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New rules for limited cost businesses

HMRC are introducing new legislation to take effect from 1 April 2017, combating abuse of the flat rate VAT scheme.

Current situation

Businesses who are VAT registered can join the flat rate scheme if their turnover is below £150,000, net of VAT. If you join, you pay a ‘flat rate’ of VAT based on your gross (VAT inclusive) turnover.

If you have very little in the way of VATable expenses and, all your customers are VAT registered, you can charge VAT at 20% then pay HMRC a maximum of 14.5% (depending on your trade) of your VAT inclusive turnover i.e. 17.4%. The difference between the 20% charged and the effective 17.4% charged is sometimes profited.

On the downside, you are unable to recover any VAT on expenses asides from if you are purchasing certain assets costing over £2,000.

New rules with effect from 1 April 2017

If you have very little in the way of VATable expenses then you may very well profit from the scheme and this is what HMRC are changing. If you are deemed a ‘limited cost trader’ then you will have to use the new 16.5% rate; effectively cancelling any profiting from the lower rates.

You will be deemed a limited cost trader if your VAT inclusive expenditure on goods is less than 2% of your VAT inclusive turnover or, greater than 2% but less than £1,000.

It is not yet clear what ‘relevant goods’ is, but we do know it will exclude capital expenditure, food and drink, vehicles, parts and fuel (except if you’re in a transport trade). The goods must also be exclusively for business use and have no private element.

Normal anti avoidance rules will apply.

Update – April 2017

HMRC have now confirmed what ‘relevant goods’ is for the purposes of this change. Broadly speaking, it will exclude most services i.e. accountancy fees, advertising, motor expenses (unless in transport sector, as above), rent, software you download and postage etc. It will include items such as stationery, office supplies, gas and electric (exclusively used for business), stock and cleaning products.

As a result, many businesses will be caught by this and may be financially better off leaving the flat rate scheme; normally by writing a letter to the VAT office at the end of the next VAT quarter, to notify them.

The detail can be found in section 4.6 of VAT notice 733: https://www.gov.uk/government/publications/vat-notice-733-flat-rate-scheme-for-small-businesses/vat-notice-733-flat-rate-scheme-for-small-businesses#section6

Please do not hesitate to get in touch with us if you have any queries.