The VAT Flat Rate Scheme is due to change in April 2017 and the changes will dramatically reduce the benefits or gains associated with operating the Flat Rate Scheme for many small businesses across the UK. The Flat Rate Scheme has been used by many businesses a method of boosting income by charging VAT of 20% on customer invoices and then paying a lesser % to HMRC and simply pocketing the gain. This is all changing and for many businesses it simply won’t be worthwhile operating the scheme in the future.
What is the Flat Rate Scheme?
The Flat Rate Scheme is a VAT scheme that small businesses can sign up to and the aim of the scheme is to offer small businesses a simplified and less burdensome approach to calculating and paying VAT to HMRC.
The scheme allows small business to charge 20% VAT on all invoices issued to customers and to then pay HMRC a reduced percentage of the total income received. If you are a management consultant, for example, your flat rate percentage would be 14%.
This means that on a £100 invoice you would add VAT of £20 (being 20%) and you would then receive total income of £120. You would then pay HMRC 14% of £120, being £16.80, resulting in a gain of £3.20.
These gains could add up across a 12 month period.
What is changing?
From 1 April 2017 small businesses with a low cost base will be impacted by the changes to the Flat Rate Scheme. This will affect many businesses that offer services and this could be anyone contracting, freelancing or providing consultancy services via a limited company or as a sole trader.
If you spend less than 2% of your turnover on goods (not services) per annum then you will be classed as a “limited cost trader” and you will be impacted by the changes.
Furthermore, if you spend less than £1,000 per annum on goods, regardless of your level of turnover, you will be also classed as a “limited cost trader” and you will be impacted by the changes.
If you fall into any of the above categories you will need to pay HMRC VAT at a rate of 16.5% of total income from sales (or turnover).
So if you are a management consultant, continuing on from the example proved above, you will need to pay HMRC 16.5% of the £120 you receive from your customer resulting in VAT due of £19.80, which leaves a gain of only £0.20.
As you can see from the example above the changes can result in major reduction in income and it hardly seems worthwhile operating the scheme post March 2017.
If you want to discuss any of the changes further then feel free to email one of our cheap accountants at firstname.lastname@example.org.