VAT flat rate rise will not reduce abuse of system

Plans to crackdown on abuse of the VAT Flat Rate Scheme (FRS) may be ineffective and have unwelcome consequences for tax compliant small businesses, claims CIOT

The FRS is a simplification measure for small businesses, which enables them to pay to HMRC a fixed rate of VAT that is determined by their type of business, rather than keep detailed records of input and output VAT, and is used by around 411,000 businesses.  

At the Autumn Statement, the Chancellor announced changes to the FRS which mean that a business that falls into a new definition of a ‘limited cost trader’ during an accounting period will pay a higher 16.5%. 

HMRC says the aim is to tackle allegations of widespread abuse of the scheme by some employment agencies and similar businesses which set up thousands of two-employee companies, to take advantage of both a favourable FRS percentage, and the NIC employment allowance.

A limited cost trader will be defined as one whose VAT inclusive expenditure on goods is either less than 2% of their VAT inclusive turnover in a prescribed accounting period; or greater than 2% of their VAT inclusive turnover but less than £1000 per annum if the prescribed accounting period is one year (if it is not one year, the figure is the relevant proportion of £1000).

Peter Dylewski, chairman of the CIOT’s indirect taxes sub-committee, said: ‘Targeted action against abuse of the FRS, which is masterminded by a relatively small number of businesses, is preferable to such wholesale changes.

‘We are concerned that HMRC has significantly underestimated the collateral impact of these changes, both in terms of the number of businesses affected and the financial impact.’

CIOT says if the changes go ahead, businesses using or thinking of joining the FRS will need to determine, typically quarterly, whether they are also a limited cost trader and, if they are, will pay HMRC 16.5% of their takings, rather than a potentially lower percentage applicable to their activity. The way in which the limited cost trader is defined means most businesses in the FRS will need to consider whether they fall into its definition during a particular accounting period, and could be caught by fluctuating in and out of the 16.5%.

In addition, CIOT claims far more than the 4,000 businesses estimated by HMRC will move back into standard VAT accounting, so as not to be affected by the new 16.5%, and that the costs of businesses doing this could be significantly higher than the £180 per annum suggested by HMRC. It says the proposed changes are also complicated, and could negate the simplification aims of the FRS.

 Any business which might conceivably fall within the definition of a limited cost trader will need to check its position for each VAT accounting period, typically quarterly, using a planned online tool at CIOT says this means the business will need to know the value of its purchases of goods during that period, effectively meaning that the business will need to have recorded most of its transactions during that period anyway, thus negating some of the simplification elements of the FRS.

Dylewski said: ‘The proposed changes add a significant level of complexity on small business owners who will need considerable guidance from HMRC. Many will have to pay for additional accounting advice. One of the main challenges will be for businesses to understand whether they have acquired goods or services, which is often unclear for expenses such as computer software, electricity and gas and professional subscriptions.’

Be the first to vote


Virtually all of our professional services clients will move onto the normal scheme away from the flat rate scheme they currently use. The additional cost isn't going to come from paying over more VAT to HMRC, it's going to be as a result of additional time spent either by them or us analysing costs to identify input tax. Why base the new test on goods excluding capex? a more sensible test would be to check if VATable purchases are less than 2% or whatever arbitrary threshold they decide on.

We aren't on the flat rate scheme anyway, but we spend lots on software, subscriptions etc and last quarter our input tax was about 20% of output VAT (so a fair approximation of the proportion of vatable purchases to sales) but goods? Less than 1% - not much more than paper, stationery and print cartridges.

Yet another bit of legislation specifically targeted to damage small businesses.

Abuse, really, the Government came up with FRS and then act surprised when people use it, just like when they devised the generous first £10,000 of limited company profits are not taxable and then acted surprised by the rush of incorporations.
Limit cost traders will include Accountants, Tax Advisers etc. not just their clients, but what is the abuse, after all, what is not paid over in VAT through use of FRS is ultimately taxed at 20% corporation tax and then no doubt at some point that money is spent in the economy where it is taxed on someone else.

Yet more evidence that the UK smaller business is not understood nor valued by Government.