Changes to the VAT Flat Rate Scheme – what you need to know

If you are using the Flat Rate Scheme (FRS) for VAT reporting purposes, then you need to be aware of the new Limited Cost Trader (LCT) category HMRC are introducing on 1st April 2017. This new category will especially impact those businesses that provide services opposed to selling goods and could have a massive impact on the amount of VAT you pay each quarter.

We outline everything you need to know about FRS and the new LCT category.

How does the flat rate VAT scheme work?

The FRS is available for VAT registered businesses with an annual turnover up to £150,000 and who aren’t associated with any other businesses.

FRS aims to make VAT accounting simpler, as you only pay VAT at a fixed percentage of turnover rather than on each individual transaction.  The rate of VAT is less than the standard 20% rate and what you pay depends on the industry you work in.

You still invoice your clients at the standard 20% VAT rate but pay HMRC a flat rate of turnover each quarter. VAT on purchases can not be claimed back as it has already been factored into the percentage.

What impact will the new LCT category have on my business?

From 1 April 2017, all businesses using the FRS scheme must work out whether they meet the definition of a Limited Cost Trader (LCT) each time they submit a VAT return. If they do, then they must automatically apply the new 16.5% FRS rate.

So, what is a LCT?

A LCT is a business whose relevant business costs in a quarter are either:

  • Less than £250; or
  • Less than 2% of VAT inclusive sales.

There are several limitations to the definition of a relevant business cost, so for example, it cannot include purchases of:

  • Capital goods (such as new equipment)
  • Food and drink
  • Expenses like travel and accommodation
  • Rent, internet, phone bills and accountancy fees
  • Vehicle costs including fuel.

More details are given in VAT notice 733 on the HMRC website or contact us for more information.

How do I work out if my business falls within the LCT category?

For some businesses, their relevant business costs may fluctuate on a quarterly basis and therefore they will need to carry out the above test every time they submit a VAT return to determine which percentage rate to use. This calculator on the HMRC website can help you with this task.

As the new rules come into effect on 1st April 2017 there are transition rules for determining the VAT status of a business whose VAT quarter straddles 1st April 2017. The calculation to determine whether a business is LCT or not needs to be pro-rated and calculated on the turnover and costs for the period AFTER 1st April 2017 (this could be 1 or 2 months depending on when the VAT quarter starts).

Still not sure if this affects your business?

If you aren’t sure whether these changes will affect your business, please get in touch. Depending on your particular circumstances, it may be better for you to withdraw from FRS and switch to using the standard VAT scheme or, if your turnover is below the VAT registration threshold of £83,000, deregister from VAT.

We are happy to talk through the options with you and advise on the best course of action for your business.

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