VAT Flat Rate Scheme changing

richard.baldwyn Public

“I trade through a limited company which is registered for VAT under the Flat Rate Scheme.  I have heard that the VAT Flat Rate Scheme is being changed from next year. What are these changes and how will they effect my business?”

In The Autumn Statement the Chancellor announced changes to the existing VAT Flat Rate Scheme (FRS – introduced in 2002) to tackle what the Government perceives as abusive behaviour by businesses.

What are the changes?

From 1 April 2017 HMRC will introduce a new category of trader – known as a ‘limited cost trader’ – which will have a FRS percentage of 16.5%.

Who will be regarded as a limited cost trader?

You will be treated as a limited cost trader if your VAT inclusive expenditure on goods is:

  • Less than 2% of your VAT inclusive turnover; or
  • More than 2% of your VAT inclusive turnover though less than £1,000 per year

What are goods as far as the new rules are concerned?

Goods are anything used exclusively for business purposes except:

  • Capital expenditure. So for example you won’t be able to purchase a new computer in order to circumnavigate the 2% rule detailed above.
  • Food and drink for consumption by you as the business owner or your employees. This is consistent with the existing rules whereby VAT recovery is blocked on business entertaining expenditure.
  • Vehicles, vehicle parts and fuel, unless your business is one which supplies transport services for example a taxi business. In any event VAT recovery on the purchase of a car, or repairs is blocked/restricted for a number of existing businesses.

Who are these measures aimed at?

The new rules are aimed at making the Flat Rate Scheme far less attractive for service-related businesses such as IT consultants or accountants who incur VAT on services such as rent, software licences, telecoms and so on but not on physical goods.

What action do I need to take?

Going forward for each VAT accounting period, you will need to consider whether your business is a limited cost trader. If you are a limited cost trader, then your FRS percentage will be 16.5% regardless of what business sector you operate in.

HMRC have promised to introduce an ‘easy-to-use online tool’ to help business owners determine whether they are a ‘limited cost trader’ and whether they should apply the rate of 16.5%. However given the unreliability of HMRC’s online services (e.g. their Government Gateway for new PAYE schemes) we are sceptical as to how well this will work in practice.

Are there any other changes I need to be aware of?

HMRC have introduced measures which take immediate effect where a business tries to reduce their post 1 April 2017 turnover by issuing invoices early.

When do these measures apply?

For most businesses, the new rules will apply for any invoices raised after 1st April 2017 which relate to services supplied after 1st April 2017.

However beware if you issue an invoice or receive a payment before 1st April 2017 which relates to services supplied after 1st April 2017.  If this applies to you then, for the purposes of considering whether the limited cost trader definition is met, your VATable supply will be treated as being made on 1st April 2017.

Where your services are performed during a period which spans 1st April 2017, an apportionment must be made on a fair and reasonable basis when applying the new flat rate percentage.

You will also need to make adjustments to your VAT turnover if you issue an invoice or receive payment after 23rd November 2016 (the date these measures take effect) and before 1st April 2017 which relate to services performed on or after 1st April 2017.

Our view…

Given that the FRS has been in force for a number of years, these changes are effectively bolting the proverbial stable door after the horse has left.  The FRS was originally introduced with the intention of simplifying accounting for VAT and to encourage small businesses to comply.  Many small business owners who are still reeling from the effect of the new dividend tax must feel particularly aggrieved by these changes. The anticipated tax yield is relatively modest and once again the Government appears to be tinkering around the edges and hitting small businesses rather than tackling head on the wide scale tax avoidance carried out by the multi-nationals.

Historically it may be that you have been better off using the FRS so from 1 April 2017, when you have to apply the higher percentage of 16.5%, you may be better off exiting the scheme and calculating VAT due to HMRC as normal. You will also have to consider whether the administrative advantages of remaining within the scheme outweigh the additional cost.

Next Steps

If you are concerned about how these changes might effect you, or would like further guidance feel free to get in touch with Richard directly.


Richard Baldwyn ATT, CTA
Tax Adviser
Partner: The Friendly Accountants
Pro Member: Business & Management Wessex (Tax channel)shape=”square”]Website[/otw_shortcode_button]

Richard is ex-HMRC and a qualified tax adviser with over 25 years experience.

Email richard(Replace this parenthesis with the @ sign)
Tel 01202 048696