into the definition. His other costs are deemed to be services.
Under the new rules, assuming John's business performs exactly as it did last year, he will make a surplus of £233
This is a reduction in profit for the year of £2,767
What should you do next?
Talk to your accountant. Depending on your circumstances and the industry you operate in you will have some choices:-
If your turnover is below the VAT threshold you can choose not to register for VAT
If you need or want to register for VAT you can choose to join the Standard Scheme or the Flat Rate Scheme
If you are on the standard scheme and are considering the flat rate talk to your accountant to see if it will still be beneficial