Local accountants and tax advisers, Trueman Brown, advise businesses that there has been a number of changes to the flat rate scheme during 2016.
The legislation changing the scheme may have made the scheme unpalatable to traders from now on. However, two cases won by traders may mean that businesses may have overpaid VAT using the flat rate scheme and that a claim can be made for a refund.
WHAT IS THE FLAT RATE SCHEME?
Since the VAT Regulations came into force in 1972, The amount of VAT a trader pays, or claims is the difference between the VAT charged by the trader to customers and the VAT paid by the trader on its own purchases.
Since 2002, smaller businesses (annual turnover less than £150,000) have had the option to pay VAT at a fixed percentage of their turnover. The fixed percentage they paid depended on what industry they worked in. Rates varied between 4% to 14.5%.
CHANGES – MAKING TAX DIGITAL
In the 2015 Autumn Statement, the then Chancellor, George Osborne, announced the plans to make tax digital (MTD). More flesh was put on these plans during the 2016 Budget.
Even so, the jury is out on whether MTD will affect the flat rate scheme. Accountants feared that the flat rate scheme may be abolished because of the implementation of MTD.
CHANGES – AMENDMENT TO VAT NOTICE 733
One of the major problems traders had applying the flat rate scheme was choosing the current industry from which to apply the correct fixed percentage.
There are only 51 industry categories available for each trader to choose the correct percentage.
HMRC were forcing traders to choose from that list of 51 categories rather than allowing them to pick the category “business services not listed”. Traders faced penalties and increased VAT liabilities if they did not use the ‘correct’ rate.
Traders were challenging the percentage rates that applied to their business.
Two traders, SSL Subsea Engineering Limited and Idess Limited, successfully challenged HMRC’s contention that they were civil engineers (percentage 14.5%) rather than mechanical engineers (business not listed category of 12%) at the Tax Tribunal.
Despite these lost cases, HMRC refused to clarify the situation so many traders were being left in limbo whether they were applying the correct rate or not.
Finally, in March 2016 the VAT Notice 733 on the flat rate scheme was amended to reflect what tribunal judges said in numerous tax tribunal cases that ‘ordinary English’ should be used in deciding what category should be used.
One Example mentioned by HMRC concerned the category “Management Consultants” which has a fixed rate percentage of 14%.
Before the amendment to the Notice, HMRC insisted that Marketing, Health & Safety and Human Resources consultants would be included in the “Management Consultants” category.
Given that there is no specific category for Marketing, Health & Safety and Human Resources consultants they are now free to apply the “business not listed elsewhere” category which has a fixed percentage of 12%.
THE JKK ENGINEERING CASE
The director of JKK Engineering was a chartered engineer working on plant and equipment as a project manager. HMRC insisted that for the purposes of the flat rate scheme, the company should be placed in the Civil Engineers category with a flat rate percentage of 14.5%.
After learning of the decisions in the Subsea and Idess cases, JKK Engineering applied to HMRC to amend the percentage to 12% for “businesses not listed elsewhere” category.
HMRC agreed to the amendment but refused to retrospectively go back four years. The director of JKK Engineering took the matter to the tax tribunal.
The tribunal supported JJK Engineering which now could make a retrospective correction to its last four years VAT Returns.
Following this case, traders should now look carefully at whether they are using the correct category and make a claim for correction if they think that have overpaid.
THE 2016 AUTUMN STATEMENT
The new Chancellor, Philip Hammond, declared that traders are abusing the flat rate scheme. The counteract this the Chancellor announced the formation of a new category called “low cost trader” (LCT) with a flat rate percentage of 16.5%. This new category into force on 1st April 2017.
LCT is defined as a trader whose VAT inclusive costs on goods are:
- lower than 2% of their VAT inclusive turnover in an accounting period;
- greater than 2% of their VAT inclusive turnover but less than £1,000 per annum if the prescribed accounting period is one year (if it is not one year, the figure is the relevant proportion of £1,000).
Goods, for the purposes of this measure, must be used exclusively for the purpose of the business, but exclude the following items:
´ Capital expenditure on equipment.
´ Food and drink
´ Vehicles, vehicles parts and fuel
These exclusions are required to prevent traders buying either low value everyday items or one-off purchases in order to inflate their costs beyond 2% and thus continue to pay VAT at a rate lower than 16.5%.
After pressure from industry, HMRC changed its definition of vehicles, vehicles parts and fuel in that such items were not excluded as goods for businesses operating in the transport industries such as hauliers, taxis, couriers and other similar industries.
Example:
John is an IT Consultant (flat rate percentage of 14.5%).
During his last accounting period, John’s VAT inclusive turnover was £150,000 (VAT £25,000) with VAT inclusive expenses of:
Materials £600 (VAT £100)
Accountancy Fees £1,200 (VAT £200)
Telephone £300 (VAT £50)
Accommodation And Subsistence £6,000 (VAT £1,000).
PRIOR TO 1 APRIL 2017
Under Normal Rules: Output VAT £25,000 less Input VAT £1,350 (£100+£200+£50+£1000) = £23,650
Under Flat Rate Scheme: £150,000 x 14.5% = £21,750
John makes a PROFIT of £1,900 by using the flat rate scheme!
AFTER 1 APRIL 2017
John will be classified as a ‘low-cost trader’.
His expenditure on goods is only £600 VAT Inclusive which is less than 2% of the VAT inclusive turnover of £150,000.
His VAT liability would now be £150,000 x 16.5% = £24,750.
John is now losing £1,100 being part of the flat rate scheme.
Local accountants and tax advisers, Trueman Brown, deliver vital services to small business. Please contact us if you require assistance.
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