The terms of the flat rate VAT scheme (FRS) were changed for 1 April 2017 when the category of limited cost traders was introduced, but many businesses are still not following the new rules correctly.
HMRC has amended VAT Notice 733 to emphasise the steps to follow when deciding which trade sector the business falls into, and hence which flat rate percentage it should apply when using the FRS (Flat rate vat scheme). If a business is defined as a limited cost trader it must use the FRS rate of 16.5% regardless of its actual trade sector.
A business must spend at least 2% of its turnover on relevant goods to avoid being a limited cost trader, and even if it manages to reach that threshold the total amount spent on relevant goods must be at least £250 per quarter or £1,000 per year. There are lots of exclusions from “relevant goods”, such as;
- capital assets;
- vehicle expenses;
- staff food & drink;
- promotional items purchased to give away; and
- goods acquired to sell when selling goods is not part of the main trade.
If a business is already registered for VAT and using the Flat rate VAT scheme the business must check that it has chosen the correct trade sector. HMRC can issue penalties and demand additional VAT for past years if a lower FRS percentage was chosen deliberately.
The catch-all category of “any other activity not listed elsewhere” (12% rate) should only be used if every other category has been checked to see if the business fits into it. There are a number of composite sectors which group apparently connected trades together such as “entertainment or journalism”.
See VAT notice 733 Flat rate vat scheme for small businesses