It is over a year since the new rules came in for the flat rate scheme (FRS) and ‘limited cost traders’ which made the scheme less beneficial many businesses. So does the flat rate scheme still serve a purpose?
What is FRS?
HMRC recognise that the standard way of completing VAT returns can be a cumbersome task for small businesses therefore the FRS was introduced to simplify the procedure. Any VAT registered entity with turnover below £150,000 (excluding VAT) can apply to use the scheme.
The scheme allows a business to calculate the VAT payable to HMRC by applying a percentage to gross income rather than accounting for output VAT on sales and input VAT on purchases separately. The percentage is determined by the relevant category published in VAT Notice 733 Flat Rate Scheme for Small and Medium-sized Businesses. Care needs to be taken as gross income for FRS purposed includes zero rated and exempt sales but not income which is outside the scope of VAT (see sections 6.2 and 6.3 of VAT Notice 733 for more details).
The FRS does not require the business to record the VAT on their purchases separately as the percentage takes account of average expenses for each sector. If any capital expenditure is incurred and the cost of the item exceeds £2,000 (including VAT) this VAT can be reclaimed.
Is the scheme for me?
If your turnover is below the threshold then there is a chance the scheme is for you, however, with the new limited cost trader rules it is not clear cut.
If your expenditure on goods is either:
- less than 2% of your VAT inclusive turnover; or
- greater than 2% of your VAT inclusive turnover but less than £250 per quarter
then you are classed as a limited cost trader and you are required to use the flat rate percentage of 16.5% no matter what category you fall into. ‘Goods’ includes stock, cleaning products, standard off the shelf software, stationery and utilities used by the business. All services are excluded from goods including telephone bills, advertising, leasing costs, vehicle expenses, accountancy, bespoke software etc. This means a lot of consultancy businesses are likely to fall into this category.
The two tests above should be reviewed each quarter to determine whether you need to use the limited cost trader rate or the rate applicable to your sector. If the tests above are not met then a lower percentage is likely and the flat rate scheme may be beneficial.
So let’s look at some numbers for limited cost traders to see whether it is beneficial. If a business makes a sale valued at £1,000 they will charge VAT of £200 giving gross income of £1,200. If they complete their VAT returns on a standard basis they will pay £200 to HMRC less any VAT on expenditure.
If they were a limited cost trader they would multiply £1,200 by the 16.5% rate to give a liability due to HMRC of £198. They do not need to account for any VAT on expenditure.
The question is, as a limited cost trader, do you have more than £2 of input VAT to reclaim? If so, this scheme may not be for you. However, when making your decision you should always take into account the ease of record keeping with the FRS. The potential cost saving could be of bigger importance to you.
If you would like some advice as to whether the flat rate scheme is beneficial to your business please contact us to discuss it further.