VAT is a minefield for the unwary
and anything that can help reduce
the burden must surely be
welcome.
A programme quietly introduced
back in April 2002, the VAT flat rate
scheme, is one such form of help
from HM Revenue & Customs that, if
appropriate for your business, 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, which can also reduce VAT liabilities. Instead of calculating output tax from your sales and deductible input
tax from your
purchases – which
may involve
complicated rules and
partial exemption
calculations – scheme
users simply pay VAT
on a percentage of
their VAT-inclusive
turnover.
The percentage to
use will depend on
the type of business,
and the amount that
the business has to
pay over to HMRC
can be lower than
under normal VAT
accounting. HMRC
has published the flat
rate scheme percentage rates for 55
different types of business at www.hmrc.gov.uk/vat/start/schemes/f lat-rate.htm#5.
Are you eligible?
The scheme is only available to small
businesses – i.e. those with standard-
rated, reduced rated and zero-rated
supplies of not more than £150,000
(excluding VAT). Unlike the turnover
limits for other special VAT schemes,
this limit has not been increased since business income – including exempt
supplies, but not capital items –
reaches £225,000 (including VAT).
The scheme cannot be used by a
“person” – which could mean an
individual, partnership or corporate
entity – who is “associated” with
another “person” carrying on a
business. Persons are “associated” for
these purposes if one can influence
the other or if they are closely bound
to each other by financial, economic
and organisational links.
Should you join?
Although you may be eligible to use
the flat rate scheme, it may not be appropriate for you.
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 that
trade sector. It will
also be unsuitable for
businesses that sell second-hand goods.
There is an incentive for new businesses to join the scheme, in the
form of a 1% discount to the
applicable flat rate scheme percentage
for the first year of VAT registration.
In some cases this could provide a
further worthwhile saving.
There is a ready reckoner at
http://vatreadyreckoner.hmrc.gov.uk/
to help businesses compare
approximate VAT liabilities under the
flat rate scheme and under normal
VAT accounting.
The examples below illustrate
when use of the scheme could either
reduce or increase VAT liabilities.
Saving time
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.
Saving money
The flat rate scheme percentages 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 the flat rate scheme.
Where a business carries on more
than one type of activity, the
percentage rate for the activity with
the higher turnover can be applied to
all of the turnover. This can provide
greater savings for the activity to
which a higher rate would normally apply.
In such situations businesses need to take care to keep an eye on the
mix of sales, as a failure to change
the rate following a change in the mix
could result in an expensive bill for
arrears of VAT.
Things to watch
Where tax is concerned, things are
rarely entirely straightforward, and the
flat rate scheme is no exception! It
works well for those who understand
it, but there are a number of pitfalls
and points to watch.
Turnover: the flat rate scheme
covers all turnover, including zero-
rated and exempt items such as rental
income. This means that scheme users
have to account for VAT on such
items, which is not the case under
normal VAT accounting, so the
scheme is unlikely to be suitable where
such items comprise a significant
proportion of sales.
Outside the scope income: income
which is outside the scope of VAT
does not have to be included in the
scheme turnover. This includes income
from supplies of services made to
businesses outside the UK.
Capital items: sales of business assets
such as property and cars are also
included in turnover for flat rate
scheme purposes, 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 who intends to sell the
business property should leave the
scheme a year before the proposed sale.
Cars also present a problem: scheme
users would have to include the value
of the sale of a car in their scheme
turnover, despite the fact that 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 is relaxed for most capital
items costing more than £2,000
including VAT, allowing input tax to be
claimed.
Bank interest: most small businesses
would not regard deposit interest on a
business bank account as part of their
turnover, but such interest does form
part of turnover for flat rate scheme
purposes.
Other VAT schemes: 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.
Income tax and corporation tax: for the
purposes of 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 finally…
It is important to note that flat rate
scheme users must still charge the
normal rates of VAT to their
customers – for example, 17.5% for
standard-rated supplies (20% from 4th
January 2011). The flat rate scheme
percentages will also change from that
date, and HMRC has already published
these at
www.hmrc.gov.uk/vat/start/schemes/f lat-rate.htm#5.
This article only briefly summarises
the flat rate scheme, and in all cases
appropriate professional advice should
be taken before joining the scheme.
