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What is the VAT Flat Rate Scheme?

If you are a VAT registered business, you are required to charge VAT on all of your sales before then reclaiming it on your purchases.

As such, you will need to keep a careful and detailed record of your transactions, as well as the VAT rate that was charged. To make the process simpler for businesses, HMRC has introduced the ‘Flat Rate Scheme’. This scheme enables you to simply pay HMRC a set percentage of your total sales, rather than calculating the VAT on your sales then deducting VAT on expenses as you were required to do so previously. As a result of the Flat Rate Scheme, most small businesses are no longer required to keep a detailed record of the VAT they pay on purchases.

The Limited Cost Trader Flat Rate VAT Scheme

Introduced by the Government in 2017, the ‘Limited Cost Trader Flat Rate VAT Scheme’ currently stands at 16.5% and is compulsory for many businesses classed as ‘labour’ such as contractors. Because this VAT rate is higher than under the normal ‘Flat Rate’ scheme, you are advised to seek further clarification with HMRC regarding what VAT status best reflects your business and how you operate. Regarding whether your business is classed as a ‘Limited Cost Trader’, HMRC define such a business as one that spends less than 2% of its total sales value on goods during the tax ‘accounting period’ (this is often quarterly). When calculating this figure, it is important to know that you cannot include the purchase of equipment used in your business, as well as employee food and drink and the cost of any vehicles.

If your business spends less than £1,000 in your specified accounting period, then your business will also be classed as ‘labour only’, regardless of whether this £1,000 is more than 2% of your total sales or not. If your accounting period is longer/shorter than one-year, this £1,000 limit is calculated in proportion to this. It is also important to know that businesses on the Flat Rate scheme need to apply for what is referred to as the ‘Limited Cost Trader Test’ every new VAT period. Finally, all new businesses that register for VAT for the first time are eligible for a 1% discount for the first 12-months. For new businesses that are also entering the Flat Rate scheme, this 1% discount is still provided.

How can I prevent my business from being classed as a ‘Limited Cost Trader’ and avoid the higher VAT rate?

If your business spends less than 2% of your total sales on goods, then you will likely meet the criteria and therefore be required to pay the 16.5% VAT rate. However, with business operating in many different industries, and therefore operating very differently, there can often be some confusion regarding what is classed as an ‘applicable good’ and what isn’t. One thing to remember is that if your business does fall under the ‘Limited Cost Trader’ classification, you will be able to claim VAT back on any goods costing more than £2,000.

Can services be classed as goods?

In general, the simple answer is no. No services or associated costs incurred during your business’ operations can be included when calculating whether you qualify for the ‘Limited Cost Trader’ policy or not. This means that expenses such as the price of hiring a subcontractor, even if only for a short period of time, cannot be classed as goods, and therefore you cannot include them in your figures when making your calculations.

Will most service-based businesses have to pay this Higher VAT rate?

The answer is quite likely yes. How businesses operate has changed significantly in recent years, thanks in no small part to advances in technology. Therefore, many business expenses can often just consist of salaries, as well as smaller costs, such as accountancy, travel and subsistence expenses. As a result, the majority of such businesses will be classed as a ‘Limited Cost Trader’ and will, therefore, be required to pay this new flat VAT rate. To help you get a better understanding of what is no longer classified as being applicable goods, we have created the following short list as a guide:

  • Advertising and accountancy costs
  • Employee food and drink expenses
  • Fuel for vehicles
  • Laptops and mobile phones used for business purposes
  • Electronic services, such as e-magazines and software that has designed for you, such as security
  • All business rental fees

Deciding the right VAT scheme for your business

As you can see, the new ‘Flat Rate’ scheme can and will have a real impact on many businesses, particularly smaller, more ‘service’ based ones. If you fall under this category it is highly likely that you will be subject to the new 16.5% VAT rate. HMRC offers significant information on this to help business owners better understand the requirements and what they can do to calculate what they will now be paying.

As you can see, there are various benefits and disadvantages of joining the ‘Flat Rate’ scheme. The most obvious benefit being that for many businesses, it makes bookkeeping much more easier – a very important factor for many business owners! This is particularly true for small businesses, as rather than having to record every single transaction, owners can simply apply the flat percentage rate to their quarterly/annual turnover. Calculating whether your business will be better off on the ‘Flat Rate’ scheme or not depends on various factors; many of which are often very specific to your business. In general, this will largely depend on how many purchases your business makes. For example, if your business makes a lot of purchases or sales that are exempt from VAT, it is likely that a more standard VAT scheme will be more suitable than what the ‘Flat Rate’ scheme offers.

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