Why The VAT Flat Rate Scheme Is No Longer Beneficial For Many SMEs

From 1st April 2017, the UK government has announced it will be removing the VAT Flat Rate Scheme (FRS) that was introduced in 2002 to simplify the VAT calculations and payments of the smallest firms.

Over the last 15 years, SMEs with taxable supplies (i.e. sale of goods and services amounting to less than £150,000 a year, exclusive of VAT) were eligible for the FRS, minimising the work required to prepare a VAT return and calculate the tax due each quarter.

In addition, businesses across a range of industries would apply a fixed VAT rate, set for each sector by the government, to their gross of VAT income. For example, engineers were able to claim a Flat Rate of 14.5%.

HM Revenue and Customs (HMRC) announced last year that two-thirds of FRS-registered businesses registered voluntarily and were below the £83,000 annual sales threshold. The reason being that the voluntary registration created potential VAT savings in two ways:

1. Firms that do business with another VAT-registered business can reclaim VAT on its own costs; while any VAT charged against its VAT-registered customer is paid for by them.

2. The percentages offered to many industries within the VAT FRS enabled businesses to secure a profit; in particular those with minor overheads. This is the area that HMRC believes has been ‘abused’ by many businesses.

In a bid to “remove the cash advantage” for small businesses with small overheads, HMRC will require all FRS-registered businesses to find out whether they are regarded as ‘limited cost traders’. This is a business whose VAT outlay on goods or services is below 2% of their overall VAT-inclusive turnover per quarter or more than 2% of their VAT-inclusive turnover, yet smaller than £250 each quarter.

Relevant goods and services exclude items such as business vehicles, fuel, refreshments for consumption by the business or its staff and pure capital expenditure.

In the event you are labelled a limited cost trader from 1st April, you will be subject to the new 16.5% VAT rate. Subsequently, for industry professionals such as those engineers previously on 14.5% they will lose out despite having continued to run their business the same way.

What’s the solution? The Standard VAT Accounting Scheme?

The changing rules mean many small retailers will simply be better off operating within the Standard VAT Accounting Scheme, allowing business owners to pay VAT on sales, whether or not their clients have paid them. They will also be able to claim VAT on supplier invoices, whether or not they have been paid.

On the Standard VAT Scheme, the VAT noted within a business’ sales and purchase invoices will be submitted to a VAT control account within most standard types of accounting software; keeping an accurate record of every amount of VAT paid and received in your business within a single framework.

At the end of each financial period – typically quarterly – business owners simply report to HMRC the difference between the VAT paid to them and the VAT out. If a business’ Sales VAT is greater than their Purchase VAT they must pay the difference to HMRC and vice versa.

For specialist VAT guidance for your retail business needs, please don’t hesitate to contact Virgate Accounts on 01452 226111 or drop us a line at help@staging.virgateaccounts.com.