The Flat Rate VAT Scheme (FRS) is Changing

The Flat Rate VAT Scheme (FRS) is Changing

If you haven't already heard, changes to the Flat Rate VAT Scheme (FRS) will be coming into effect from April 2017. These changes will affect the majority of small businesses who currently rely on FRS to simplify the VAT process.

HMRC has encouraged small businesses to take advantage of the scheme since it was first introduced in 2002. Under FRS, businesses with an annual turnover of less than £150,000 have been able to issue VAT invoices to their customers as usual, while accounting for VAT at a flat rate percentage of turnover. This simplifies record keeping and makes it easy to work out how much VAT a business owes. The rate is dependent on the industry and set by the government. For instance, a publishing company would use a rate of 11%, whereas the rate is 7.5% for a retail business selling clothes. 

As well as making the VAT process easier, many businesses have been able to keep a small amount of the VAT they have charged customers, after paying their FRS percentage to the government.

However, the government perceives use of this scheme by some businesses as 'aggressive abuse', despite it being used legally and at the encouragement of HMRC officers. The new legislation means that from April 2017, businesses will need to decide whether they meet the definition of a 'limited costs trader' to be eligible to use the scheme.

The government is defining limited cost traders as businesses that spend less than 2% of their sales on goods (not services) in an accounting period.

This amount cannot include purchases of:

§capital goods (such as new equipment used in a business)

§food and drink (such as food for employees)

§vehicles or parts for vehicles (unless the company is a vehicle hiring business)

A business will also be a limited cost trader if it spends less than £1,000 a year, even if this is more than 2% of the firm's turnover on goods.

Businesses that meet the definition will be eligible to use FRS, and a new flat rate of 16.5% will apply to all industries.

There is no doubt that these changes will affect many traders who have used the scheme honestly and legitimately as a simplification measure, for which it was originally designed.

Understandably, businesses currently using (or thinking of using) FRS will want to know the financial implications of these changes. Businesses have the following options when deciding how to calculate VAT:

  • Deregister from VAT if turnover is below the VAT registration threshold of £83,000.
  • Move to standard VAT accounting. This allows businesses to reclaim VAT on every eligible item bought or sold. However, it does require extra administration and record keeping as part of the quarterly VAT submission.
  • Use the new flat rate of 16.5%, if eligible for FRS.

If you would like to discuss how this VAT change will affect your business, or would like to find out how VAT returns can be integrated into the bookkeeping serviceswe provide, please contact us at info@expertacc.com or call 0207 887 2437.