The government’s VAT Flat Rate Scheme is designed to make VAT simpler for small businesses, allowing organisations with a turnover of £150,000 or less to pay VAT at a fixed rate, and to keep the difference between what is charged to customers and what is paid to HM Revenue & Customs (HMRC).

However, this system became more complex in April 2017, with the introduction of a new rate applying to businesses that operate on a low-cost basis. In order to avoid falling foul of these rules, all companies that potentially fall into this category need to be aware of how the revised regulations work, and ensure they are in compliance.

How the changes to the Flat Rate Scheme work

The change to the Flat Rate Scheme, which came into effect on April 1st 2017, is specifically designed to impact adversely on businesses such as consultancies, which have benefited from being able to retain the difference between the VAT they pay and the amount they invoice, while incurring little in terms of VAT on their business costs.

As such, the amended rules dictate that any companies meeting HMRC’s criteria of being a "limited cost business" must use a higher flat rate percentage of 16.5% when calculating how much VAT to pay HMRC under the scheme.

What is a limited cost business?

Under the terms of the Flat Rate Scheme, an organisation can be defined as a limited cost business when its spending on relevant goods, including VAT, is either:

  • less than 2% of its VAT flat rate turnover, or;
  • greater than 2% of its VAT flat rate turnover, but less than £1,000 per year

Relevant goods are classified as purchases of physical items from UK or non-UK suppliers, but this definition does not include the cost of services, capital expenditure items, or goods purchased for sale or lease by a business where this is not their normal activity.

What is the impact of this change?

The revisions to the scheme mean that a limited cost business that previously paid a 12% flat rate on its VAT now has to pay at a 16.5% rate.

Up to April 1st 2017, if an organisation in this category was previously charging customers £20 VAT on every £100 net sale and paying HMRC £14.40 VAT to HMRC, the business would benefit by retaining the £5.60 difference. After the change, this same business would instead need to pay £19.80 in VAT to HMRC, and only retain 20p of the VAT they have charged.

The lesson for businesses

For any organisations in this position, the change creates a need to monitor their costs more closely. In some cases, this has meant it has become more economical for some limited cost businesses to simply avoid using the scheme altogether.

If your business is using or looking to make use of the Flat Rate Scheme and want to know more about how to find the most financially sensible arrangement for your circumstances, speak to one of our expert VAT consultants on our free helpline by calling 0333 3638 012.

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