A sting in the tail for contractors using the simplified VAT Flat Rate Scheme has just been announced in the Autumn Statement.
Anti avoidance legislation is to be introduced from 1st April 2017 for limited cost traders (labour only businesses e.g. contractors and freelancers) meaning that their Flat Rate percentage will rise to a massive 16.5%
Typically a contractor will be on a rate of 14.5%.
The new rules
The new rules on the GOV.uk web site state that:
Quoted directly from the site ….
A limited cost trader will be defined as one whose VAT inclusive expenditure on goods is either:
- less than 2% of their VAT inclusive turnover in a prescribed accounting period
- greater than 2% of their VAT inclusive turnover but less than £1000 per annum if the prescribed accounting period is one year (if it is not one year, the figure is the relevant proportion of £1000)
Goods, for the purposes of this measure, must be used exclusively for the purpose of the business but exclude the following items:
- capital expenditure
- food or drink for consumption by the flat rate business or its employees
- vehicles, vehicle parts and fuel (except where the business is one that carries out transport services – for example a taxi business – and uses its own or a leased vehicle to carry out those services)
These exclusions are part of the test to prevent traders buying either low value everyday items or one off purchases in order to inflate their costs beyond 2%.
The 2% is for goods not services so your accountant’s fee doesn’t apply nor will your Cloud accounting software as this is called Software as a Service (SaaS) or any software that HMRC may think you’ll need to buy for Making Tax Digital.
The 2% is for each accounting period; we expect this means a VAT quarter. So you cannot go out and made a large purchase of goods once a year.
It excludes capital expenditure but these days most laptops, phones etc would not be capitalised.
The financial impact
Let’s have a look at the figures.
A typical contractor on £70,000 net turnover a year (£84,000 including VAT) will collect £14,000 of VAT on behalf of HMRC and pay over £12,180 in VAT to HMRC.
That’s a profit of £1,820 which is the benefit of the using the simplified VAT Flat Rate scheme as the contractor does not have to record all of their purchases.
Bear in mind that the £1,820 is subject to corporation tax (currently 20%).
So after all of the taxes that’s £1,456.
Assuming that the contractor spends less than £1680 (Vat inclusive) on goods (not services) in a year (spread over the VAT accounting periods) then the Flat Rate percentage bumps up to 16.5%.
So that means the contractor will still collect £14,000 of VAT on behalf of HMRC but pay over £13,860 in VAT to HMRC giving a difference of just £140 (£112 after corporation tax).
Best advice may be to deregister
Contractors with a turnover in excess of the VAT registration threshold who fail the limited cost trader test will have to switch to standard VAT accounting and suffer the additional administration that the systems imposes by recording all VAT input tax on purchases and loss of the Flat Rate profit.
If the contractor has high outlays for services then it may be beneficial to switch to the standard VAT accounting scheme and file a VAT return each quarter accounting for the VAT input tax in purchases.
Contractors who fail the limited cost trader test and whose turnover is below the VAT registration limit may want to just deregister for VAT to avoid the admin of standard VAT accounting for miniscule benefit.
It’s Hobson choice!
I suspect that this is pay back by HMRC for losing the high profile Flat Rate cases on Engineers who fought, and won, against HMRC who tried to change them from the 12% rate to the 14.5% flat rate.
Not Tax Simplification
The limited cost trader test will need to be performed each quarter and the correct flat rate applied. So that’s another thing for businesses to remember to do and more tax rules for them to remember.
That’s not simplifying things is it!
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