The VAT Flat Rate Scheme (FRS) is designed to simplify the calculation of VAT due for small businesses. 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 but businesses can’t reclaim VAT on purchases except for certain capital assets over £2,000. The flat rates are determined according to the trade sector of the business and currently range from 4% to 14.5%.
As well as simplifying the calculation, the FRS may also save the business money, particularly if the business supplies services rather than goods. This is because businesses charge their customers VAT at 20% on the services they supply but only pay over VAT at the appropriate flat rate. If there are limited amounts of purchases made by the business, there is a relatively small loss of VAT reclaims on purchases and therefore an overall gain in using the FRS.
The government considers that some businesses with ‘limited costs’ are obtaining too much advantage in using FRS as, although they correctly use the flat rate appropriate to their trade sector, they have significantly lower costs than most small businesses in that sector. So a new flat rate of 16.5% for certain businesses with limited costs will be introduced from 1 April 2017.
The government estimates that of the 411,000 businesses using the FRS, 123,000 have limited costs and will be affected by these changes.
A ‘limited cost trader’ is defined as one that spends less than 2% of its VAT inclusive turnover on goods in an accounting period. A business is also defined as a limited cost trader if its expenditure on goods is greater than 2% of its VAT inclusive turnover but less than £1,000 a year. There will be exclusions from the calculation to prevent attempts to inflate costs above 2%. So some businesses will need to perform calculations to determine whether the trade sector rate or the 16.5% rate applies.
The additional tax cost may result in some businesses choosing to:
- cease to operate the FRS, or
- opt to deregister from VAT altogether where they are under the VAT threshold.
Please contact us if you are currently using the FRS and consider the new rate may apply to you. Also please contact us if you are not currently in the FRS and your VAT turnover is expected to be less than £150,000 (excluding VAT) in the next 12 months. You may find the FRS is of benefit to you.