Most VAT-registered business can use the flat rate scheme if it is expected that VAT taxable turnover in the next 12 months to be £150,000 or less. Read this short blog to see if your business would benefit from switching to the FRS.

FRS for VAT – Who is it for?

The VAT flat rate scheme (FRS) is used by many small businesses to help simplify their VAT reporting obligations, although some VAT experts would argue that the scheme is not simple to use.

Broadly, the FRS is a simplified VAT accounting scheme for small businesses, which allows users to calculate VAT using a flat rate percentage by reference to their particular trade sector. When using the FRS, the business ignores VAT incurred on purchases when reporting VAT payable, with the exception of capital items which cost £2,000 or more.

If the business incurs few expenses, and it operates in a sector with a relatively low FRS percentage, it will pay out less VAT to HMRC under the FRS than it would outside the scheme. Historically, many businesses have registered for VAT voluntarily before their turnover reached the VAT registration threshold, so they could make use of the cash advantage offered under the FRS.

Most VAT-registered business can use the FRS if it is expected that VAT taxable turnover in the next 12 months to be £150,000 or less. Certain other eligibility criteria apply.

The business must leave the scheme if:

  • it is no longer eligible;
  • on the anniversary of joining, turnover in the last 12 months was more than £230,000 (including VAT) – or if it is expected to be in the next 12 months;
  • total income in the next 30 days alone is expected to be more than £230,000 (including VAT)

 

The VAT flat rate used usually depends on the business type.

Common percentages used by service-related businesses in recent years include:

  • Accountancy and legal services 14.5%
  • Computer or IT consultancy 14.5%
  • Estate agents and property management 12%
  • Management consultancy 14%
  • Business services not listed elsewhere 12%

 

A 1% discount on the relevant flat rate is given in the first year as a VAT-registered business.

Since 1 April 2017, a flat 6.5% FRS rate has applied for businesses with limited costs (see below). Since the rate of 16.5% of gross turnover equates to 19.8% of the net, the result is that there will be almost no credit for VAT incurred on purchases.

A ‘limited cost’ business is defined as one whose VAT inclusive expenditure on goods is either:

  • less than 2% of their VAT inclusive turnover in a prescribed accounting period;
  • greater than 2% of their VAT inclusive turnover but less than £1,000 per annum if the prescribed accounting period is one year (if it is not one year, the figure is the relevant proportion of £1,000).

‘Goods’ for these purposes must be used exclusively for the purpose of the business but exclude the following items:

  • capital expenditure goods;
  • food or drink for consumption by the flat rate business or its employees;
  • vehicles, vehicle parts and fuel (except where the business is one that carries out transport services – for example, a taxi business – and uses its own or a leased vehicle to carry out those services).

 

(These exclusions are part of the test to prevent traders buying either low value everyday items or one-off purchases in order to inflate their costs beyond 2%.)

FRS and MTD

With regards to record-keeping, HMRC confirm that for compliance with Making Tax Digital (MTD) for VAT obligations businesses using the FRS do not need to keep a digital record of:

  • purchases unless they are capital expenditure goods on which input tax can be claimed;
  • the relevant goods used to determine if the business needs to apply the limited cost business rate.

 

Not all software packages are configured to accommodate the FRS, and many will only permit sales to be recorded as standard rated, reduced rated, zero rated or exempt. Users of the FRS should use one of the following methods to record sales:

  • record the supply as one standard rated supply and one zero rated supply (i.e. have two entries for each supply); or
  • record the sale at one rate and correct the VAT through an adjustment at the end of the period (as is suggested for cases where more than one supply is invoiced on a single invoice).

 

Partner Note: VATA 1994 s 26B; SI 1995/2518, Regs 55A-55V, 57A, 69A; HMRC VAT Notice 733: Flat Rate Scheme for small businesses; VAT Notice 700/22: Making Tax Digital for VAT, para 4.6

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The delayed start date for the domestic reverse VAT charge has given businesses an extra year to prepare for the charge. We explain what you can do to prepare.

Domestic reverse VAT charge for building and construction services

The domestic reverse VAT charge for building and construction services was due to come into effect from 1 October 2019. However, in early September it was announced that the start date had been put back one year. As a result, the charge will now apply from 1 October 2020.

Who is affected?

The charge will affect individuals and businesses who are registered for VAT in the UK and who supply or receive specified services that are reported under the Construction Industry Scheme (CIS).

Nature of a reverse charge

The reverse charge means that the customer receiving the specified supply has to pay the VAT rather than the supplier. In turn, the customer can recover the VAT under the normal VAT recovery rules.

Supplies within the scope of the charge

The reverse charge will apply to supplies of building and construction services which are supplied at the standard or reduced rates that also need to be reported under the CIS. These are called specified supplies.

However, where materials are included within a service, the reverse charge applies to the whole amount. By contrast, where deductions are made from payments to subcontractors under the CIS, no deductions are made from any part of the payment that relates to material.

Move to monthly returns

The introduction of the reverse charge will mean that some businesses may become repayment traders claiming VAT back from HMRC rather than paying it over to HMRC. To aid cashflow and reduce the delay in claiming the VAT back, repayment traders can move to monthly returns.

Planning ahead

The delayed start date has given businesses an extra year to prepare for the charge. In order to be ready for its introduction, businesses within the CIS should:

  • check whether the reverse charge will affect their sales, their purchases or both
  • update their accounting systems and software to deal with the reverse charge from 1 October 2020
  • consider whether the change will impact on cashflow
  • ensure that staff who are responsible for VAT accounting are familiar with the reverse charge and how it will operate

Contractors should review their contracts with subcontractors to determine whether the reverse charge will apply to services received under the contract. Where it does, they will need to notify their suppliers.

Subcontractors will need to contact their customers to obtain confirmation from them as to whether the reverse charge will apply, and also whether the customer is an end user or intermediary supplier.

Impact of change of start date

HMRC recognise that the start date was changed at short notice and that businesses may have changed their invoices to meet the needs of the reverse charge and cannot easily change them back. Where errors arise as a result, HMRC will take the change of date into account.

Partner Note: The Value Added Tax (Section 55A) (Specified Services and Excepted Supplies) Order 2019 (SI 2019/892); The Value Added Tax (Section 55A) (Specified Services and Excepted Supplies) (Change of Commencement Day) Order 2019 (Si 2019/1240).

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Even if your business hasn’t reached the £85,000 turnover threshold, there are some benefits to registering for VAT early.

VAT registration – sooner or later?

Once a business is up and running, the next major administrative area to be faced often concerns the subject of VAT. At first glance, it looks complicated – not to mention time-consuming – particularly for small businesses. However, taken one step at a time, the rules governing VAT registration and invoicing are generally quite straight-forward and relatively easy to navigate.

The law states that all traders – whether sole traders, partnerships, or limited companies – are obliged to register to charge and pay VAT once their taxable turnover reaches a pre-set annual threshold, which is currently £85,000. Broadly, a business must register for VAT if:

  • its taxable outputs, including zero-rates sales (but not exempt, non-business, or ‘outside the scope’ supplies), have exceeded the registration threshold in the previous 12 calendar months – unless the business can satisfy HMRC that its taxable supplies in the next 12 months will not exceed a figure £2,000 below the registration threshold (so currently £83,000); or
  • there are reasonable grounds for believing that the business’s taxable outputs in the next 30 days will exceed the registration threshold; or
  • the business takes over another business as a going concern, to which the two bullet points above apply.

A business can register for VAT voluntarily if its turnover is below the threshold and it may actually save tax by doing so, particularly if its main clients or customers are organisations that can reclaim VAT themselves.

Example

Sandra is a non-VAT registered carpenter and a basic rate taxpayer. She buys a new saw to use in her business, which cost £100 plus VAT, so she pays a total of £120 (£100 plus VAT at 20%), which can be set against her business profits for income tax purposes. As Sandra is a basic rate (20%) taxpayer, she will save tax of £24 (20% of £120), so the saw actually costs her £96. However, if the business is VAT-registered, the £20 VAT paid on the item (the input tax) can be reclaimed and £100 is set against business profits for income tax. The tax reduction is therefore £20 (20% of £100) and the saw actually costs him £80 – saving £16 by being registered for VAT.

Is non-registration preferable?

VAT-registered businesses supplying goods and services to private individuals often feel dis-advantaged compared with their non-registered counterparts because they have to charge an additional 20% on every bill issued.

A trader who does not want to have to register for VAT, may be able to stay below the annual VAT registration threshold by supplying labour-only services and getting customers to buy any goods needed themselves.

Example

Bob is a non-VAT registered plumber, but his turnover is creeping up towards the VAT registration threshold. He could ask his customers to buy materials for a job directly from a DIY shop. Although the customers will have to pay the VAT on these items, they won’t have to pay VAT on Bob’s invoice for labour services. This will also have the additional advantage of reducing Bob’s annual turnover for VAT registration purposes.

Registration benefits

Deciding whether to register for VAT voluntarily before the registration threshold is reached is a big decision that can have lasting implications for the financial health of the business. It is vital therefore, that the matter is given careful consideration. There are several positive reasons supporting voluntary registration, including:

  • Reclaiming VAT – although a registered business will have to charge VAT on goods and services (known as charging ‘output tax’), it will also be able to reclaim VAT that it is charged by other businesses (known as ‘input tax’). Where input tax exceeds output tax in a given period, the business will generally be able to reclaim the difference from HMRC.
  • Marketplace perceptions – some businesses choose to register for VAT in order to appear larger than they are. Customers are likely to be aware of the £85,000 registration threshold and where a business is not registered, its customers will know that the business turnover is lower than this. A business may therefore consider registration as a way of increasing its standing amongst competitors, and in the eyes of clients.

Partner note: VATA 1994, Sch 1; HMRC VAT Notice 700/1

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Inspired by Grand Designs? You are entitled for a VAT refund if you build your own home.

VAT refunds for DIY builders

If you build your own house or convert an existing property into a home, you may be eligible to apply for a VAT refund on building materials and services. You do not need to be VAT registered to claim a refund.

What qualifies?

Refunds can be claimed in respect of building materials that are incorporated into the building and which cannot be removed without tools or without damaging the building. Refunds are available for materials used to build both new homes and for certain conversions.

A new home will qualify if it is separate and self-contained and you build it for you and your family to live in. The property must not be used for business purposes, although you are permitted to use one room as a home office.

Conversions will qualify if the property was previously used for non-residential purposes and is converted for residential use. Conversions of residential building will only qualify if they have not been lived in for at least 10 years.

Where you use a builder, the builder’s services will normally be zero-rated where they work on a new home. However, you can claim a refund for VAT charged by a builder working on a conversion.

What does not qualify?

Refunds are not available in respect of:

  • materials or services on which no VAT is payable because they are zero-rated or exempt;
  • professional fees, such as architects’ fees or surveyors’ fees;
  • costs of hiring machinery or equipment;
  • building materials which are not permanently attached to or part of the building;
  • fitted furniture, some gas and electrical appliances, carpets and garden ornaments.

A refund is also denied if the building is not capable of being sold separately, for example, as a result of planning restrictions.

How to claim

The claim is made on form 431NB where it relates to a new build and on form 431 where it relates to a conversion. The forms are available on the Gov.uk website. The claim must be made within three months of the date on which the building work was completed.

You must include all the relevant supporting documentation with your claim, such as valid VAT invoices to support the amount claimed. The refund will normally be issued within 30 days of making the claim.

Partner note: www.gov.uk/vat-building-new-home/eligibility.

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Do you run a business? Should you register for VAT? What are the conditions? We answer all these questions here

All traders – whether sole traders, partnerships, or limited companies – are obliged to register to charge and pay VAT once annual sales reach a pre-set annual threshold. This threshold remains at £85,000 for the year commencing 1 April 2019.

The annual VAT threshold is determined by total sales and is not the same as total profits (which is generally sales minus expenses). A business can make a loss and still need to register for VAT!

In summary, a business must register if:

  • its taxable outputs, including zero-rates sales (but not exempt, non-business, or ‘outside the scope’ supplies),have exceeded the registration threshold in the previous 12 calendar months – unless the business can satisfy HMRC that its taxable supplies in the next 12 months will not exceed a figure £2,000 below the registration threshold (so currently £83,000); or
  • there are reasonable grounds for believing that the business’s taxable outputs in the next 30 days will exceed the registration threshold; or
  • the business takes over another business as a going concern, to which the two bullet points above apply.

The threshold operates on a month-by-month basis, so a check should be made at the end of each month to make sure the business hasn’t gone over the limit in the previous twelve months.

The month-by-month basis also works by looking forward, so it is equally important at the end of each month to consider whether the limit will be exceeded in the following twelve months. If it is anticipated that total sales may exceed the VAT threshold, the business needs to register.

Where registration is required, HMRC must be notified:

  • within 30 days of the end of the relevant month (past sales condition); or
  • by the end of the 30-day period (expected sales condition).

If the business does not register with HMRC within the specified time limit, a penalty will be charged, which can eventually be up to 15% of the VAT owed – in addition to the actual VAT due.

Voluntarily registration

A business can register for VAT even if its turnover (total sales) is below the threshold and it may actually save tax by doing so, particularly if its main clients or customers are organisations that can reclaim VAT themselves.

Example

A non-VAT registered sole-trader buys a new office photocopier for the business. The copier costs £100 plus VAT, so a total of £120 is paid (£100 plus VAT at 20%). £120 is set against business profits for income tax purposes. If the trader is a basic rate (20%) taxpayer, there will be a tax saving of £24 (20% of £120), so the copier actually costs the trader £96. However, if the business is VAT-registered, the £20 VAT paid on the item (the input tax) can be reclaimed and £100 is set against business profits for income tax. The tax reduction is therefore £20 (20% of £100) and the copier costs the business just £80 – £16 is saved by being registered for VAT.

The business must not charge or show VAT on its invoices until the VAT number is received from HMRC. However, the VAT for this period must still be paid to HMRC. Therefore the business will need to increase its prices to allow for this and tell its customers why. Once the VAT number is received, the business can reissue the invoices showing the VAT separately.

Once registration has taken effect, there are a series of administrative obligations which must be complied with, and, importantly, a severe penalty regime exists for getting it wrong.

Partner Note: VATA 1994, Sch 1; HMRC VAT Notice 700/1

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