In the January issue of NSS, while reporting the changes to VAT, we said the Flat Rate Scheme percentages had been recalculated to reflect the new standard VAT rate of 20%. Readers have asked us for more information about the Flat Rate Scheme. Here, Steve James, a Tax Principal with accountants BDO, explains.
This year’s increase in the standard rate of VAT from 17.5% to 20% has naturally resulted in higher VAT liabilities for Flat Rate Scheme users. However, where use of the Flat Rate Scheme results in a saving, that saving is also greater.
VAT is a minefield for the unwary and anything that can help reduce the burden must surely be welcome. The VAT Flat Rate Scheme, quietly introduced by HM Revenue & Customs for small businesses in April 2002, is one such scheme. If it is appropriate for your business, it will not only save you time and much form filling, but could also lower your VAT bill – legitimately.
In simple terms, the VAT Flat Rate Scheme is a way for small businesses to account for VAT so that instead of calculating output tax from sales and deductible input tax from purchases – involving complicated rules and possibly partial exemption calculations – VAT is simply paid as a percentage of VAT-inclusive turnover.
Different kinds of businesses pay different rates. HMRC publish rates on their website (www.hmrc.gov.uk). General building or construction services are at 9.5% and labour-only building or construction services at 14.5% (labour-only building or construction services means where the value of materials supplied is less than 10% of relevant turnover).
The scheme is only available to small businesses – that is, those with standard-rated, reduced rated and zero-rated supplies of not more than £150,000 in a year (excluding VAT). Furthermore, a business cannot remain in the scheme once income – including exempt supplies, but not capital items – reaches £230,000 (including VAT).
Even if you are eligible to use the Flat Rate Scheme, it may not be appropriate for you. For example, it will certainly not be appropriate for businesses that regularly receive VAT repayments under normal VAT accounting, and it is unlikely to be suitable for businesses that either make more zero-rated / exempt supplies, or incur more VAT input tax on their purchases than the average for businesses in their trade sector.
There is an added incentive for new businesses to join the scheme in the form of a one percentage point discount for the first year of VAT registration.
The Flat Rate Scheme covers all types of supplies, so record-keeping is easier – it will normally only be necessary to record gross takings, instead of keeping a record of gross, VAT, net and exempt amounts.
In addition, with minor exceptions, there is no need to record input tax or worry about whether or not the input tax on certain types of goods or expenses is deductible.
For businesses that make some exempt supplies, the scheme also avoids the need to make complicated quarterly and annual partial exemption calculations and adjustments.
The Flat Rate Scheme rates take into account the amount of input tax that businesses in each sector typically recover, so businesses with lower than average amounts of standard-rated expenditure will often be able to reduce their VAT liabilities under this scheme.
Much greater savings might be possible where business expenditure is low.
But where tax is concerned things are rarely entirely straightforward, and the Flat Rate Scheme is no exception.
It covers all turnover, including reduced rate, zero-rated and exempt items. The scheme is unlikely to be suitable where zero-rated or exempt items comprise a significant proportion of sales.
Sales of business assets such as property and cars are included in turnover under the Flat Rate Scheme, irrespective of whether VAT is charged to the customer. This can result in some very costly mistakes, especially where a business property is sold. Any Flat Rate Scheme user intending to sell a business property should leave the scheme a year before the proposed sale.
Scheme users have to include the value of the sale of a car in their turnover as well, even though they would not have been able to recover any input tax on its purchase.
The picture is not quite as bleak for other assets, such as plant and equipment. The rule that Flat Rate Scheme users cannot separately recover any input tax, including VAT, is relaxed for most capital items costing more than £2,000.
However, where input tax is claimed separately in this way, output tax must also be accounted for separately on the sale of the asset, at the full rate of VAT (not the scheme percentage rate). Where input tax has not been claimed separately on items of plant and equipment, any proceeds on disposal need to be included in scheme turnover.
Most small businesses would not regard interest on bank deposits as part of their turnover, but it is for Flat Rate Scheme purposes.
The Flat Rate Scheme can be used in conjunction with the Annual Accounting Scheme to further simplify VAT accounting. It cannot be used with the Cash Accounting Scheme or Special Retail Schemes, but accounting methods can be adopted which give a similar result within the Flat Rate Scheme.
For the purposes of income tax and corporation tax in the business’s annual accounts, Flat Rate Scheme tax is simply deducted from gross sales. All purchases, expenses, and capital items costing less than £2,000 (including VAT) will be shown in the accounts at their VAT-inclusive amounts.
And in case there is any doubt about it, please note that Flat Rate Scheme users must still charge the normal rates of VAT to their customers – ie 20% for standard rated goods and services.
This article only briefly summarises the flat rate scheme, and in all cases appropriate professional advice should be taken before joining the scheme.
Examples
Peter is a self-employed mason. His VAT-inclusive turnover is £120,000 a year, and he spends about £40,000 (including VAT) on standard-rated goods and services. Under normal VAT accounting, assuming all sales are standard-rated, his annual VAT liability this year would be £13,333 (£20,000 output tax less £6,667 input tax).
The Flat Rate Scheme percentage for him (where the materials he uses comprise 10% or more of turnover) has been 9.5% since 4 January, so under the Flat Rate Scheme, his VAT liability would be £11,400 (£120,000 x 9.5%), which is a saving of £1,933 (£218 more than before the increase in the VAT rate to 20%).
If Peter were to spend about £55,000 a year (including VAT) on standard-rated goods and services, his annual VAT liability under normal VAT accounting would be £10,833 (£20,000 output tax less £9,167 input tax). This is £567 less than under the Flat Rate Scheme, but Peter might consider £567 was a reasonable price to pay in order to save time, trouble and administration costs.
If Peter had purchased a new van for £12,000 (£10,000 plus £2,000 VAT), his VAT liability for the year under the Flat Rate Scheme would be £9,400 (£11,400 - £2,000), which is £950 more than before the change in the VAT rate.