Flat Rate VAT Scheme

Introduction 

The HMRC Flat Rate VAT scheme (FRS) was originally introduced by HM Revenue & Customs in 2002.

Ordinarily, the amount of VAT that a business pays or claims back from HM Revenue and Customs (HMRC) is the difference between:

  • The VAT that is charged by the business to customers; and
  • The VAT the business pays on their own purchases.

The key features of the HMRC flat rate scheme are:

  • Your business will pay a fixed rate of VAT to HMRC.
  • The business gets to keep the difference between a) what your business charges your customers and b) pay to HMRC.
  • You cannot reclaim the VAT on your purchases -except for certain capital expenditure that cost over £2,000.

The aim of the scheme here was to simplify paperwork for small businesses when accounting for VAT.

Businesses that have less than £150,000 VAT taxable turnover (excluding VAT) in a financial year are eligible for the Flat Rate Scheme. Once a business joins the scheme, it will not have to leave until its VAT inclusive annual turnover exceeds £230,000.

Joining and leaving the HMRC flat rate scheme

How to join

You can join the scheme online when you initially register for VAT. Alternatively, when you are already VAT registered, you can complete form VAT600 FRS and either:

Alternatively, you can also complete form VAT600 FRS and either:

  • Send it by post to BT VAT, HM Revenue and Customs, BX9 1WR (use this address rather than the address on the form).

You will receive confirmation that you have joined the scheme through:

  • your VAT online account (if applying online)
  • through the post (if you send the form through the post)

How to leave 

You can choose to leave the scheme at any time. In addition, you must leave if you are no longer eligible to be in it.

The process involved when leaving the scheme is to write to HMRC VAT Registrations at BT VAT, HM Revenue and Customs, BX9 1WR and they will confirm your leaving date.

After leaving the scheme. you must wait 12 months before you can apply to re-join the scheme.

How it works

Under the HMRC Flat Rate VAT scheme, a business that is registered for VAT and is operating under FRS will charge VAT on its goods and services at the standard rate of VAT at 20% (on the net value of work).

However, under FRS (in the past), it would pay over a lower percentage (e.g., 14.5% for the IT consultancy sector -now 16.5% -see below), and you calculate the FRS VAT on the gross value of work. HMRC provide a list of VAT Flat Rate percentages.

Besides paying over a lower rate of VAT, the business cannot reclaim the input VAT on its costs and expenses except on capital assets costing £2K or more.

Therefore, in most cases (previously) the amount of VAT that would be paid over would be 14.5% of the gross sales for an IT contractor.

Completing the bookkeeping and VAT returns under the VAT Flat Rate scheme is also more simplified. The reason for this is because the business cannot reclaim the VAT on costs as mentioned above therefore there is less analysis work to do.

Our VAT guide covering VAT in more detail gives you an overall insight into how VAT works.

Limited cost business

In April 2017, the rules for the HMRC flat rate scheme changed, and a new entity came into play known as the `limited cost trader’.

If a business falls under the limited cost trader classification, the Flat Rate scheme VAT percentage is a fixed rate of 16.5% (on the gross value of work). Under these rules, the majority of a contractors business expenses will not class as relevant goods (see below).

What is a limited cost trader?

HM Revenue & Customs defines these as those whose gross expenditure on relevant goods is either:

  • Less than 2% of their VAT inclusive turnover or
  • Greater than 2% of their VAT inclusive turnover but less than £1,000 per year

Relevant goods

According to HMRC guidelines, the relevant goods should not include:

  • Any services which are anything but not goods.
  • Expenses like travel and accommodation.
  • Food and drink ate by yourself or your staff.
  • Vehicle costs including fuel unless you are in the transport business using your own, or a leased vehicle.
  • Rent, internet, phone bills, and accountancy fees.
  • Gifts, promotional items and donations.
  • Goods you will resell or hire out unless this is your main business activity.
  • Training and memberships.
  • Capital items for example office equipment, laptops, mobile phones and tablets.

Therefore, due to the services that contractors provide, it is likely that most will be `limited cost traders’.

How the VAT Flat Rate Scheme compares to the normal scheme

Let us now look at the previous gains and the current gains, if you are operating under the Flat Rate scheme:

  • Prior to the change in April 2017 -£10,000 monthly invoice + VAT (£2000) = £12,000 x 14.5% = £1,740.

£2,000 VAT charged – £1,740 FRS VAT = £260 gain per £10,000 invoiced to the customer.

  • After the change in April 2017 -£10,000 monthly invoice + VAT (£2,000) = £12,000 x 16.5% = £1,980.

£2,000 VAT charged – £1,980 FRS VAT = £20 gain per £10,000 invoiced to the customer.

Therefore, under the Flat Rate Scheme, the bookkeeping and VAT return completion is more simplified. However, now for each £10,000 that you invoice, you only gain £20.

Final thoughts 

From the above, you can work out what you are gaining per month under the Flat Rate VAT scheme and compare it against the VAT that you incur per or month accounting period on your expenses (that you can claim under the `normal’ VAT scheme).

For example, if you charge £8,000 per month pre-VAT for your work. £20 / £10,000 * £8,000 = £16 gain per month under the HMRC flat rate scheme. If the VAT on your accountancy fees, mobile phone bill, and other VAT inclusive costs add up to £100 for example, then you would be better off by £84 (£100 – £16) per month by being under the normal VAT scheme as opposed to the FRS scheme. In general, operating under the normal VAT scheme is one of my handy tax tips for contractors and small business owners.

As mentioned, the bookkeeping is not as straightforward under the normal scheme because you need to reclaim VAT on all of your costs. Since 2019 however, we are now in Making Tax Digital. Therefore, most business are using online software such as  FreeAgent , and this helps calculate the VAT on costs. You only really need to know which costs do include VAT (i.e., which receipts have UK VAT numbers on and are a VAT inclusive cost) and then select the appropriate option for the VAT rate in the online software.

Link to Contractor Advice UK group on

LinkedIn    https://www.linkedin.com/groups/4660081/

Published On: March 13th, 2021 / Categories: Company Taxes /

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