Small business may suffer from VAT abuse crackdown

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The Chartered Institute of Taxation (CIOT) has expressed concern that HMRC’s new measure to crackdown on abuse of the VAT Flat Rate Scheme (FRS) simplification may be ineffective, and bring unwelcome consequences for tax-compliant small businesses.

The FRS, which enables small businesses to pay HMRC a fixed rate of VAT determined by their type of business rather than keep detailed records, has come under fire following allegations of widespread abuse by some employment agencies and similar businesses, which set up thousands of two-employee companies to both benefit from a favourable FRS percentage and NIC employment allowance.

To tackle this issue, during last year’s Autumn Statement the Chancellor announced changes which mean a business that falls into a new definition of a ‘limited cost trader’ during an accounting period will pay a higher 16.5% rate.

If the changes go ahead, businesses using or considering joining the FRS will need to determine whether they are also a limited cost trader. If they are they will pay HMRC 16.5% of their gross sales, rather than a potentially lower percentage applicable to their activity.

HMRC estimates that 411,000 businesses use FRS, and that approximately 4,000 businesses will move back into standard VAT accounting following the change. However, the CIOT believes far more business will be affected and that the costs of doing this could be significantly higher than the £180 per annum suggested by HMRC.

Targeted action – not wholesale changes

While the CIOT accepted that the government must tackle abuse, it believes that the current proposals must be changed to avoid collateral damage to the majority of small traders who do not abuse the system. There is concern that HMRC has significantly underestimated the collateral impact of these changes, both in terms of the number of businesses affected and the financial impact.

The CIOT has urged HMRC to rethink its view that existing legislation and legal principles cannot be used to tackle abuse of the measure, and suggested that HMRC further investigate alternative approaches, such as to restrict the FRS to businesses required (rather than eligible) to be registered for VAT, or tighten up the associated business rule.

There will be difficulties building in effective anti-tax avoidance measures to prevent traders side-stepping the new measure. It is strongly suspected that gaps will remain in the legislation and will be exploited. It is also concerned that some users might simply ignore the changes, and just liquidate any businesses subsequently assessed by HMRC.

Administrative problems

The CIOT also believes that the changes are likely to cause administrative problems for FRS users. Any business which might fall within the definition of a limited cost trader will need to check its position for each VAT accounting period using a planned online tool on

To effectively use the online tool, the business will need to know the value of its purchases of goods during that period. The proposed changes add a significant level of complexity on small business owners who will need considerable guidance from HMRC.