Flat rate scheme changes: bad news for sole trader business advisers

In the 2016 Autumn Statement the Chancellor of the Exchequer announced a change to the Flat rate scheme to address an abuse of the scheme. The Flat rate scheme is intended to provide small businesses with an administratively easy way of accounting for VAT. The scheme is intended to bring in about the right amount of VAT without giving businesses a significant saving on the amount of VAT they pay.

The scheme works by allowing small businesses, those with a turnover of up to £150,000, to pay HMRC a percentage of their VAT inclusive income, rather than use the standard system. Under the standard system of accounting for VAT a business pays the difference between the VAT is has charged customers, and the VAT it has been charged by its suppliers. Under the Flat rate scheme businesses would sometimes pay a little too much VAT, and at other times pay a too little, when compared to the standard system. Overall the two would give more or less the same answer.

The abuse arose because some service providers that have low costs, e.g. a VAT consultant, compared to income were paying far less VAT than would have resulted had they been using the standard system of VAT accounting. The change is intended to address this.

HMRC have decided that ‘low cost traders’ are those businesses that spend no more than 2% of their income in a VAT period on goods for the business. HMRC are excluding capital expenditure, food bought for consumption within the business, cars, car parts, etc. The definition of capital expenditure is wider than usual, covering any items that are used by a business for more than a year, e.g. mobile phones, tablet computers, etc. Businesses that use cars to provide their service, e.g. taxi and car hire, will be allowed to include the cost of cars, parts, etc. in the calculation of the 2% figure.

From 1 April 2017 ‘low cost traders’ will have to review their spending and if they fail to meet the new criteria will have to apply a flat rate of 16.5% to their VAT inclusive income to work out how much VAT to pay in that period. This is going to be significant change in the amount of VAT that these businesses have to pay.

This article is only intended as an overview. If you think your business is going to be affected, I suggest you ash a professional adviser for further information.

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