Is flat rate about to fall flat?

Emma Woods explains that VAT regulations are set to change at the beginning of April 2017. The new regime may effectively spell the end of the flat-rate scheme for many small businesses.

For a number of years now, many businesses with a turnover of less than £150k have opted to make use of the flat-rate VAT scheme.  Rather than balance the VAT they charge with the VAT they incur through purchases, they are given a percentage figure to apply to the gross sales over a three-month period. This rate will depend on the industry they are in and can vary quite considerably. In compensation for the beneficial repayment rate, they are not allowed to claim back VAT they have been charged, the only exception being capital items above £2,000.

In December 2016, the government entered into consultation on the flat-rate scheme which makes it much less attractive to many small businesses. Originally, it was effectively possible for small companies to gain from the charging of VAT, by retaining a proportion of the money collected as taxable profit. HMRC seems determined to close off what is now seen as a loophole, but which may have been presented originally as a benefit to encourage registration and growth rather than supressing sales to stay below the VAT threshold.

From 1st April 2017, a large proportion of businesses on the flat-rate scheme will have to apply the figure of 16.5% to their gross sales. So with £100,000 in sales and £20,000 in VAT on top, charged out to customers, the payback rate becomes £19,800. As a result, many small business owners currently on the flat-rate scheme may choose to opt out and record VAT in the traditional way.

There is, however, one way in which you can stay on the flat-rate scheme and retain its more favourable terms. That is if you can prove you are not a ‘limited cost trader’.

The definition of the limited cost status is that your expenditure on goods is less than 2% of your VAT-inclusive turnover. In some circumstances, it may be more than 2% but less than £1,000 per annum.

The issue giving accountants sleepless nights is over the precise definition of goods. We know that it excludes capital expenditure, food and drink and any type of vehicle maintenance or fuel (unless you’re running a taxi service). Where things become more complex would be, for instance, over the purchase of something like a software subscription. It seems that if the software is bespoke to your business, it will probably count as a service not goods.

It’s these kinds of assessments that small businesses will need to make and it’s important to take professional advice, as the situation is still fluid and everyone is racing to interpret what exactly the new regime will mean. HMRC will be writing to all affected companies in due course, but given the short time frame, it is well worth starting a conversation with your accountant to be prepared for 1st April.