VAT Flat Rate Scheme (FRS)

Tax Question of the WeekPosted by Tony Hawkins FCCA Wed, November 30, 2016 11:13:37

What is a “limited cost trader”?

In an attempt to cut back on aggressive use of the FRS, the Chancellor announced the introduction of a 16.5% VAT flat rate for businesses with limited costs.

In practice, many traders that currently use the FRS actually pay less VAT than if they had used the standard method (output tax less input tax). Businesses that make the most profit tend to be those that have very low costs subject to VAT.

For example, a business with an annual turnover of £100,000 with no costs subject to VAT and registered for the FRS (using a 14% rate) will be adding £20,000 output tax to their sales invoices but only paying £16,800 (£120,000 x 14%) to HMRC – a cash profit of £3,200. As noted above, HMRC see this as aggressive use of FRS.

From 1 April 2017, FRS traders who meet the following definitions will be considered “limited cost traders” and will be obliged to use a new 16.5% rate. A limited cost trader will be defined as one whose VAT inclusive expenditure on goods is either:

1. less than 2% of their VAT inclusive turnover in a prescribed accounting period

2. greater than 2% of their VAT inclusive turnover but less than £1000 per annum if the prescribed accounting period is one year (if it is not one year, the figure is the relevant proportion of £1000)

Goods, for the purposes of this measure, must be used exclusively for the purpose of the business but exclude the following items:

- capital expenditure

- food or drink for consumption by the flat rate business or its employees

- vehicles, vehicle parts and fuel (except where the business is one that carries out transport services ,for example a taxi business - and uses its own or a leased vehicle to carry out those services)

HMRC explain: These exclusions are part of the test to prevent traders buying either low value everyday items or one off purchases in order to inflate their costs beyond 2%.

Extending our example quoted above, 16.5% of £120,000 is £19,800, still a cash profit of £200 from using FRS, but only if there is no lost VAT input tax on costs or capital purchases…

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