In his Autumn Statement of November 2016 the Chancellor announced changes to the FRS designed to combat perceived abuse; predominantly by labour only agency workers. It will however affect many other service sector businesses.
The announcement was followed by HMRC guidance and then, in December 2016, by Draft legislation.
The changes are still subject to consultation but here is a summary of the proposals.
What’s changing?
The FRS is a simplified VAT scheme in which the business charges standard VAT to its customers but who then pays VAT to HMRC as fixed percentage of their turnover, with little if any ability to reclaim the VAT they suffer on purchases and expenses.
The FRS percentage used is based on industry sectors however, from 1 April 2017, HMRC will introduce a new category, “limited cost trader”, with a VAT flat rate of 16.5% which, for businesses with low purchases of goods, overrides the industry rates.
So for a business which falls foul of the new rate, for every £ of VAT it charges its customers, 99 pence is paid over to HMRC. Consequently the government is anticipating many businesses either deregistering or moving to standard VAT registration, in order to reclaim VAT on their expenditure.
What is a “Limited cost trader”?
A business is a limited cost trader if its VAT inclusive expenditure on goods is:
- Less than 2% of its VAT inclusive turnover in a VAT period, or
- Greater than 2% of their VAT inclusive turnover but less than £1,000 per annum (£250 per quarter).
What are “Goods”?
Goods are those used exclusively for business purposes, but exclude:
- Capital expenditure (eg equipment)
- Food & drink for consumption by the business
- Vehicles, vehicle parts and fuel (except where the business is one that carries out transport services using its own vehicles eg couriers & taxi firms)
It appears that gas and electricity charges will be regarded as goods, as will software bought off the shelf, whereas downloaded software will not be goods.
Because of the “exclusively for business” description it also appears that any expenditure on goods with a non-business element, eg for personal purposes, will also be excluded.
For many small service sector businesses therefore, unless they spend over the limits on things like stationery and printer cartridges, they will fall foul of the new rate for some or all of their VAT returns.
So what next?
Obviously we will have to wait for the final legislation but businesses should be anticipating the change and whether their purchases of “goods” are likely to be sufficient to enable them to continue using their current FRS rate.
Note that this may not be an all-or-nothing situation in that the calculations are based on VAT periods and so a business may be able to use their normal FRS rate in one quarter and 16.5% in the next.
As anticipated, it’s likely that many businesses, who are voluntarily VAT registered, will decide to deregister and others will decide to switch to standard VAT registration.
If you need to consider these options here are links for VAT deregistration and leaving the FRS.
