The Chancellor Philip Hammond, on advice from the Treasury, has finally woken up to this "nice little earner" and the Scheme will undergo major modifications that take effect for all VAT quarters commencing on or after 1 April 2017.
These modifications will mean that the vast majority of businesses using the Scheme will be forced to leave and account for VAT on a conventional basis.
The first and significant modification is the introduction of a new Flat Rate percentage of 16.5%.
Regardless of your hitherto industry specific sector, you may from 1 April 2017, be classified as a "limited cost trader".
- less than 2% of their VAT inclusive turnover in a prescribed accounting period
- 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)
Some examples taken from HMRC VAT Notice 733 are as follows:
Example 1
A business has a flat rate turnover of £10,000 a quarter. It spends £260 on relevant goods.
This is more than 2% of the flat rate turnover and more than £250 so the rate they need to use is the sector rate for their business.
Example 2
A business has a flat rate turnover of £20,000 a quarter. It spends £325 on relevant goods.
This is more than £250 but less than 2% of the flat rate turnover so the rate they need to use is 16.5%.
Example 3
A business has a flat rate turnover of £10,000 a quarter. It spends £225 on relevant goods.
This is more than 2% of the flat rate turnover but less than £250 so the rate they need to use is 16.5%.
Relevant goods are goods that are used exclusively for the purposes of your business, but don't include:
vehicle costs including fuel, unless you're operating in the transport sector using your own, or a leased vehicle
food or drink for you or your staff
capital expenditure goods of any value
goods for resale, leasing, letting or hiring out if your main business activity doesn't ordinarily consist of selling, leasing, letting or hiring out such goods
goods that you intend to re-sell or hire out, unless selling or hiring is your main business activity
any 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%.
Due to the fact that services are excluded from the calculation, the key issue is whether your business will be incurring £1,000 per annum / £250 per quarter on relevant goods used exclusively for your business.
By choosing to remain in the Scheme you will end up remitting 19.8% of the VAT collected if you do not satisfy the quarterly test which in all probabilities will leave you out of pocket.
As everyone's circumstances are different, we are not offering any blanket advice on this and the choice to remain in the Scheme or not will really be yours dependent on your forecast sales and forecast expenditure on relevant goods moving forward.
Even if your next VAT quarter goes beyond 31 March 2017, HMRC will allow you to leave the Scheme, if that is your choice, on 31 March 2017 so your VAT quarter can consist of VAT calculated on both the FRS Scheme basis and conventional basis of accounting for VAT.
You may feel that you would like to stay in the Scheme for the sale of simplicity and if you are incurring very little input tax then this may well make sense.