Changes to the VAT Flat Rate Scheme (FRS), announced in the Autumn Statement, came into affect on 1 April 2017. Businesses defined as being a ‘limited cost trader’ will now have to calculate VAT using an increased flat rate percentage. We explain what this will mean for many businesses using the FRS.
The VAT Flat Rate Scheme (FRS) is designed to make it easier for small businesses to calculate the VAT they must pay.
Under the scheme, VAT is calculated by applying a predetermined flat rate percentage to the business turnover. The flat rate is lower than the 20% standard rate of VAT. The percentage is determined by the trade sector in which the business operates and ranges from 4% to 14.5%. Unlike the standard VAT scheme, businesses using the FRS can not reclaim the tax on purchases other than for certain capital assets over £2,000.
As well as lightening the administrative load of VAT, the FRS may also save the business money. If the business supplies services rather than goods they would still charge their customers VAT at 20% for their services, but only pay VAT at the appropriate flat rate. Where the business only makes a limited number of purchases, using the FRS would lead to an overall gain.
Businesses ‘taking advantage’ of VAT Flat Rate Scheme
The changes are designed to tackle cases where the government considers businesses with ‘limited costs’ gain too much advantage by using the FRS. Although they are using the correct flat rate for their trade, they have significantly lower costs than most small businesses in the same sector. A new flat rate of 16.5% for certain businesses with limited costs is now in effect as of 1 April 2017.
The government estimates that the new rate will affect 123,000 of the 411,000 businesses using the FRS due to them having limited costs.
What is a limited cost trader?
A business that spends less than 2% of its turnover inclusive of VAT on goods in an accounting period is classed as a ‘limited cost trader’. A business will also fall into the category of limited cost trader if it spends less than £1,000 a year on goods – even if this figure is more than 2% of its VAT inclusive turnover. Exclusions are in place to prevent attempts to inflate costs above 2%. Some businesses will need to perform calculations to work out whether to use the rate for their trade sector or the 16.5% rate.
The new rate and increased VAT liability may lead some businesses to:
- discontinue using the FRS, or
- opt to deregister from VAT altogether in cases where they are under the VAT threshold.