The HMRC has published their draft legislation for the proposed introduction of a new VAT Flat Rate of 16.5% for ‘Limited Costs’ businesses to tackle what they perceive as abusive use of the scheme.
The target of the legislation are labour-intensive businesses with little expenditure on goods such as contractors, consultants and accountancy firms. However, this may prove the catalyst for a digital transformation to make the capture of VAT data straightforward.
The VAT Flat Rate Scheme was introduced in 2002 to simplify VAT and reduce the administrative burden on small businesses. Instead of paying across the VAT on sales and recovering the VAT on purchases, the business can apply a percentage to their gross revenue based on their trade sector.
Take an IT contractor with a net turnover of £100,000. Currently, the VAT Flat Rate is 14.5% which is applied to the gross sales. As a result, £20,000 of VAT would be charged to the clients but only £17,400 (14.5% of £120,000) paid to the HMRC. The remaining £2,600 is kept by the company in lieu of the VAT on purchases.
From 1st April 2017, if the IT contractor falls under the new VAT Flat Rate of 16.5%, £20,000 of VAT would still be charged to the clients but now £19,800 (16.5% of £120,000) is paid to the HMRC leaving £200 in lieu of the VAT on purchases.
A Limited Costs business is defined as a company whose VAT inclusive expenditure on goods is either:
- less than 2% of their VAT inclusive turnover in their defined accounting period;
- greater than 2% of their VAT inclusive turnover but less than £1,000 per annum to pro-rata if the defined accounting period is less than a year.
In this context, goods must be used exclusively for the purpose of the business but will exclude the following items:
- capital expenditure;
- food or drink for consumption by the flat rate business or its employees;
- vehicles, vehicle parts and fuel (except for businesses that provide transport services).
The description of capital expenditure goes beyond the normal accounting convention to include any goods which are bought to be used in the business over a period of time irrespective of the costs.
These exclusions are designed to prevent a company from buying either low value everyday items or one off purchases in order to inflate their costs beyond 2%.
In the context of VAT, goods are tangible objects where the legal title transfers to the purchaser on acquisition. On this basis, expenditure on services are totally excluded.
Both businesses currently operating under the VAT Flat Rate Scheme and new businesses joining will be required to test whether they must use the new rate and the test must be repeated for each accounting period. The first-year discount of 1% will apply to new businesses registering under the 16.5% rate.
HMRC promise to introduce an online tool to assist in determining the correct rate. However, the past performance of similar online calculators leaves a doubt to the accuracy and consistency.
Although there is an eight-week consultation period, this seems more of a technical consultation on the implementation rather than an opportunity to modify the legislation.
CooperFaure will be making representations to HMRC to remove the exclusions on goods and to include expenditure on services incurred purely for business purposes. We are also seeking clarity on the treatment for VAT periods that straddle April 2017.
However, we are sceptical of there being any substantive amendments.
The consideration for labour-intensive businesses is whether the simplified administrative benefit of continuing to use the Flat Rate Scheme is greater than the financial loss.
The HMRC impact assessment indicates that they expect around 4,000 businesses to switch to standard VAT accounting. The compliance cost of switching to HMRC is estimated at £180 per business.
Our view is that HMRC have severely under-estimated the number of switchers. Take our IT contractor example who spends a very modest average of £420 per month on allowable business items that include VAT. That equates to an annual VAT recoverable of £840 compared to the £200 that the new flat rate is offering.
The key is making the process of recording and claiming this VAT as simple as possible. As a result, in the first quarter of 2017, CooperFaure will be evaluating digital platforms to make the capturing of this data as simple as a click of a button.
We will also be providing comparative analysis to our clients affected by this change to enable them to make an informed decision.
If you are uncertain of whether you will be impacted or would like advice on the best course of action, please contact us at firstname.lastname@example.org to schedule an initial call to discuss this further.