New VAT legislation leaves businesses feeling Flat

Since its inception in 2002, thousands of small VAT registered businesses have been enrolled and utilising the Flat Rate Scheme to report to HMRC.  Originally designed to simplify the VAT calculation and remove the burden of reconciling VAT on both sales and purchases, the scheme has proved popular for qualifying businesses with a VAT turnover of less than £150,000.

In the chancellor’s recent budget, he noted that the government felt that a large portion of SME’s who were enrolled onto the scheme had done so, just for a “financial advantage”.  In fact he went as far as saying that new legislation would be needed to “tackle aggressive abuse of the Flat Rate Scheme”.   A new alteration to the scheme was announced, which adds a new trading category to the trading list: a limited cost trader with a rate of 16.5%.  This new rate for businesses that “qualify” would eradicate any so called “tax benefit” for remaining on the scheme.  The changes have been proposed to take place on 1 April 2017.  Now the short consultation period has ended, these changes have now been confirmed, with HMRC refusing to change the proposed date.

What does this mean?

“Small businesses enrolled on the scheme will now need check cost of “goods” purchased each quarter and identify whether it can submit the return based on its normal FLS trade sector category or whether its VAT inclusive expenditure on ‘goods’ is less than 2% of its gross sales or £250, and the 16.5% rate will therefore apply.”

The meaning of the word “Goods” is not immediately clear.  But we can confirm that it does not include overheads such as rent, telephone or postage.  Neither does it include the cost of fixed asset purchases.  In the purest form we are talking about cost of sales items, for which most small consultancy businesses will simply not have on a quarterly basis.

To give us an insight into the reasons for the legislative changes, the following statistics have been published by HMRC:-

  • The new limited cost trader category will increase the annual tax yield by £130m.
  • Two thirds of FRS users are registered for VAT on a voluntary basis (annual taxable sales are less than £83,000) and HMRC anticipate that the new category will mean that “many of them may decide to deregister”.
  • The limited credit for input tax that is evident with the 16.5% rate means that an estimated 4,000 FRS users will revert to standard VAT accounting.


The reason for this change (other than the £130m in additional tax revenues) is that in the government’s eyes, they believe that a good number of “single director low overhead” businesses were enrolled onto the scheme to save VAT.  To be honest they are not wrong, but in our view this should have been taken into account when the scheme was implemented, not 15 years later.  For many who qualified for the scheme, they have done so because they meet the criteria and the simplified calculation rules help save time.  Also we genuinely feel that the changes have a “broad brush stroke” effect, which penalises those who have genuinely enrolled on the scheme due to qualifying with those who have purposely joined just to save tax.

To help with the quarterly review, HMRC have stated that an online tool will be developed to assist with the decision as to whether to “stick or twist”, but from experience it should be quickly apparent which percentage a business should use and if they should decide to deregister from the Flat Rate Scheme altogether.

Should you have any additional questions relating to this blog entry, please contact a member of the WHA team who will be happy to help.