21 April 2017 | Taxation
A new flat rate category for limited cost traders will be introduced on 1 April 2017. What are the detailed rules, and are there ways to avoid having to apply the new punitive rate?
The proposed changes to the flat rate scheme (FRS) that were announced in the 2016 Autumn Statement. Now that draft secondary legislation is available, we can understand the detail of the changes.
The new limited cost trader (LCT) category must be selected after 1 April 2017 by any business whose spending on “relevant goods” is either:
For a business that is on the annual accounting scheme and completes only one VAT return each year instead of four, the relevant figure will be £1,000 rather than £250. This is a simple test at first glance, but there are a few issues concerning the definition of relevant goods. The test has to be applied each time that a business completes a VAT return.
The following items are always excluded from the calculations of “relevant goods”: vehicles, road fuel and motor parts, food, drink and capital items (unless the business is a transport business which owns or leases a vehicle in its business; it can then include motoring costs).
Supplies of gas and electricity are included because they are goods, whereas rent, telephone and Internet charges are services, so are excluded.
Only expenses that are wholly business related are included in the calculations. This means that a gas or electricity bill with part business and part private use must be excluded completely.
The legislation helpfully confirms that the exclusion for food and drink items only applies to “consumption by the flat-rate trader or employees of the flat-rate trader”. This means there is no problem with food or drink purchased by a business, such as a hotel, pub or restaurant, where the items are consumed by customers, i.e. where the purchase is a cost of sale rather than an expense in the profit and loss account.
For the VAT quarter ending 30 June 2017, a journalist using the FRS had gross sales of £10,000 including VAT. The VAT-inclusive spending on relevant goods (all stationery) for the same period was £240. The business must adopt the 12.5% rate and pay £1,250 of VAT because although the spending on goods is more than 2% of gross sales, it is below the de minimis figure of £250.
There are some tips and techniques which might help avoid falling into the new LCT category.
The Limited Cost Trader calculation must be made by a trader when they complete each VAT return, usually on a quarterly basis. If the journalist in the example above has income of £10,000 and spends £240 on goods each quarter, they will always be an LCT. But what happens if they change their buying strategy and buy goods over three quarters instead of four, i.e. spending £320 in three quarters and nothing in the other quarter?
Most scheme users affected by the new 16.5% category will be service businesses, such as consultants, accountants and labour only builders. Most professionals purchase books and magazines to keep their knowledge up to date on technical and product issues. The purchase of these books will be included in the 2% test.
You have to be aware that magazines and books in paper format are classed as “goods” and are therefore relevant to the 2% test for the LCT category. But online subscriptions to technical websites are classed as services and are excluded. Business should opt for a hard copy version wherever possible.
In February 2017 HMRC slipped out an amendment to the rules to restrict the test to the main activity only. The following paragraphs is now completely inapplicable.
The extra annual VAT payment of many businesses as a result of the LCT rules could be as high as £10,000. Think of a business that has gross annual sales of £225,000 having to change from a 12% sweep-up category to the new 16.5% rate. The extra VAT payable each year will be £10,125. Although a client can only join the FRS if it expects its taxable sales in the next twelve months to be less than £150,000 excluding VAT, it does not need to leave until gross sales have exceeded £230,000 on the anniversary date of when it first joined the scheme. In this situation, explore the possibility of you starting a secondary activity of buying and selling some goods, perhaps on eBay, in order to avert the LCT outcome.
Mike is a journalist who uses the FRS (12.5% rate) and has annual gross income of £225,000. He spends £500 each year (£125 per quarter) on buying stationery items. This is his only spending on goods. If John introduces a new activity of buying and selling, say, music CDs on eBay or Amazon (or indeed any goods, even zero rated items), then he will need to spend £4,000 each year on buying goods for resale (£1,000 each quarter) and then will avoid being an LCT. His total spending on goods will be £4,500 including stationery.
The irony of the rules with the LCT category is that even if you make a loss from a secondary activity of buying and selling goods, the loss will generally be much less than the VAT suffered by the 16.5% rate for a LCT.
Question: is there a 1% discount with the LCT? Answer: No.
The new 16.5% rate for a Limited Cost Trader means that a business with wholly standard-rated sales is only getting £10 of input tax credit for every £1,000 of output tax charged to customers. It might be worth leaving the FRS on 31 March 2017. This decision should take into account the time-saving benefits of the FRS – is it worth paying more tax to retain these benefits? A business must notify HMRC of its decision to leave the scheme.
HMRC estimates that 80,000 of the 123,000 businesses that will be affected by the new LCT category are registered for VAT on a voluntary basis, i.e. annual taxable sales are less than £83,000. You can de-register at any time if you expect your taxable sales will be less than £81,000 in the next twelve months. Businesses can apply to de-register on-line or by completing Form VAT7.
The business only needs to have input tax of more than £10 per £1,000 of output tax to be better off with standard VAT accounting – output tax less input tax. It might be worth de-registering for VAT on 1 April 2017, especially if they have customers who cannot fully claim input tax, such as private individuals, many charities or a business with some exempt sales. The 20% VAT saving could be matched by a fee increase of, say, 10%, i.e. sharing the tax saving.
Anna is an accountant with annual taxable sales of £60,000 excluding VAT, as she is registered for VAT on a voluntary basis. She has negligible input tax to claim and has minimal spending on goods. She will therefore be an LCT from 1 April. Her effective credit for input tax will only be £120 with the LCT category: £72,000 gross sales x 16.5% = £11,880, i.e. £12,000 output tax charged to customers less £120 notional input tax credit.
If, say, 25% of her fees are earned from customers who are not VAT registered, then she could increase her fees to these clients by 10% (£15,000 x 10% = £1,500) if she de-registered from VAT and shared the VAT saving with her clients. The £1,500 increase in fees is a better outcome than the £120 input tax credit she would have received with the Limited Cost Trader category – and her clients will be pleased with the overall reduction of £1,500 in their total fees as well, as they no longer have to pay VAT.
However, if you deal with large companies it may be wise to check with them that de-registration is not an issue, as the sometimes will not deal with businesses that appear too small.
For more information on any of the above to understand if you are a Limited Cost Trader, please contact Jane Hird.
The information provided is for general information purposes only.
Legislation and details may have changed since this was written. The text may not include all matters that are relevant to your individual situation.
You should not make decisions, or refrain from making decisions, without taking further professional advice about your specific circumstances.
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