Autumn Statement 2016 - How will the VAT Flat Rate Scheme Restriction Affect Contractors?

In his Autumn Statement, Chancellor Phillip Hammond announced important changes to the Flat Rate VAT Scheme (VAT FRS): from 1 April 2017, a new 16.5% rate will be introduced for businesses with limited costs, such as many businesses providing services.

Many contractors and small businesses were encouraged to use the VAT FRS to simplify VAT reporting. Many registered for VAT voluntarily before their turnover reached the VAT registration threshold, specifically to make use of the benefits of the VAT FRS.

All seemed to be going quite well, when, all of a sudden, the use of the 12% or 14.5% VAT Flat Rate Scheme rate by contractors and small businesses was seen as “aggressive abuse” by HMRC. Honestly, you wonder what’s going on, when HMRC designed the scheme to benefit small businesses, but when it actually benefits small businesses and contractors, they remove it!

The VAT FRS now

The VAT FRS was designed to simplify VAT reporting. At present, users ignore VAT incurred on purchases when reporting VAT payable, with the exception of capital items costing £2,000 or more. Users multiply the gross turnover (including VAT charged at the normal rates) by the FRS percentage set for the particular trade sector of their business.

Most service-related contractors and businesses use these percentages:

- Accountancy and legal services 14.5%

- Journalism or entertaining 12.5%

- Computer or IT consultancy 14.5%

- Business services not listed elsewhere 12%

- Estate agents and property management 12%

- Management consultancy 14%

What is the advantage?

There are definite advantages, because if few expenses are incurred and the VAT FRS user operates in a sector with a relatively low VAT FRS percentage, less VAT is paid to HMRC than would be paid at standard rates. This is why the Chancellor has announced this change, it’s a kneejerk response to criticism that contractors and small businesses have not been using the VAT FRS as the law intended. By changing the terms of the scheme, from April 2017, the VAT FRS will be much less attractive, and any cash advantage service-related contractors and businesses once enjoyed are all but removed.

The VAT FRS after April 2017

Although the VAT FRS will continue, the restrictions will make it less economically attractive for wide use. From 1 April 2017, a VAT FRS of 16.5%must be used by all “low-cost traders”. Low-cost traders are contractors / businesses whose expenditure on goods (not services) is less than 2% of gross turnover, or if more than 2% of turnover, when the amount spent on goods is less than £1,000 per year (where expenditure on capital items, motor expenses, or food or drink for consumption by the business, is ignored). In VAT terms, a service is:

- Anything intangible ‒ intangible assets are taxed on the basis of the location of the person consuming the thing supplied ‒ such as an IT consultant who fixes your broadband or a consultant who spends a day doing an audit of your systems;

- Costs related to a tangible asset ‒ a tangible asset is something that is taxed at the place where the thing is being consumed (a desktop computer), but not of a temporary use, of that asset – such as hiring a temporary staff member.

How will the change affect contractors?

All the trade sectors listed above will suffer, as will many other service-related businesses and contractors. As 16.5% of the gross turnover is equivalent to 19.8% of the net total, that leaves virtually zero credit for VAT incurred on purchases; and what’s more, the emphasis on “goods” discriminates against businesses who incur VAT on services (rent, software licences, IT support, digital journals, subcontractors, telecoms, etc).

What should contractors do now?

An immediate review of the VAT FRS is essential.

- Contractors trading under the VAT threshold of £83,000 could consider de-registering as of 1 April 2017;

- Some contractors trading over the threshold may need to withdraw from the VAT FRS from the same date;

- Some contractors trading under or at the threshold might benefit from continuing under the standard rate VAT and recovering VAT on expenses.

Conclusion

There are options according to individual circumstances and the situation needs urgent review. Please do not try invoicing early to avoid the changes: an invoice issued in advance for services to be provided on or after 1 April 2017 will be treated as if the invoice was issued on 1 April 2017.

Meanwhile, the Office of Tax Simplification has been asked to carry out a review on aspects of the VAT system, and keeping you posted as the details are announced will be our priority. However, unfortunately, this most recent reform spells the end of a generous benefit small business used to get. Now we all left wondering. Contractors and small businesses might have thought this government was rooting for them; Mr Hammond put production, innovation, and infrastructure at the heart of yesterday’s Autumn Statement. But if they’re supporting innovation, small businesses, and entrepreneurship, they’ve got a funny way of showing their support, when it seems they are doing everything to remove all the benefits that help make all the effort of running a business worthwhile. In case of any query regarding VAT Return and Registration, Please consult professional VAT Experts.