1. Introduction

The Autumn Statement in late 2016 introduced a new compulsory flat rate for VAT of 16.5% for “Limited Cost Traders” (LCTs). In simple terms, a LCT is a business which does not spend sufficient/much on “relevant goods” – see Appendix for “What is a LCT” and what is meant by “Relevant Goods”.

These rules are designed to adversely affect businesses who supply services (essentially their own labour) who do not generally incur many costs on “goods” as opposed to services.

The change has been introduced because HMRC has eventually woken up to the fact that the current FRS rates are too generous for businesses which essentially supply their labour.

The new 16.5% FRS rate has been “spun” by HMRC as “Tackling aggressive abuse” – another sad example in our view of HMRC blurring the distinction between evasion, avoidance and people naturally using rules specifically created by Government which turn out to be too generous.

WHAT Negative Impact will the change have on my business?

Every business currently on the FRS needs to assess whether it is a LCT. If you are, you’ll need to assess the extent of the negative financial impact in order to decide on the best option going forward (see further below).

This assessment must be done before 31 March 2017 when the new rules bite.

Exactly how much worse off you’ll be depends on your particular circumstances, particularly how much profit you currently make from the FRS. This in turn depends on three factors:

- your total annual sales
- the FRS percentage you are on
- the number of costs where you have to pay VAT which is reclaimable

(See the Appendix for a worked example)

WHAT SHOULD I DO and WHAT WILL IT COST?

We recommend that the first step is for us as your accountants to review your particular circumstances.

We will discuss your situation with you and then advise you in writing which option(s) would be best for you (see below).

This initial review will cost just £99 + VAT if you ask us before the end of February or £134 + VAT if you ask us after.

We will also let you have a fixed fee in advance to implement the necessary change.

SO WHAT ARE MY OPTIONS?

As mentioned, the best option for your business depends on your unique circumstances.

However, the general options are:

a) Try to stay on your old FRS rate and outside the punitive 16.5% rate

How? – the only way is to ensure you spend enough on “relevant goods” so you exceed the minimum spend limit set by HMRC. Only by doing this can you avoid losing the profit you’ve been making from the existing FRS rate and avoid having to pay much more VAT over to HMRC.

In the Appendix, I have set out some possible strategies whereby you may be able to spend more/enough on goods.

If you can’t achieve a), we then need to assess which of the following 3 options is best for you as having the least negative impact on your business.

b) De-register your business from VAT

This is only possible where your total annual sales are less than £81,000.

It may only be beneficial where the VAT suffered on costs is less than the extra accountancy fees for doing quarterly VAT returns. Once you’ve de-registered you won’t need to do VAT returns any more but you won’t be able to recover VAT anymore on costs.

c) Stay on the FRS but move to the 16.5% higher rate

This is only going to be beneficial where you have very few costs which have VAT charged on them.

The numbers need to be crunched to see if this could work for you.

d) Come off the FRS onto “normal” VAT accounting

Normal accounting for VAT means each period you pay VAT on the difference between Output VAT on your sales minus Input VAT on your costs. The VAT on sales is payable now at the full 20% not the reduced FRS rate.

Again, the numbers need to be crunched to see if this leads to the lowest amount of VAT payable and the highest retained profits within your business.


APPENDIX

1. What is a “Limited Cost Trader (LCT)”?

2. What are “Relevant Goods”?

3. How much worse of will I be? – A Worked Example

4. Practical ways you could spend more on goods and stay on your low FRS rate

5. What other impact could this have on me?


1. What is a Limited Cost Trader (LCT)?

A LCT is defined as a business which incurs costs on “relevant goods” (including the VAT) in a VAT Return period of:

  • Less than 2% of your gross sales (including VAT); OR
  • More than 2% of your gross sales, but at least £1,000 a year or £250 a quarter (gross).

Thus to avoid being a limited cost trader, you must spend at least 2% x your gross sales or £250 a quarter if this is higher than 2% of sales.

2. What are “Relevant Goods”?

“Relevant goods” are goods used or to be used exclusively for your business, but excluding the following:

a) Vehicles, vehicle parts and fuel (except where these are typical goods for services you supply – e.g. a taxi driver or courier);

b) Any food or drinks for consumption by the flat-rate trader or employees of the trader; or

c) Capital expenditure goods such as computers or plant & equipment.

If you do quarterly VAT Returns (as most do), you’ll need to spread expenditure on goods evenly during a year - i.e. you need to meet the 2% test or £250, if less, each and every quarter to be able to stay on your old FRS VAT rate each quarter. It won’t work if you spend the right percentage/amount in Q1 but don’t do so in the subsequent three quarters.

3. How much worse of will I be? – A Worked Example

If say:

  • - your annual sales are say £120,000 excluding VAT;
  • - you are currently on a 12% FRS rate; and
  • - you have costs of say £2,000 net for goods and £3,750 net for services on which you can recover the VAT

the position is:

Option a) above

Option c) above

Option d) above

Details

Prior to 1 April 2017
12% FRS

Details

On or After 1 April 2017
16.5% BUT Stay on FRS

On or After 1 April 2017
Off FRS Normal VAT

VAT on Sales £120,000 x 20% =

24,000

VAT on Sales £120,000 x 20% =

24,000

24,000

Less: VAT Claimed on Costs

-

Less: VAT Claimed on Costs £5,750 x 20%/p>

-

(1,150)

VAT Paid £120,000 x 1.2 x 12%

17,280

VAT Paid £120,000 x 1.2 x 16.5%

23,760

22,850

Profit Made from the FRS

6,720

240

Amount Better off by coming off FRS

910


For this business:

  • it can’t de-register as the sales are over £81,000
  • it can’t continue to benefit from the large profit of £6,720 it makes from the existing low FRS rate - Column headed Option a) – it does not spend the necessary 2% x gross sales on goods
  • its best option is thus to come off the FRS and onto the normal accounting for VAT – Column headed Option d). It now has to pay VAT of £22,850 instead of £17,280 – it is £5,570 worse off than before. BUT it is marginally better by £910 than simply adopting the higher 16.5% FRS rate – Column headed Option c)

The position for this business could be different however if:

  • the value of the relevant goods were increased by £400 net or £480 gross a year, so the annual gross total came to £2,880, i.e. 2% x £144,000 (the VAT inclusive sales total) – meaning the company is not a LCT and can remain on the 12% FRS rate

The best option could also be different if:

  • Net sales were lower at say £70,000 (here we could consider de-registering completely from VAT); OR
  • Costs on which VAT is suffered were lower (here maybe we could consider simply adopting the higher 16.5% FRS rate

4. Practical ways you could spend more on goods and stay on your low FRS rate

a) You may already be spending quite a lot on stationery and computer consumables.

Maybe you could increase the purchase of these and sell any surplus on at a profit.

b) You cannot create a new business within your existing business simply to ensure you spend enough on goods so the total spend comes to at least 2% x gross sales or £1,000 a year, if lower.

Goods for resale don’t count unless the “main business activity ordinarily consists of selling, leasing, letting or hiring out such goods”. Whilst the exact meaning of “consists” is unclear, we think that if you essentially supply a service but the supply of goods relates to that service, this would be OK. For example a tutor who also supplies books or a tennis coach also supplies tennis rackets and clothing should qualify as “goods” for this test. So the sale of goods as an integral part of a service should be OK - but in marginal cases it may be worth seeking confirmation from HMRC.

Because of the need to assess spending levels against turnover each and every VAT period, for some it will make sense to move to Annual VAT Returns. In this way, you’ll only need to do one VAT Return a year and thus you’ll only need to comply with the necessary spending level for goods once a year, not every quarter.

5. What other impact could these changes have on me?

The Government introduced the FRS scheme as a simplification, designed to make it easier for businesses to account for VAT. As you simply apply a fixed percentage to your gross sales but generally never recover VAT on your costs, you don’t need to:

  • check whether you’ve got a valid VAT receipt for every cost; and
  • strip out the VAT and have to show 3 separate figures in the bookkeeping (Gross, VAT & Net); and
  • understand complex rules on whether an item has VAT on it or not (e.g. some car parking, books and biscuits have VAT on them and some don’t); and
  • know whether you can reclaim the VAT anyway (e.g. entertaining or gifts).

The “old” FRS rules also made it simpler and thus advantageous for HMRC - they don’t need as many staff to check that hundreds of “smaller” businesses were recovering VAT on all their costs correctly.

The new FRS rate and rules means that simplification has gone and VAT Returns are much more complex.

(i) The VAT Quarter in which the change occurs

For a business whose VAT quarter ends with the calendar quarters, i.e. ends 31 March, 30 June, 30 September & 31 December, any necessary change to the way you account for VAT is relatively easy.

You can complete your VAT quarter to 31 March 2017 as before using the old FRS rate. The change will take effect from the beginning of the next VAT quarter.

However, for any business whose VAT quarters end other than at the calendar quarters, it is much more complex.

For example, if your VAT quarter is from 1 February to 30 April 2017, the VAT on sales received in the first 2 months will be based on the old FRS %, whilst the VAT on sales received in April 2017 must be based on the new VAT system adopted (no VAT if de-registered OR VAT at 16.5% OR Normal VAT accounting if you have moved to one of these).

This way, you do benefit from the existing low FRS rate for as long as possible, right up to the date of change, 31 March but there are issues, in particular:

(ii) Bookkeeping Issues

What exactly has to be done to ensure the correct VAT is calculated in the first VAT quarter of any change to a new VAT position (and in future) will vary according to your method of bookkeeping:

  • SAGE; or
  • QuickBooks; or
  • XERO or some other cloud accounting software; or
  • Spreadsheets

In all cases, especially where your VAT quarter straddles 1 April 2017, it is vital that data is first entered only up to 31 March 2017 and that the VAT position is “finalised” and checked within the system, BEFORE entering ANY data at all from 1 April 2017 onwards.

Only when you’ve reconciled and checked that the right VAT payable figure is showing as due for the period to 31 March 2017 should you enter data, make the changes to the VAT rates or enter a change in VAT status with effect from 1 April 2017.

This fact sheet is for information only. It provides an overview of the regulations currently in force and no action should be taken without consulting the detailed legislation or seeking professional advice. Therefore, no responsibility for loss occasioned by any person or refraining from action as a result of this material can be accepted by the authors or the firm.