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HMRC are proposing to introduce a new category of trade to the flat rate scheme called a ‘limited cost trader’, this new category will use a flat rate percentage of 16.5%.

The flat rate scheme was initially introduced as a simplified way of dealing with VAT, however many businesses make extra profit by being on the flat rate scheme which HMRC are now looking to clamp down on.

Currently, under the flat rate scheme, a business chooses the most appropriate percentage for them according to what industry it is in. Under the new proposals the business owner or their accountant will have to consider whether they meet the conditions for a ‘limited cost trader’ and if they do they will have to use the 16.5% percentage going forward. This may well be considerably higher than the percentage they are currently using.

A business is a limited cost trader if its VAT inclusive (gross) expenditure on goods is:

  • Less than 2% of their VAT inclusive (gross) turnover in its last accounting period
  • Greater than 2% of their VAT inclusive turnover but less than £1000 per annum if the last accounting period is one year (if it is not one year, the figure is the relevant proportion of £1000)

The big unknown at the moment is exactly what will be included in the definition of ‘goods’.

The current draft guidance says that goods are those used exclusively for business purposes, excluding:

  • Capital expenditure
  • Food & drink for consumption by the business’ employees
  • Vehicles, vehicle parts and fuel (except where the business is one that carries out transport services)

What this does not clarify is whether items that are traditionally seen as being services rather than goods can count towards the cost base of the business – for example will telephone expenses or accountancy fees count as “goods”? It would seem unfair if these do not count as business costs when it comes to the definition of a ‘limited cost trader’, but the current draft guidance is unclear.

HMRC are currently consulting to discuss practical aspects of the new rules. We will be in touch with all of our clients who are currently on the flat rate scheme individually once we have an exact picture of who will be affected and how. We will be recommending one of the options below and discussing the impact on your business.

What are the options if you are affected by these changes?

  • If you fall into the limited cost trader category you can accept that your VAT flat rate percentage will be 16.5% going forwards and calculate your returns on that basis.
  • Opt out of the flat rate scheme and switch to the standard VAT scheme where you offset VAT on your expenses against VAT on your sales.
  • De-register from VAT if you are below £81,000 in turnover.