Flat rate. The flat rate scheme (FRS) is an agreement with HMRC to pay over VAT at a lower rate than the standard 20%. The exact rate depends on what your business does, e.g. couriers pay 10% on the FRS.
Operation. If you’re on the FRS, you don’t claim your input VAT on most of your purchases, so you don’t need to spend all the time going through your receipts at the end of each VAT period. Instead, you charge your customers 20% as normal, then pay over the flat rate amount to HMRC.
Example. In your last VAT quarter you had sales of £10,000, and so charged £2,000 VAT. You are a courier business, so you will need to pay £1,200 to HMRC, i.e. 10% x (£10,000 + £2,000). As long as you didn’t incur expenses with more than £800 VAT (the difference), you will be better off than under the standard VAT regime.
Low cost. The FRS is a good idea if you are usually in a repayment position. Until now it has also been a potential planning point for businesses that have little to no ongoing expenses. However, that’s set to change in 2017. HMRC has cottoned onto the use of the FRS to simply obtain a lower effective rate of VAT. Therefore, from April 2017, a new category for “limited cost traders” will apply. If your business fits the new definition, the appropriate flat rate will be 16.5% – wiping out most of the savings.
Test. A limited cost trader will be one where the VAT-inclusive spend on goods in a VAT period is less than 2% of its VAT-inclusive turnover (for the same period); or where the spend is more than 2%, but will be less than £1,000 for the accounting year.
Tip. The test will need to be applied for every accounting period individually, so make it part of your regular filing procedure if you are using the FRS.
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