Rendered all but useless to many by the Limited Cost Business rules introduced in April 2017, the VAT Flat Rate Scheme seems to be one that’s inciting business owners to actively seek out tax evasion tactics to avoid the application of the 16.5% standard Flat Rate percentage.
It’s time for the whole scheme to be reviewed and potentially abolished.
Background to the Flat Rate Scheme
The Flat Rate Scheme was originally introduced to ease the administrative burden of VAT accounting for small business negating the need for them to record the input VAT on all purchases. Instead they paid VAT to HMRC at an appropriate industry percentage based on their VAT inclusive turnover.
Rather than be used in the way intended, over the years the Flat Rate Scheme developed into a “Tax Windfall” for those with little in the way of VATable purchases. Not only that but unscrupulous users attempted to retro fit their business into one with a more favourable industry percentage. Abuse was rife. Hence the wholescale change to the Flat Rate Scheme and the introduction of the Limited Cost Business Rules.
What are the Limited Cost Business Rules?
If you are a Limited Cost Business the Flat Rate percentage to use is 16.5%.
As that is applied to the gross turnover (VAT inclusive) then this means that you pay HMRC 19.8% of your net sales – only 0.2% difference to using the standard VAT accounting system.
In short if you are a Limited Cost Business you may as well use the standard VAT accounting rules.
Define a Limited Cost Business
HMRC say that you are a limited cost business:
“if the amount you spend on relevant goods including VAT is either:
- less than 2% of your VAT flat rate turnover
- greater than 2% of your VAT flat rate turnover but less than £1,000 per year
If your return is less than one year the figure is the relevant proportion of £1,000. For a quarterly return this is £250.”
A business can fall in and out of these rules quarter on quarter. Therefore it is essential to apply the check to every VAT return and not just do it once a year.
Definition of Goods
Of course the crux is what is defined as goods. There are some obvious things that are goods and some that clearly are not goods. HMRC give some guidance on this here.
The Catch All
Importantly the guidance says that the following do not qualify as goods:
“goods which are bought solely to meet the test, as these would not be used exclusively for the purposes of your business, for example, if the quantity of goods being bought cannot reasonably be used by the business and are simply ‘stockpiled’ or thrown away, even if the business may normally use those items is smaller quantities such as office materials”
Presumably this was included for the “Smart Alecs” who thought they could simply buy extra stationery each year to meet the Low Cost Business Rules.
Defunct and Abused
Realistically many who were using the Flat Rate Scheme now qualify as Limited Cost Businesses meaning that the Flat Rate Scheme has become all but defunct. Even worse is the rise in the number of businesses stretching the definition of what are goods are so that they do not fall within the Limited Cost Business regime.
It’s amazing what some people will try to claim are goods just to “pay less VAT”; money which isn’t even theirs in the first place.
Added to that is the population of users of the Flat Rate Scheme who are completely unaware of the Limited Cost Business Rules and are carrying on using their industry percentage incorrectly.
Unpaid Tax Collector
What many seem to forget is that the VAT collected does not belong to the business in the first place. So this is not an area where “I want to pay less VAT” should even apply if there is ever a time to say those words.
The thing about VAT ……. It’s not your money. It should never be used to fund the business or worse, fund your own lifestyle.
VAT is a tax applied by HMRC which you just collect on their behalf paying it over to them less the amount of input VAT that you may have suffered.
Looking at it this way may require a mindset shift but it’s a shift that needs to happen and quickly!
Review or Abolish it
Such is the increase in abuse of the Flat Rate Scheme, whether intentional or unintentional by ignorance of the existence of the Limited Cost Business rules, the system needs a fundamental review if not immediate abolition.
Statutory Declaration on each VAT Return
At the very least and as an immediate action HMRC should introduce a Statutory Declaration” tick box on the VAT return which is displayed if the VAT registered business is on the Flat Rate Scheme.
The use of the Flat Rate Scheme is usually easy to determine as the box for input tax and purchases will be £zero.
The declaration should be completed by those using the Flat Rate Scheme confirming that they have applied the Limited Cost Business Test for the quarter in question and that they fall outside of the rules making it clear what the penalties are for abuse of the rules.
That’s a simple low cost test that can easily be implemented as part of the Making Tax Digital Project – a bit like a speed camera on a known speeding hotspot.
Of course abuse of the tax rules will continue whilst reliefs and allowances exist.
Potentially fuelled by the rise in big business avoiding UK taxation by arranging their affairs to “make profits” only in the countries with the lowest tax rates, we’ve move into an era of tax avoidance and evasion becoming a game to be won by the general tax payer.
Signing up to Schemes or finding loopholes in tax reliefs has become normal to many with them no longer seeing this tax evasion as an illegal criminal activity.
Is it time for all Schemes, legitimate and otherwise, to be abolished? Do we need one system of tax which is applied to all without further relief? Do we need a wholesale review of the UK system of taxation?
What does it take to change the attitude of the UK taxpayer away from “I want to pay as little tax as possible” to “tax pays for the public services that I demand. The more I pay the more I’m earning which is a good thing”?