Rethink Flat Rate VAT changes, HMRC urged

A plan to crackdown on the abuse of a VAT simplification scheme may be ineffective and have unwelcome consequences for innocent small companies, the taxman has been warned.

So although the idea to tackle those who misuse the VAT Flat Rate Scheme is right, HMRC’s proposal needs to be tightened to avoid collateral victims, says the CIOT, which issued the warning.

In particular, if the changes go ahead, contractors using the FRS will need to determine, typically quarterly, whether they are a ‘limited costs’ trader -- a new term in force from April 2017.

If they are (specifically, if their VAT inclusive expenditure on goods is either less than 2% of their VAT inclusive turnover of less than £1K in total a year), they must pay HMRC 16.5% of their takings.

And they must pay this 16.5% “rather than a potentially lower percentage [currently] applicable to their activity,” pointed out the Chartered Institute of Taxation (CIOT).

“Because of the way the limited cost trader is defined, 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 per cent rate.”

The institute also believes that far more than some 4,000 businesses estimated by HMRC will move back into standard VAT accounting, so as not to be affected by the new, typically higher 16.5% rate.

“The costs of businesses doing this could be significantly higher than the £180 per annum suggested by HMRC,” the CIOT said. “The proposed changes are also complicated, and could negate the simplification aims of the FRS.”

The answer is for HMRC to double-check whether it can use existing legislation and legal principles to tackle the abuse of the FRS, potentially extending to restricting the scheme or tightening the ‘associated business’ rule.

If it cannot, then the Revenue is heading for “difficulties,” predicts the institute’s Peter Dylewski, as the proposed legislation will contain “gaps” that underhanded traders will be able to sidestep.

As to the rule-abiding majority of small businesses, the proposal will “add a significant level of complexity” as they will need considerable guidance from HMRC, he said.

Some of that guidance will need to be in relation to a promised VAT tool, but businesses will have to know the value of their purchased goods during a certain period to use it properly.

“Many will have to pay for additional accounting advice,” Mr Dylewski reflected. “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.”