The VAT Flat Rate Scheme, known as FRS, for small business’s is a simplification scheme which allows VAT registered traders to work out the VAT which they pay over to HMRC by applying a fixed percentage to their gross (VAT-inclusive) turnover. The percentage used to work out the VAT that is due depends on the sector in which the business operates. The scheme removes the need to keep detailed records of purchases as it is not necessary to record input VAT separately – relief for input VAT is built into the flat rate percentage used to calculate VAT.
The question of whether the FRS remains appropriate is particularly relevant where the business comes under the definition of a ‘limited cost business’. Since 1 April 2017, a flat rate percentage of 16.5% has applied to limited cost business’s. A business is a limited cost business if the amount spent on ‘relevant goods’ is either:
- less than 2% of the business’s VAT flat rate turnover; or
- greater than 2% of the business’s flat rate turnover but less than £1,000 a year (£250 per quarter
However, in applying the test, not all expenses and purchases are taken into account – only those falling within the definition of relevant goods, which excludes:
- vehicle costs, including fuel (unless the business is operating in the transport sector using their own vehicle or a leased vehicle);
- food and drink for the business or the business’s staff;
- capital expenditure goods of any value;
- goods for resale, leasing or letting or hiring where this is not the main business activity;
- goods that the client intends to re-sell or hire-out, unless selling or hiring is the main business activity;
- goods for disposal as promotional items, gifts or donations;
- any services
The problem is that a flat rate percentage of 16.5% is equivalent to 19.8% of net turnover, meaning that a limited cost business pays over virtually all the VAT that they charge over to HMRC, with little relief for input VAT incurred. If the client incurs significant input tax on goods and services that are outside the definition of relevant goods, they may be better off leaving the FRS and working out VAT in the usual way. There is no substitute for doing the sums.
Where a business is within the FRS, the existing relaxations on record keeping are replicated and under MTD for VAT business’s using the FRS will not need to keep a digital record of purchases unless they relate to capital expenditure on which VAT can be reclaimed (i.e. capital items costing more than £2,000 including VAT) or are purchases of relevant goods used to determine whether the business is a limited cost business.
Vat Notice 733: Flat Rate Vat Scheme for small businesses
Vat Notice 700/22: Making Tax Digital for VAT