Businesses who spend very little on purchasing goods – mainly those who provide services – and have an annual turnover of less than £150,000, often qualify for the Flat Rate VAT Scheme. Those who qualify for the scheme pay a fixed rate of VAT based of the nature of their business – often significantly less than the standard 20%.
The Flat Rate VAT Scheme provides a welcome tax break for small businesses, who are able to pocket the difference between the 20% VAT they charge clients and the lower rate that they pay to the Government. The scheme also simplifies bookkeeping and makes it easier for these businesses to work out the amount of VAT they have to pay.
However, the Government is concerned that some businesses are manipulating their accounts in order to qualify for the Flat Rate VAT Scheme, and as a result are paying less VAT than is appropriate.
In the 2016 Autumn Statement, the Chancellor announced that there will be significant changes to the current VAT system to avoid it being abused.
From April 2017, businesses will only be eligible to join the scheme if they are a limited cost trader – a business that charges for a service it provides as opposed to selling products. To qualify for the scheme businesses must incur the bulk of their costs purely through labour and spend less than 2% of their annual turnover on goods.
There will also be significant changes to how the scheme operates. The rate of VAT those on the scheme have to pay will no longer be based on business sector, instead there will be a fixed rate of 16.5% – an increase on the current rates.
The increase will be particularly significant for those who currently pay the lowest level of flat rate VAT, such as farmers who currently pay 6.5%. It may mean that for some businesses it will be more cost-effective to switch to standard VAT accounting, which will allow them to reclaim VAT on their purchases; something that those on the scheme will not able to do.
If you currently qualify for the Flat Rate VAT Scheme, it’s important that you seek advice on how the changes will impact your business.