Flat Rate VAT Guide for Contractors

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In the 2016 Autumn Statement, it was announced that the government was planning on reforming the VAT Flat Rate Scheme from 1st April 2017.

Now that the consultations have been completed by HMRC, we’re able to give you a little more information on what the reform may mean to you as a contractor. Our guide below aims to give you all of the information about the reforms to the Flat Rate VAT Scheme.

What is the Flat Rate VAT Scheme?

The Flat Rate Scheme is a simplified method for eligible businesses to work out their VAT liability. It works by allowing these businesses to apply for a fixed VAT percentage which is based on the trade or profession. Under this method, any reclaimable VAT is restricted (except for capital equipment greater than £2000).

For example, if you’re an IT contractor, you would have a typical fixed percentage of 14.5%. If you invoice a client for £2,500 + VAT, you will pay HMRC £435 (£3,000 x 14.5%). The standard rated method involved calculating the VAT liability based on VAT charged on sales less VAT incurred on purchases.

Changes to Flat Rate VAT

From April 1st 2017, any businesses using the flat rate scheme must perform an additional test every three months to confirm that they meet the criteria to be a limited cost trader.

What is a limited cost trader?

Limited cost traders are defined as one whose gross expenditure on relevant goods is either:

  • Less than 2% of their VAT inclusive turnover or
  • Greater than 2% of their VAT inclusive turnover but less than £1000 per year

Goods do not include:

  • any service that isn’t goods
  • expenses (for example, travel and accommodation)
  • food and drink eaten by yourself or your employee(s)
  • vehicle costs including fuel unless you are in the transport business using your own or a leased vehicle
  • rent, internet, phone bills and accountancy fees
  • gifts, promotional items and donations
  • goods you will resell or hire out unless this is your main business activity
  • training and memberships
  • capital items for example office equipment, laptops, mobile phones and tablets

If you’re unsure whether you meet the criteria of being a limited cost trader, you can use HMRC’s Check your VAT Flat Rate tool.

If you are deemed to be a limited cost trader, rather than applying the fixed VAT percentage based on your profession, a rate of 16.5% should be applied to your VAT inclusive turnover. If for your example you are an IT contractor currently on a fixed rate of 14.5% this is an increase of 2%. If you are in the first year of the Flat Rate Scheme a further 1% discount will still be applied.

Transitioning to a new flat VAT rate

On November 23rd 2016, legislation was published to prevent businesses from issuing invoices or receiving payment before the 1st April 2017 for services provided after this date. This was to ensure a smoother transition for businesses that will now have the new flat rate tax rate of 16.5%.

Thoughts from ClearSky Contractor Accounting

If you’ve already been using the Flat Rate Scheme and are still within the first 12 months of VAT registration, you will still be eligible for the 1% first year discount. This is the simplest and most efficient way to calculate your VAT liability.

If you have been a user of the Flat Rate Scheme, have been VAT registered for more than one year and will be deemed a limited cost trader, leaving the scheme and accounting for VAT under the standard calculation method can produce a relatively insignificant saving of between £78 - £355 per year (based on turnover of between £60k - £90K per annum and reclaiming input VAT on accountancy fees alone). To reclaim input VAT on eligible purchases under this method you will be required to analyse and provide VAT receipts to support each purchase. This will require your additional time for potentially minimal benefit, dependent upon your level of expenditure eligible for reclaim.

Whilst the choice is entirely up to you, of the clients we have spoken to many have decided to continue with our existing VAT arrangement. Whilst this may be the best option for these clients, ultimately the choice lies with you and your own personal circumstances.

How can ClearSky help?

If you’re an existing ClearSky Contractor Accounting client looking for more help and information about the flat rate VAT scheme please do not hesitate to contact your personal accountant or call our client services team on 01925 645255 who will be able to help.

If you’re not yet a ClearSky client but are thinking of working through your own limited company, take a look at our accountancy packages or give our best advice team a call on 0800 646 0338.