VAT flat rate scheme changes

Among the measures relating to business taxation in Autumn Statement 2016, Philip Hammond announced a change to the VAT flat rate scheme. This could have significant effects on the tax liability of small businesses that currently make use of the scheme.

So what is going to change and who is likely to be affected?

What is the VAT flat rate scheme?

When calculating how much VAT it needs to pay or claim back from HMRC, a business usually works out the difference between the VAT they charge their customers and the VAT they pay on their own purchases.

The flat rate scheme simplifies this process by introducing a fixed rate of VAT which is payable to HMRC. Participating businesses are allowed to keep the difference between what they charge customers and what they pay HMRC.

Businesses may be able to reclaim VAT on capital items that cost £2,000 or more.

To be eligible for the scheme a business must be VAT registered and have VAT turnover of £150,000 or less in the next 12 months.

The fixed rate of VAT that a business will pay depends on their type. So, for example , IT consultants pay 14.5% while those in the publishing sector pay 11%.

What is changing?

From April 2017 there will be changes affecting businesses with very low cost bases. These businesses will now be classed as "limited cost traders" if they spend:

  • less than 2% of their VAT inclusive turnover on goods in an accounting period; or 
  • more than 2% of their VAT inclusive turnover but less then £1,000 a year.

The amount spent on goods does not include the purchase of capital goods such as new equipment, food and drink and vehicles or parts of vehicles.

Limited cost traders who participate in the flat rate scheme from April 2017 onwards will have a fixed rate of 16.5%. This means that work sold for £120 with £20 of VAT will result in a flat rate VAT charge of £19.80.

In his speech the chancellor said that the measure was designed to "shut down inappropriate use of the VAT flat rate scheme that was put in place to help small businesses".

The government believes that some businesses have been using the scheme to pay less VAT than they should be. In particular, if a business has small expenses and operates in a sector with a low fixed rate of VAT, it will pay HMRC less than it would if it were outside the scheme.

Businesses can voluntarily register for VAT before their turnover reaches the £83,000 VAT registration threshold so they can make use of the flat rate scheme and have a cash advantage.

Who will be affected?

The measure will increase the VAT bill of businesses that are labour-intensive but spend little on goods.

Examples of the kind of entities that may be affected are IT contractors, consultants and construction workers who supply their labour but are not responsible for purchasing the raw materials.

Next steps

Businesses have time to comment on draft legislation which was published on 5 December 2016.

This article only provides an overview of the flat rate scheme and the changes announced by the chancellor. Get in touch with our expert team for more technical advice and information.