Warning: Flat Rate Restrictions Ahead

Thursday, December 1, 2016

Taking up just a few seconds of airtime in Parliament and only one paragraph of the Autumn Statement document, a significant announcement was nestled deep in the Autumn Statement that will impact many small businesses, particularly contractors and service providers – including accountants.

. In an unexpected move, the Government is restricting the advantages of the VAT Flat Rate Scheme (FRS).

This will affect the amount of VAT that many businesses pay, specifically those currently using the VAT Flat Rate Scheme, but which spend relatively little on raw materials and buying-in ‘goods’. Given that three quarters of all businesses in the UK are in the services industries, the Autumn Statement announcement is pertinent to the many firms availing of the scheme to simplify their taxes and gain cash advantages.

From the 1st of April 2017, the Government will introduce a new 16.5% rate of VAT for businesses with limited costs. The Autumn Statement says: “This will help level the playing field, while maintaining the accounting simplification for the small businesses that use the scheme as intended.”

Currently businesses determine which flat rate percentage to use by reference to their trade sector. It is complicated, with percentages varying for different types of business, and different ‘types’ of sales being classified in different ways. Given it is just an approximation, businesses consequently pay different levels.

Concerned that some businesses are exploiting the (legal) ambiguities in the scheme to pay less VAT than they might. Mr Hammond has tightened the potential loophole. The full legislation is unlikely to be published until March 2017 and will come with anti-forestalling provisions.

The changes will affect ‘limited cost traders’, those with a low-cost base, defined as a firm that spends less than 2% (or less than £1,000) of its sales on goods – not services – in a financial year. These ‘limited cost traders’ will still be able to use the Flat Rate Scheme, but the percentage will be fixed at 16.5%.

It is worth noting that the term ‘goods’ does not cover new equipment and capital goods, food and drink, or vehicles or parts thereof. It also refers to tangible items, which ignores the swathe of businesses in the service sector that incur VAT on services including IT support, sub-contractors, software licences, digital subscriptions, etc.

Ultimately the scheme is becoming less attractive and reducing the cash advantage of using it. The losers in this tax change will be those spending very little on physical ‘goods’, so labour-intensive firms – service providers with relatively small outgoings – like accountants. Retailers, restaurants, and firms with higher cost of sales will fare better.

There will be businesses that can remain within the scheme, but that will pay more because of the changes – it may no longer be an economical option. A new online tool will be published in due course to help show whether a business should use the new rate; prompting firms to consider whether to apply to join the scheme at all.

SMEs and advisors to small businesses need to be informed; now is the time to review all clients you have currently on the scheme. Businesses trading under the VAT threshold may opt to deregister from VAT when these new measures come into effect, and those trading over the threshold may need to exit the scheme. Many firms will be better off using standard VAT accounting and recovering VAT on expenses.

While it doesn’t come into effect until April of next year, draft legislation will appear in early December. Should you wish to make your voice heard on this topic, businesses will have a couple of months to respond with their views.  You can read more on the changes here.