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Contractors' VAT Flat Rate

Summary of Key Points

  • Contractors benefitted by up to £5,000 per year fom being in the scheme until 31 March 2017.
  • From 1 April 2017, take great care if you are claiming a rate under 16.5%.
  • VAT administration is much easier in the scheme, so most businesses with sales under £150k will benefit.
  • There is much less chance of a VAT fine if you are within the scheme.
  • The main pitfall is to ensure you choose the right sector.
  • Your expected sales need to be under £150,000 for the year if you are going to join.

Background

VAT is a complex tax.  The VAT flat rate scheme is an attempt by the Government to relieve small businesses from getting involved in its complexities.  Most contractors could secure a very favourable 12% rate until the rule changes on 1 April 2017.  There is pressure to reverse these changes which is the only reason this page is still up!

Who can join the scheme?

Any business can join providing it has reasonable grounds for believing that its sales for the next 12 months – excluding any VAT charged on invoices – will be below £150k.  There are various extra rules dealing with businesses which have been in the scheme but whose turnover starts increasing.  There are also some businesses which are excluded, especially those found guilty of a VAT offence in the past.

If you are a new business, it is often a good idea to join the scheme unless you will be spending a lot of money on non-capital items.  The reason for this is that you get a 1% discount on the normal rate during your first year of VAT registration.  Within the scheme you can still recover input VAT on capital items but not non-capital ones.

From 1 April 2017 there are lots of really silly rules on "limited cost" businesses, which forces them on to a 16.5% flat rate unless they spend more than 2% of sales on "goods".  These rules are complex and have pretty much wrecked the scheme.

How do I join?

The Scheme Rate for Sectors

If you follow this link http://www.hmrc.gov.uk/vat/start/schemes/flat-rate.htm#4 there is a table of all the rates by industry.  Be sure to check on the rate regularly, especially when the standard rate of VAT changes.

Contractors should carefully select the correct sector.  90% of the time the right answer was 12% - now 16.5% - but the wrong sector can easily be selected.

Submitting returns

It is normal to submit quarterly returns.  However, you can also apply to use annual accounting along with flat rate scheme accounting if you want to.  For businesses which are new to VAT it is advisable to start off on a quarterly basis until they’re confident about what they’re doing.

Calculating the VAT to pay is much simpler than under the normal rules.  As an example, John begins trading as a sub-post office on 1 July 2014 and is sent a VAT return date of 30 September 2014 when he registers.  During these three months, his turnover including VAT is £20,000.

The normal rate for postal services is a very low one, 5%.  John is in his first year, so he can apply a 1% discount and use 4% for his VAT calculation.

VAT to pay = 4% x 20,000  =   £800

Keeping Account of your VAT

Within the scheme, you still need to set aside an account in your system for VAT control.  This will include:

  • VAT on any invoices you raise at the standard rate of VAT.
  • VAT on any significant capital items you wish to reclaim the input VAT on.
  • The VAT due under the flat rate scheme calculation.

Pitfalls

There are some pitfalls in the scheme.  Even though it’s quite easy to leave the scheme, you should consider these before joining it:

  • You need to spend £2,000 on an item before you can claim input VAT.  So it is not worth joining if you’re going to spend a lot in the coming months.
  • The definition of the individual sectors is “woolly” at best.  HMRC have mounted challenges on the sector being claimed by businesses – in one contractor case they lost, they tried to say the flat rate being used should be 14% and not 12%.
  • The rates for some sectors are very stingy, and the 16.% rate is especially stingy.  So double check before joining that it’s not going to cost you in extra tax.
  • Make sure you apply the flat rate % to total sales including VAT – many people get caught out by this.