Contractor Flat Rate VAT Scheme

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Introduction 

The contractor Flat Rate VAT Scheme is an option available when your business registers for VAT. However, what is the Flat Rate VAT Scheme for UK contracting professionals who run their own company, and how does this work in practice? The HMRC Flat Rate VAT Scheme (FRS VAT) was initially introduced by HM Revenue & Customs in 2002. As a UK business, VAT is one of your main limited company taxes if you become registered. Under UK Flat Rate VAT for IT contractors and other contracting professionals, your business pays a lower rate of VAT to HMRC. This is when you compare the HMRC Flat Rate Scheme to what VAT you pay under the Standard VAT Scheme (UK). Therefore, is it worth joining the VAT Flat Rate Scheme when you’re UK contracting or trading in business?

This is a detailed guide on the Flat Rate of VAT scheme for UK contractors and small business. We’ll look at how the system works and what savings you can make under the Flat VAT rates. What’s more, we’ll research Flat VAT rate for consultancy services (UK) and discover the Flat Rate percentage for IT contractors. Furthermore, we’ll go over the VAT Flat Rate Scheme application process and how to apply for FRS. In addition, we’ll investigate the rules for FRS accounting and what savings you make under this scheme. What’s more, we’ll consider the new Flat Rate VAT rates and new rules for limited cost trader VAT. As part of this, we’ll discover what to consider by summarising a Flat Rate VAT return example under the new rules. 

Initial thoughts on Contractor Flat Rate VAT 

How VAT returns work

A VAT registered business submits their VAT returns monthly, quarterly, or annually. However, most businesses including contractors opt to file these quarterly. Ordinarily, under the VAT Standard Rate Scheme, 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 on its invoices to its customers; and
  • The VAT the business pays on their purchases and services on invoices from its suppliers.

As we mention earlier, the VAT due to HMRC under the VAT FRS scheme is less than under the Standard Rate VAT Scheme. As we show above, under the Standard Rate Scheme, a business pays over to HMRC the difference between the VAT it receives from customers and the VAT it pays to suppliers. What’s more, as mentioned, a business will usually complete and file VAT returns with HMRC on a quarterly basis. However, let’s now take the time to investigate the contractor Flat Rate VAT scheme rules and how this works.

Common questions

As a UK contractor or small business, some common questions may arise on FRS VAT. These’ll involve how this scheme works and how to join it and they include:

  • What is Flat Rate Scheme?
  • How does FRS VAT work?
  • How much is FRS VAT?
  • What is the VAT rate under FRS?
  • What is VAT FRS Scheme for small businesses?
  • Does net cost include VAT?

In this guide, we’ll research the above and how to apply for Flat Rate VAT registration. In addition, we’ll research how FRS VAT works in the UK and consider the HMRC Flat Rate percentages. Furthermore, we’ll look at how to calculate FRS and discover the which rate applies to IT contractors.

Key features -the contractor Flat Rate VAT (UK) scheme

There are several key features of the HMRC FRS scheme for UK contracting professionals. Indeed, when you’re accounting for Flat Rate VAT these include:

  • Simpler record keeping for your business under Flat Rate (HMRC). Therefore, when you operate under the Flat VAT Rate Scheme, your business will pay a VAT fixed rate to HMRC.
  • VAT savings for your business under the Flat VAT Scheme. Your company gets to keep the difference between a) what your business charges your customers and b) what it pays to HMRC.
  • Contractor Flat Rate VAT -capital purchases. Under the scheme you can’t reclaim the VAT on your purchases. However, you can reclaim the VAT on certain capital expenditures that cost over £2,000.

HMRC’s VAT Notice 733 contains full details on how the scheme works and conditions for applying for the scheme. You can also view the HMRC community forums with questions from visitors on the FRS scheme.

The original aim of the HMRC FRS scheme was to simplify paperwork for small businesses when accounting for VAT. Businesses who are under the UK Flat Rate VAT threshold of £150,000 VAT taxable turnover (excluding VAT) in a financial year, are eligible for the FRS scheme. Once a business joins the FRS scheme, it’ll not have to leave until its VAT-inclusive annual turnover exceeds the Flat Rate VAT limit of £230,000.

Joining and leaving the HMRC Flat Rate scheme for contractors

Join Flat Rate scheme 

Let’s now consider how to register for VAT Flat Rate scheme for small businesses in the UK. Basically, you can join the FRS scheme when you initially register for VAT. Therefore, if you apply for Flat Rate Scheme online as part of your VAT registration, you’ll be registered for FRS from the outset. Alternatively, you can register for Flat Rate VAT by completing a Flat Rate Scheme application when you’re already VAT registered. Basically, you can join the scheme with HMRC by either:

  • Completing and sending form VAT600FRS through the post to BT VAT, HM Revenue and Customs, BX9 1WR, United Kingdom. Please make sure you use this address, rather than the address on the actual form.

You’ll receive confirmation that you have joined the HMRC Flat Rate scheme for VAT through:

  • Your VAT online account (if applying online).
  • Through the post (if you send the form through the post).

What’s more, a notification that you’ve joined the scheme will come through in couple of weeks or so, depending on how busy HMRC are at the time.

Leaving the Flat Rate scheme 

Let’s now consider how to leave Flat Rate scheme and what you need to do as part of this. Basically, you can choose to leave the contractor FRS scheme at any time during your contracting career. A reason for leaving could be that the FRS scheme is no longer beneficial to your business. We’ll go into this in more detail later. In addition, you must leave if you’re no longer eligible to be in it.

When you leave, you must write to HMRC VAT Registrations and inform them that you would like to leave the scheme. Their address is BT VAT, HM Revenue and Customs, BX9 1WR. Once they reply, they’ll confirm your leaving date. After leaving the scheme, you must wait 12 months before applying to re-join.

How the FRS scheme works and the FRS percentages 

VAT FRS scheme initial considerations

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

However, when calculating Flat Rate (UK) in the past, it’d pay over a lower Flat Rate Scheme percentage to HMRC. E.g., a consultancy VAT rate of 14.5% for the IT consultancy sector (now 16.5% -see below). In addition, you calculate the FRS VAT on the gross value of work, rather than the net of VAT amount. HMRC provide a list of UK Flat Rate VAT percentages which show the Flat Rate VAT categories and FRS VAT rates for different types of business. Therefore, you can search for your trade and check your VAT Flat rate under the list of HMRC VAT Flat Rate scheme percentages. As a result, under this VAT FRS rates list, you can find which rate you’ll pay under the HMRC Flat Rate Scheme.

Besides paying over a lower VAT rate under the FRS scheme, the business can’t reclaim the input VAT on its costs. That is unless it’s on certain capital assets costing £2K or more. Therefore, in most cases previously, under the VAT Flat rate percentages available, the Flat Rate VAT (IT contractor) percentage would’ve been 14.5% of the gross sales.

When we look at how to calculate Flat Rate VAT (UK), completing the bookkeeping, and VAT return completion, under the VAT FRS scheme this is very much simplified. The reason for this is the business can’t reclaim the VAT on costs as mentioned above. Therefore, there’s much less analysis work to do, and this makes the Flat Rate VAT for IT contractors quite attractive.

Our guide to VAT

Our VAT guide on this website covers the UK VAT system in much more detail. We go into this in more depth in this guide, and it explains clearly how the VAT system works. Therefore, this is a great read for first time contractors, and it gives you a comprehensive insight into UK VAT. The guide is now also very popular online with Google searchers who are looking to find out how VAT works. In summary, this is worth a read as a new or even experienced UK contractor because it’ll give you a clearer picture on how the VAT system operates in the UK.

There are also many other guides on our website for UK contractors. Indeed, these cover many different areas on subjects that affect UK contractors. Within these, we explain how to operate efficiently and save tax in the process. 

VAT FRS scheme -limited cost business

In April 2017, the FRS scheme rules changed for those on, or wanting to join the fixed rate VAT for small businesses scheme. As a result of the HMRC Flat Rate scheme changes, a new Flat Rate VAT limited cost trader entity came into play. Basically, the term `limited cost trader’ is also known as the FRS `low-cost trader.’

If a business falls under the VAT Flat Rate limited cost trader (HMRC) classification, the FRS scheme Flat Rate VAT percentage is a fixed rate of 16.5% VAT Flat Rate on the gross value of work. Under these Flat Rate Scheme low cost trader rules, in most cases the majority of your UK contractor business expenses won’t be classed as relevant goods (see below).

What is a limited cost business or low-cost trader Flat Rate VAT?

HM Revenue & Customs (HMRC) define a limited cost trader as a business 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 annually.

Relevant goods

Under the HMRC FRS scheme guidelines, the relevant goods shouldn’t include:

  • Any services which are anything but not goods.
  • Expenses like travel and accommodation.
  • Food and drink which is eaten by yourself or your staff.
  • Vehicle costs, including fuel, unless you’re 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’ll resell or hire out unless this is your primary business activity.
  • Training and memberships.
  • Capital items, including office equipment, laptops, mobile phones, and tablets.

Therefore, most UK contractors will likely be’ limited-cost traders’ due to the types of services that they provide. In other words, if you provide services rather than selling goods, you’re likely not to meet the relevant goods threshold. As a result, you’ll need to use the standard VAT scheme and pay or reclaim VAT in the `normal’ way.

Other thoughts 

Contractor Flat Rate VAT vs standard VAT scheme 

Let’s now look at a contractor Flat Rate VAT example of a Flat Rate VAT calculation. In this VAT Flat Rate scheme example, let’s consider what the previous and current gains are under this scheme. Therefore, if you’re operating under the VAT FRS 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, the bookkeeping and contracting Flat Rate scheme VAT return completion is much simpler under the FRS scheme. However, as we show in this Flat Rate example, under the low-cost trader Flat Rate VAT rules, for each £10,000 you invoice you only gain £20. As a result, this makes FRS for contractors much less beneficial than prior to the change. Therefore, many contractors are better off by operating under the Stand Rate VAT Scheme. 

Flat Rate VAT for IT contractors and other independent contractors 

When you’re a limited company contractor you can choose whether to register for the HMRC fixed rate VAT scheme. This is of course subject to your business being over the VAT Flat Rate Scheme threshold where you wouldn’t qualify for the contractor Flat Rate Scheme. The contractor Flat Rate VAT return itself is much easier to complete. In addition, there’s less analytical work to do for each accounting period. As most limited company contractors will fall under the limited-cost trade bracket, the rate for contractor FRS VAT is 16.5% of the gross invoice. 

From the above, you can work out what you’ll gain per month under the FRS scheme. As a result, you can then compare it against the VAT that you incur per month on your expenses (that you can claim under the VAT standard rate scheme).

For example, if you charge £10,000 per month pre-VAT for your work, your gross invoice is £12,000. In other words, £10,000 plus VAT at 20% (£2,000) equals £12,000. If we then multiply £12,000 by 16.5%, this gives FRS VAT of £1,980. Under the normal scheme the VAT payable to HMRC is £2,000. Therefore, there’s a £20 gain under the HMRC fixed rate VAT scheme. Next, you should add up the VAT on your monthly costs. Therefore, let’ assume the VAT on your accountancy fees, mobile phone bill, and other VAT-inclusive costs add up to £100. In this case, you’d be better off by £80 (£100 – £20) per month by being under the standard VAT scheme compared to the FRS scheme. Indeed, as VAT is one of your contractor taxes, operating under the Standard VAT Scheme is one of our handy tax tips for contractors and small business owners.

Final thoughts 

When we consider the contractor Flat Rate VAT scheme, many still use this, including lots of IT contractors. The contractor VAT Flat Rate scheme makes your VAT record keeping easier to maintain. Therefore, if you’d like easier bookkeeping, FRS may be preferable. However, as highlighted earlier, UK Flat Rate VAT for IT contractors is no longer as beneficial financially.

Alternatively, bookkeeping isn’t as straightforward under the standard VAT scheme. Basically, this is because you can reclaim VAT on all your costs. As a result, you must check your invoices to see which costs include UK VAT. Therefore, some contractors who like easier bookkeeping still join the scheme for FRS. If you’re happier with simpler bookkeeping, you should check if you fall under the low-cost trader rules. If you do, your rate will be 16.5% of your gross invoices. If you don’t, you can check the Flat Rate VAT scheme rates to find out which rate applies to your trade.

Since 2019, Making Tax Digital is on the scene. Therefore, most businesses use online software such as FreeAgent, which helps calculate the VAT on costs. This also makes the analytical work much easier as the VAT return figures are computed automatically on the digital software. Therefore, the analytical work is now much easier when you use online software.

Finally, when using digital software, you only need to know which costs include VAT (i.e., which receipts have UK VAT numbers on and are a VAT-inclusive cost). As a result, you can select the appropriate option for the VAT rate in the online software. This makes the process of updating your business records easier. As a result, most UK contractors use digital software to keep their business and accounting records.

Link to Contractor Advice UK group on

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

Published On: January 4th, 2024 / Categories: Company Taxes /

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