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VAT or (Value-Added Tax) has always been more or less a nuisance for business owners. But recently, the VAT Flat Rate Scheme has also been changed in ways that don’t make it viable any longer for businesses. In 2017, the UK government introduced revisions in the VAT Flat Rate Scheme, which has existed since the 2002 Budget.
In this post, we will discuss some of these changes and their relevance to your business.
Value-added tax (commonly VAT) is a tax levied on the sales of goods and services. VAT-registered businesses charge their customers a VAT rate of 20% on the goods or services they purchase. The taxable turnover threshold is currently £85,000 which determines whether a business must be registered for VAT.
According to the UK government, the Flat Rate Scheme has been designed to simplify your business’ record-keeping of sales and purchases. You just pay a fixed flat rate percentage to your gross turnover in order to determine the VAT due. That fixed flat rate is determined depending on your business sector.
HM Revenue and Customs introduced the VAT Flat Rate Scheme for small business, and small limited companies, in the 2002 Budget. It was catered towards small business owners so as to alleviate the administrative stress of preparing VAT returns.
Up until 2017, the VAT Flat Rate Scheme was a helpful route for small business to increase their profit margins because the flat rate of VAT paid on their sales was significantly lower than the headline VAT rate that they charged their customers. This allowed small business owners to keep the difference.
However, this benefit was substantially curtailed from 1st April 2017 when the government of UK clamped down upon what it saw as the “aggressive abuse” of the VAT Flat Rate Scheme. The introduced changes included a higher flat rate of 16.5% for “limited cost” traders, which are defined as business whose VAT-inclusive expenditure on goods is either below 2% of their VAT-inclusive turnover in a prescribed period, or above 2% of their VAT-inclusive turnover (though less than £1,000 per annum).
Another disadvantage of the Flat Rate Scheme is that a business cannot reclaim VAT on its purchases, compared to Standard VAT Accounting. If your business buys stock or if you have a high amount of VAT-able expenses, you cannot get that money back! Except for certain capital expenditures which are over £2,000
A more hidden drawback of the Flat Rate Scheme is that if your business is registered for the scheme, your “exempt” income, i.e., income earned from leasing out commercial land or property – is taxed on the flat rate (apart from bank account interest). This can be a major trap for businesses since it also applies to zero-rated and reduced-rate supplies.
A key challenge that businesses also face is that it is difficult to identify the correct VAT flat rate based on their business type. Its often unclear what trade class a business belongs to. Moreover, HMRC refuses to make a decision on the scheme’s rate on behalf of the business and can even challenge the rate chosen by the business.
Your business’ growth rate is another important factor in determining the usefulness of the Flat Rate Scheme. If your business’ revenue is likely to quickly exceed the upper threshold of £230,000, you will have to leave the Flat Rate Scheme soon anyway. So, it is essential that you consider your business plan and forecast turnover figures to see if there is an expectation of quick growth. If there is, then it’s more beneficial to register under the standard scheme from the start to create a good practice.
Because of these reasons, it has become increasingly nonviable for your business to register for the VAT Flat Rate Scheme. Instead, choosing the Standard VAT Accounting Scheme and streamlining your accounting work is a much better option in the long run. This will ensure that you can reclaim VAT on your purchases and will allow you to have a better command over your books without unnecessary administrative stress.
Every business is different and has different sets of needs according to its VAT-able purchases and expenses. Therefore, its good to speak to your accountant to decide which scheme is more suitable and beneficial for your business, both from an administrative and taxation perspective.