New VAT rules for Limited Cost Traders

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New rules have been introduced from the 1st April 2017 removing the VAT saving that many small businesses previously obtained through the Flat Rate Scheme (FRS).

All FRS users will now need to check, each time they complete a VAT return, if they are Limited Cost Traders. This is defined as one whose VAT inclusive expenditure on goods is either:

  • less than 2% of their VAT inclusive turnover in a quarter, or
  • greater than 2% of their VAT inclusive turnover, but less than £250 per quarter.

They must calculate their total spend on ‘relevant goods’ for the quarter. If this is less than either £250 in a VAT quarter or less than 2% of gross sales, they must adopt a special 16.5% rate.

It is expected that many VAT FRS users will either leave the scheme or deregister from VAT completely.

What are relevant goods?

Goods, for the purposes of this measure, must be used exclusively for the purpose of the business, but exclude the following items:

  • capital expenditure
  • food or drink for consumption by the flat rate business or its employees
  • vehicles, vehicle parts and fuel (except where the business is one that carries out transport services and uses its own or a leased vehicle to carry out those services).

These exclusions are part of the test to prevent businesses buying either low value everyday items or one off purchases in order to inflate their costs beyond 2%.

Businesses must not include the cost of any goods that are used in full or in part for private use. For example, printer ink and stationery that are used for both office and your home would not be included. It would also exclude goods acquired with the intention of giving them away or donating them to a third party.

Capital expenditure relates to amount spent on the cost of any goods that are bought to be used in the business over a period of time, e.g. longer than a year. In accounting terms they are described as fixed assets. Examples include equipment such as a computers, mobile phones, office furniture, a tablet or a printer.

The 1% discount continues

The new 16.5% rate for limited cost traders will be subject to the same rules that apply to the other 55 FRS categories. This includes the 1% discount that applies in the first year of VAT registration, if a limited cost trader uses the FRS. If the business joins the FRS part way through its first year of registration, they only get the 1% discount for the remaining period of the 12-month window

HMRC revealed some interesting statistics:

  • It will represent a major change to 123,000 FRS users.
  • The limited credit for input tax that is evident with the 16.5% rate means that an estimated 4,000 FRS users will revert to normal standard VAT accounting, i.e. output tax less input tax.
  • HMRC quotes an average figure of £390 in cost savings for a business that chooses to deregister after 1 April 2017.
  • The new limited cost trader category will increase the annual tax yield by £130m.

Everyone agrees that the new 16.5% category will not assist the ‘simplification’ aims of the FRS. Life will definitely get more complicated.

Deregistration

If a business expects its taxable sales in the next 12 months to be less than £81,000 (the deregistration threshold) then it may deregister. This will avoid having to worry about limited cost trader calculations. Many businesses will decide to deregister if they are limited cost traders every quarter because of the minimal input tax credit effectively given by the 16.5% rate.

Leave the FRS?

A business that is defined as a limited cost trader from 1 April 2017, with all standard rated sales, only needs to have input tax of more than £10 per £1,000 of output tax to be better off with normal standard VAT accounting .  Businesses must notify HMRC of its decision to leave the scheme and once a business leaves, it cannot re-join for 12 months.

What action should you take now?

You should consider the 2% and £1,000 per annum tests now for your business and decide if you should:

  1. stay in the scheme,
  2. leave the scheme and move to standard VAT accounting,
  3. or deregister for VAT

If you stay in the scheme, and become a limited cost trader, then any part of a VAT quarter that straddles 31 March 2017 must be split into a period before 31 March (using the existing FRS rates) and that after 1 April (using potentially) 16.5%.

If you decide to leave the scheme, but remain VAT registered, then you must separate and record your sales, purchases and costs into gross, VAT and net for each invoice, receipt or purchase within your accounting records. If you use our firm’s Excel cashbook template then please feel free to ask for our Excel cashbook template for standard VAT accounting.

If you have any doubt as to whether you should be in the scheme, e.g. if you are on the borderline £250 pq purchase of goods then you should consider either leaving the scheme or deregistering for VAT with effect from 1 April 2017. Staying in the scheme could be more expensive than adopting the standard method of VAT accounting.