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The VAT Flat Rate Scheme is frequently used by small businesses to simplify their tax payments and, in some cases, to help reduce the amount they owe overall. However, the advantages of the scheme are undermined if a mistake is made and the incorrect flat-rate percentage is applied.

A tribunal hearing from 2015 demonstrates the potential legal complication that this kind of miscalculation can create, and underlines the need for users of the Flat Rate Scheme to ensure they are using the scheme correctly.

The risk of regulatory penalties

In this First-Tier Tribunal case, a company called KDT Management Ltd found itself facing penalties by HM Revenue & Customs (HMRC) for allegedly using an incorrect flat-rate percentage for numerous VAT returns. 

As a rule, the flat-rate percentage applicable to a business's turnover is determined by the category of business activity undertaken by the company in question during the relevant period. In this instance, KDT Management had registered itself as a management consultancy, and initially made use of the flat-rate percentage applicable for this business category; however, when the rate for this category increased, the company continued to pay at the lower percentage, having made the judgement that the services it was actually performing could be more accurately categorised as advertising consultancy.

HMRC took the view that the taxpayer was obliged to use the percentage for the trade sector that was entered on the original application form, until such time as an application was made to change that category. As a result, the business received an assessment from HMRC to make up the difference between the VAT that had already been declared, and the amount that would have been due if the percentage for management consultants had been applied.

In this instance, the ruling went in favour of the business, as the tribunal deemed that the original management consultancy categorisation used on the application form was incorrect, and that HMRC was therefore unable to legally insist that the higher flat-rate percentage for management consultants needed to be paid.

The lesson for businesses

Although in this case KDT Management was able to appeal against additional charges from HMRC, the difficulties they encountered demonstrate the importance of applying the correct flat-rate percentage when making use of the scheme. Failure to do so can result in legal and regulatory scrutiny, with the potential of having to pay more once the mistake is uncovered.

If you are making use of the VAT Flat Rate Scheme and wish to discuss the business category that is appropriate for your company, the experts at The VAT People are here to help. Speak to one of our VAT consultants by calling our free VAT helpline on 0333 3638 012.

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