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The Impact of Flat Rate VAT changes on small businesses

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Odiri Tax Consultants & Accountants
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Odiri Tax Consultants & Accountants, Odiri Tax Consultants & Accountants

Controversial new changes that are being made imminently will adversely affect many one-person and other small businesses. Here is an outline of what to expect.

The Flat Rate Scheme for VAT (FRS) is being altered from April 2017.

FRS is a scheme that has real benefits for hard-pressed owner-operator businesses and they can ill-afford new costs on top of the 7.5% dividend tax increases (that have been calculated to add over £1,500 p.a. to those drawing £48k, but only just over £1,300 p.a. to those drawing £78k because of the inequities of the tax banding).

Micro-businesses with an annual turnover of under £83,000 are not obliged to register for a full VAT accounting scheme (whereby you charge VAT to most categories of customer but can claim back VAT on qualifying purchases and business costs). It requires quarterly returns and payments, which small businesses often find onerous.

Under FRS, accounting is simpler. It can be used by businesses with a turnover of under £150k. You do not pay over VAT in the normal way, you charge it then automatically pay over the difference between what you have charged, and a reduced percentage on your costs based on your business sector (based not on the net sales but on VAT-inclusive sales). Because not all purchases are subject to VAT, many fully-registered VAT companies in reality are still better off than FRS ones, so it can be a close call which way to go.

So for example, different retailers pay different percentages:

  • Retail of food or childrens’ clothing: 4% (because these are supplied and sold at zero rate)
  • ‘Other retail’ not otherwise classified: 7.5% (because on average some VAT items are included in the course of business)

What is the change?

Because the ‘black sheep’ were in the employment sector, where people sell their own services and their costs are extremely low, the Government has focused on ‘Limited Cost Traders’, or labour-only operators.

These have costs of less than 2% of their turnover, or less than £1,000 p.a. if the costs total more than 2%. They will in future have to pay 16.5% tax. This in conjunction with the current increase in tax on dividends will make it a tough year for many.

This is an increase for many consulting firms that previously paid 14.5%. But that’s not the only bad news.

In addition, tight new constraints are being applied by HMRC on what expenses the business can claim. Although they are in the services sector, and by their very nature they will sub-contract services from other practitioners, or buy in IT (even just in terms of essential web server supply) they will not be able to mitigate these fundamental costs. Only hard physical goods will count. Even then, there are important exceptions – you cannot claim for:

  • Food and drink, even if this is for sustenance on a business trip
  • Vehicles and parts, even though many people cannot operate without a car or van ( except where the business is one that carries out transport services – like taxi)
  • Capital goods, unless they are capex of over £2,000 – so blown-up printers or computer cables cannot be claimed

What are the options?

There are three routes that such operations can follow:

  1. Continue with the FRS Scheme and swallow the cost increases
  2. Register voluntarily for the full VAT accounting scheme
  3. De-register completely from VAT

We at Odiri Tax Consultants are specialists in accounting for small businesses and we can advise you on the best course to take in your particular situation.

If you continue with FRS in such cases, your costs will rise but you will continue to have a somewhat easier administrative burden, but it is about to become more onerous than before in terms of qualifying costs.

If you switch to the full scheme then your quarterly accounting will be more time consuming and you will in many cases require our services to offload the burden as well as ensuring that you avoid costly mistakes and penalties.

If you de-register then you lose the administration work: but you cannot claim back any VAT costs that you suffer in the course of your business.

We stand ready to assist you with any queries or concerns that you may have in this fast-changing situation. Call us on 01733808075.