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The Flat Rate Scheme – Explaining the VAT Changes

06 March
The Flat Rate Scheme – Explaining the VAT Changes

In the most recent autumn statement, the chancellor Philip Hammond announced changes which will affect how VAT is calculated for ‘limited cost traders’ – that is, businesses who spend very little on goods. While understanding the new system might seem complicated, it may have implications for how your business calculates its VAT bill, so it’s important to get to know it. Here’s what the changes will mean for businesses – and how they may affect you.

How does the system work currently?

In general, businesses calculate what they owe HMRC in VAT by deducting the VAT on inputs (the goods they’ve bought) from the VAT on outputs (the goods they’ve sold). That involves a two-stage process, first calculating the VAT on inputs and outputs, then making the deduction.

But there is also a simpler system which many businesses use, the Flat Rate Scheme, which is a one-stage process. Instead of making any deductions, these businesses can calculate the VAT they owe on outputs with a flat, lower rate of VAT. How low these rates can be varies depending on the type of business – for example, the rate for a clothes shop is 7.5%, while the rate for a detective agency is 12%. The announced changes affect only the Flat Rate Scheme.

What is changing?

The change will affect a particular type of business which currently uses the Flat Rate Scheme – limited cost traders. Limited cost traders are defined as businesses whose expenditure on goods in a prescribed accounting period, including VAT, is less than 2% of their VAT-inclusive turnover. If your business spends more than £1000 annually on goods, then it will also be defined as a limited cost trader. Put simply, limited cost traders are businesses who don’t purchase a lot of goods, and for that reason pay relatively little VAT on their inputs.

The changes mean that limited cost traders must pay a fixed rate of 16.5%, regardless of their type of businesses. While before what your business paid in VAT on the Flat Rate Scheme depended on the type of business, under the new system, businesses will have to decide on whether they are a limited cost trader and pay their VAT bill accordingly. Anti-forestalling legislation has been introduced to make sure that all limited cost traders pay the new 16.5% rate from the 1st of April 2017.

Who will the changes affect?

There will be a particular impact on labour-intensive businesses who pay little for goods, with their expenditure focused instead on employees and labour. For example, IT contractors, consultants, hairdressers, and advisory firms may be especially affected by the new system. It will also affect those construction workers who supply their labour but the raw materials are supplied by a main contractor, since those construction workers are spending little on inputs.

Though it’s often forgotten by entrepreneurs, retaining an accountant can actually let you reap greater rewards in the long run. With their knowledge of your finances and your sector they’ll be able to help your business grow smoothly at every stage. So if you’re interested in retaining an accountant, please get in touch with us. At Dua & Co. we’re experienced accountants in Watford, and we’d be delighted to work with you to help grow your business.

How we can help

If you are currently on the flat rate VAT scheme and would like to know more about ‘Limited Cost Traders’ and need help with explanations, calculations, allowable and dis-allowed goods and services, Dua & Co. are experienced accountants in Watford, and we are here to help

If you’re already a Dua & Co. client, please email or call your Portfolio Manager, who will be happy to offer guidance with the new system, and explain what it could mean for your business.

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