Flat Rate Scheme (FRS) allows businesses to pay a percentage of their gross sales – this means businesses do not need to separately account for VAT on their purchases. You can simply pay a percentage of your client’s gross fee; this helps small businesses to reduce administration.
If you are a newly VAT registered company, for the first 12 months you will get an additional 1% saving on these flat rate percentages.
New 'limited cost trader' rules
From April 2017, HMRC have introduced a new flat rate of 16.5% for contractors who are deemed to be ‘limited cost traders’. The government believe that some contractors have unfairly benefitted from using the Flat Rate Scheme (FRS), and should thus pay more VAT.
What is a 'limited cost trader'?
VAT Notice 733 by HMRC defines 'limited cost trader' as a business that has a VAT-inclusive expenditure on 'relevant goods' of either:
✓ Less than 2% of the VAT inclusive turnover in a prescribed accounting period
✓ Greater than 2% of the VAT inclusive turnover, but less than £1000 a year
'Relevant goods' are exclusively used for the purpose of your business. Usual contractor expenses such as accountancy fees, travel and accommodation are not considered as ‘relevant goods’; these are excluded from the above 2% calculation.
'Limited cost traders' will be required to apply the new 16.5% if they continue to use the Flat Rate Scheme (FRS)
The comparison table below demonstrates the difference between contractors on 14% FRS versus 16.5%.
The table shows VAT savings to have dropped from £1,056 to £66 per quarter.
What to do?
Contractors who are within their first year of VAT registration can apply a reduced rate of 15.5% until the end of their first 12 months. This will still attract some tax savings.
If you have been on a Flat Rate Scheme (FRS) for more than 12 months and have been deemed as a ‘limited cost trader’, then you will need to apply for a Flat Rate Scheme (FRS) of 16.5%. Dhikr Accountants will automatically inflate your Flat Rate Scheme (FRS) to 16.5%.
An alternative to being on the Flat Rate Scheme (FRS) is to move to standard reporting; this means that you will be able to offset VAT on your purchases against the VAT on your invoice to your client. Transitioning to standard VAT reporting may be more tax beneficial for contractors that have incurred a considerable amount of vatable expenses. Whether or not you should transition to standard VAT reporting is dependent on your circumstances, and you should get in touch to discuss this with Imran via email