Changes to Flat Rate VAT Rules

You may remember we talked about changes to the Flat Rate VAT rules coming into effect 1 April 2017, in our Budget special.

KP216075The Flat Rate VAT changes are now a reality for many of us, so it’s time we went into a little more detail.

This scheme has been a great way for service businesses to account for and to declare their VAT.

The Old Way

The business still charges VAT at 20% when it  invoices clients, but when it comes to declaring and paying the tax man, they can apply a Flat Rate to their gross income.

For example, if Peter Quill uses the flat rate of 14%*, and invoices a client for £1,000, he adds VAT at £20%, so his total invoice to his client is £1,200 (£1,000 plus £200 VAT).

Using the flat rate scheme he declares and pays £1,200 x 14% to the tax man, which is £168, instead of the full £200 VAT he charged to his customer.  So he keeps the rest of the VAT, to cover any VAT on business expenses.

However, Peter doesn’t claim any VAT back on his business expenses.

*There are different flat rates for different types of business, so this is just an example.

The New Way

HMRC have cottoned onto this, and have decided to nip it in the bud.  From 1 April 2017, if you’re using the flat rate, and your VAT inclusive goods purchased are 2% or less than your VAT inclusive sales, then you have to move to a flat rate of 16.5%.

This doesn’t sound too bad, it’s still a lot less than 20% right?  Well let’s look at the numbers (we like numbers).

In Peter’s case.  If he now calculates £1,200 x 16.5% it works out at £198, which is just shy of the full 20% VAT, so there’s no real benefit in him using the flat rate any more (remember that on the flat rate Peter’s not claiming back any VAT on his business expenses either).

But my goods are more than 2% I hear you say.  Unfortunately HMRC have thought of this too – goods cannot include any services (eg accountancy fees, telephone charges) and cannot include the following:

  • Capital assets
  • Food and drink consumed by the business or employees
  • Motoring costs
What To Do Now If This Affects Me?

Firstly here’s HMRC’s handy calculator to see whether you’re affected by the higher rate of 16.5%.

You have 3 main choices:

1. Do nothing and automatically move to 16.5%

2. Deregister from the flat rate, and move to declaring the full 20% VAT on your sales but also start claiming back VAT on your business expenses.

3. Deregister from VAT altogether if you’re below the VAT threshold (currently £85,000) and it won’t affect how you do business.

If this is all gobbledeegook or you just want to find out what your options are please give us a shout, we’re here to help.