The Flat Rate Scheme and the new 16.5% low cost trader category

As part of the Autumn Statement, it was announced by The Chancellor that a new Flat Rate Scheme category would be introduced and become effective from April 2017. The new category will be known as the ‘limited cost trader’ and those businesses that fall within this category will be required to account for VAT on the gross turnover at a rate of 16.5%. The new 16.5% rate is likely to affect a significant number of businesses using the Flat Rate Scheme.

The new category has supposedly been introduced to tackle aggressive abuse of the scheme. However, there is no doubt that this will affect a large number of honest traders who use the flat rate scheme as a simplification measure for which it was designed. The new 16.5% category will result in the FRS becoming more complicated, as businesses will be required to perform more checks and advisers will be required to interpret new legislation in order to comply with the new rules.

Business will be require to check its VAT inclusive expenditure on goods each quarter, in order to determine whether it falls within the 16.5% rate. A business is a limited cost trader if its VAT inclusive expenditure on goods is:

  • Less than 2% of their VAT inclusive turnover in a prescribed accounting period; or
  • Greater than 2% of their VAT inclusive turnover but less than £1000 per annum if the prescribed accounting period is one year (if it is not one year, the figure is the relevant proportion of £1000).

The big unknown at the moment is exactly what will count when it comes to the definition of ‘goods’. The current draft guidance states that goods are those used exclusively for business purposes, but excludes the following items:

  • Capital expenditure;
  • Food & drink for consumption by the flat rate business or its employees; and
  • Vehicles, vehicle parts and fuel (except where the business is one that carries out transport services – for example a taxi business – and uses its own or a leased vehicle to carry out those services).

Businesses and advisors are then left with a question as to whether items that are traditionally seen as being services rather than goods can count towards the cost base of the business, for example will internet and telephone costs count as goods? Many service based businesses do not spend much on goods but do have services expenses including subscriptions, telephone costs, software and accounting fees. It would seem harsh if these do not count as business costs when it comes to the definition of a ‘limited cost trader’, but the current draft guidance is unclear.

We are still waiting for HMRC to publish details as to how the new rules will be implemented, and then things may become more clear.

Although the new category will be introduced in April 2017, HMRC have introduced anti-forestalling provisions, which will prevent business that fall within the definition of a limited cost trader from continuing to use a lower flat rate beyond 1 April 2017. This will affect businesses that supply services on or after 1 April 2017, but either issue an invoice or receive payment for that supply before 1 April 2017.

Action to be taken

It is important to look at the financial implications for your business and determine whether the limited cost trader category would apply. Where it does apply businesses have the following options:

  1. Deregister from VAT (if your turnover is below the VAT registration threshold of 83,000);
  2. Move onto standard VAT accounting. Standard VAT accounting allows you to reclaim VAT on all your expenses irrespective of how much you have incurred. However, it does involve some extra admin as part of your quarterly VAT submission; or
  3. Account for VAT at the new 16.5% rate. Depending on your circumstances this may still be the most advantageous option.

Should you wish to discuss how this VAT change will affect your business/clients, please do not hesitate to contact me.