The VAT Flat Rate Scheme Changes Contractors need to be aware of

Significant changes to the VAT Flat Rate Scheme come into force on 1 April 2017 and will affect the amount of VAT some contractors and small businesses have to pay. 

Despite being announced in the 2016 Autumn Statement, very little information has been released by the Government about exactly how the changes will be implemented and the type of expenses that will be allowed.

To help you prepare your business for the arrival of the changes, we have put together this guide to the new VAT Flat Rate Scheme with the information that’s been released to date.

How does the Flat Rate Scheme currently work?

The VAT Flat Rate Scheme is a method of VAT accounting that was introduced to make it easier for small businesses to calculate how much VAT they have to pay. Normally, a business deducts the VAT suffered on the products and services it buys, from the VAT it charges on its sales. The result is that the business either owes or can claim money back from HMRC.

The Flat Rate Scheme simplified that by introducing set rates of VAT for particular business types. For example, accountants pay a flat rate of 14.5 percent VAT, while a computer repair specialist pays 10.5 percent. The aim of the flat rate is to make VAT payments to HMRC roughly the same as they would have been, but without the need for such extensive record keeping.

What’s changing?

Because the Flat Rate Scheme is an approximation of the VAT businesses owe, the government Government is concerned that some businesses are paying less than they should. The changes that come into force will increase the amount of VAT businesses with very low costs, known as ‘limited cost traders’, have to pay.

Limited cost traders are businesses whose expenditure on goods (not services) is less than 2 percent of gross turnover for the VAT accounting period; or where expenditure on goods is more than 2 percent of gross turnover for the VAT accounting period, but less than £1,000 over the course of the year.

Limited cost traders will still be able to use the Flat Rate Scheme, but the VAT rate they pay, regardless of the sector they operate in, will be fixed at 16.5 percent. So, for a business selling £200 worth of work, the flat rate VAT amount it must pay will be (£200 x 16.5 percent) £33.00.

Are you a limited cost trader?

When calculating a business’s expenditure for an accounting period, only the cost of goods, not services, should be included.

That means businesses that incur VAT on services such as rent, IT support, sub-contractors and digital journals will lose out.

However, when working out the amount spent on goods, it cannot include the purchase of:

  • Capital goods (such as new equipment to be used in the business)
  • Food and drink (such as lunches for staff)
  • Vehicles or parts of vehicles (unless running a vehicle hiring business

That means the changes are likely to apply to ‘labour-only’ businesses that provide a service rather than goods, such as IT contractors, gardeners, hairdressers, cleaners and driving instructors.

How will limited cost traders be affected?

The new flat rate of VAT means businesses that do have limited cost trader status will end up paying more. A computer repair specialist currently paying 10.5 percent will see their VAT liability rise by 6 percent, to 16.5 percent.

This means that for a number of small businesses, it may be cheaper to switch to standard VAT accounting. Businesses supplying a service that takes place on or after 1st April are not allowed to issue an invoice or take payment in advance at a lower rate.

Why not speak to us now 020 8945 5479 to get on top of your finances today.