Limited companies and the Flat Rate VAT scheme (FRS)

The Flat Rate VAT scheme (FRS) is designed to make it easier for small businesses to fulfil their value-added tax (VAT) obligations.

However, the Flat Rate VAT scheme isn’t necessarily right for everyone: depending on the amount of costs you incur, the standard unsimplified VAT system may be a better option.

And with new changes coming into force in early 2017, the previous tax advantages of the FRS have been slashed for some – meaning it’s more likely you’ll need to look into making a change.

What is the Flat Rate VAT scheme?

Under normal circumstances, the amount a business can usually claim back from Her Majesty’s Revenue and Customs (HMRC) is the difference between what has been charged from the business to its customers and what the firm has paid out in VAT on purchases the company itself has made –  the standard VAT scheme.

But under the Flat Rate VAT scheme, companies can instead opt to pay a fixed amount of VAT instead – which, in some circumstances, can save them money.

If they go for this, the business in question is also able to pay the difference between what they have charged to their customers and what they pay to the Exchequer, but they then give up the right to claim VAT on most purchases they make. In some circumstances, the VAT claimed on capital assets over £2,000 can still be claimed back – even if your business is a part of the scheme.

In order to be eligible for the scheme, it’s vital that your VAT turnover is £150,000 or under (not including VAT). You’ll need to apply to HMRC in order to be considered.

Am I eligible for the Flat Rate VAT scheme?

Depending on the type of business you operate, there’s a chance you might not be able to enrol in the Flat Rate VAT scheme.

Provided you’re already a business that is registered for VAT and that your total VAT taxable turnover is likely to be £150,000 or less (without including VAT) in the next year, it’s likely you’ll be able to enrol.

However, there are some circumstances in which you might find yourself unable to join the scheme, so it’s worth preparing in advance for this eventuality.

For example, if you were previously a member of the scheme but left in the last year you’re not entitled to rejoin, while if you’ve committed a VAT-related offence in the last year (such as tax evasion) then you’ll also be banned from enrolling.

There could also be complications if your business is deeply tied to another business, so check with your accountant or financial advisor if this applies to you.

There are also other conditions attached to joining the scheme, so check in advance before getting your hopes up.

The new “limited cost trader” rules

The Flat Rate VAT scheme has been a real boon for a lot of small companies. But there has also been what the government has described as “aggressive abuse” of the scheme, and for that reason, some changes were made to the system in April 2017.

Now, all companies who sign up for the scheme have to demonstrate whether or not they are a “limited cost trader”.

Limited cost traders are those who spend under 2%, or less than £1,000, a year of their VAT inclusive turnover on goods. For the purposes of this system, “goods” have been defined by HMRC as anything used exclusively for the business – although capital expenditure, drinks and food for the employees, or transport are all exempt.

The idea behind the changes is to stop a trend which saw traders making purchases simply for the sake of pushing their costs up above 2% to acquire tax advantages. And for a small business, the impact of these changes could end up being quite large – as they may make you think twice before opting for the Flat Rate system.

So while the FRS system is more simple, it could also be more costly. In order to avoid a higher rate, it’s worth asking your accountant to look into the changes and see what your new tax obligation might be.