The VAT flat rate scheme: is it still useful?
The government announced a new restriction on the use of the VAT flat rate scheme in the Autumn Statement 2016. In response to what chancellor Phillip Hammond called the “inappropriate use” of the scheme, businesses with limited costs are now paying a new 16.5% rate of VAT.
The VAT flat rate scheme
The scheme provides small businesses with a simplified way of accounting for VAT. Businesses with annual turnover of less than £150,000 pay HMRC a fixed rate of VAT.
This rate is dependent on your sector, and ranges between 5% for post offices to 14.5% for accountancy firms, IT consultants and legal services.
The flat rate scheme therefore provides small businesses with a significant tax advantage, allowing them to pocket the difference between the 20% rate charged to their customers and the lower rate paid to HMRC.
The 16.5% rate and ‘limited costs’
Since 1 April 2017, businesses with low expenditure have had to pay an increased flat rate of 16.5%, which for some types of business has resulted in a significant reduction of the scheme’s tax benefits.
Businesses with ‘limited costs’ are those that spend either:
- under 2% of their annual turnover (including VAT charged to customers)
- more than 2% of their annual turnover but less than £1,000.
The government defines goods as anything that is used solely for business purposes, except the following:
- capital investment
- vehicles, vehicle parts and fuel
- food and drink.
Is the flat rate scheme still useful for limited cost businesses?
The question for all limited cost business owners is whether they should leave the scheme. Your final decision should factor in the following:
Your capital expenditure: Having a low capital expenditure – and thus the potential for only a small sum of reclaimed VAT outside the scheme – may continue to make the flat rate scheme attractive.
Simplified accounting: The flat rate scheme will continue to provide a simplified way of accounting for VAT. Remaining registered as a limited cost business will cost you more in tax but leaving will mean extra time spent reclaiming VAT on your purchases.
The first-year VAT reduction: Businesses that registered within the previous 12 months will continue to receive the 1% first-year VAT reduction. It can therefore be advantageous to register for the flat rate scheme, if only for 1 year.
You should seek professional advice before making any decisions about leaving the flat rate scheme.
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