How will the VAT rise affect me?

Contractor's Question: For VAT-registered business dealing directly with consumers, I understand that the rise in VAT in January is a cost that needs to be dealt with - i.e. they pass the extra pain on to the customer or not. But as a contractor, I'd like to know what steps a small, VAT-registered limited company should consider, or is the impact on them likely to be only minimal, indicating that action by such a company isn't necessary? And is the impact of the 2.5% rise in VAT likely to differ if the business is a user of the Flat-Rate VAT scheme?

Expert's Answer: Increasing prices now is presumably a clever piece of marketing so that when the increase becomes effective next January, these consumer-facing businesses can make headlines that despite the VAT increase, their prices are staying the same!

The situation for the small, VAT- registered freelancer businesses is that there should be minimal cost to implementation and compliance - after all there are no electronic tills to re-programme for example, and no products to re-label to reflect price changes.

Furthermore, most freelancers are providing business-to-business services and not selling direct to the consumer. As most freelancers' end-clients will be VAT registered, the end-clients will be able to recover the VAT so the rate is immaterial. However arguably, cash flow for some end-clients, if they are already struggling, could potentially be a problem.

Where a freelancer is supplying services to an organisation, which cannot reclaim the VAT which it is charged, then the VAT increase becomes an extra cost to that business. It is therefore conceivable that there might be pressure on the freelancer to reduce rates if the end-client is not prepared to suffer the 2.5% increase.

Similarly, freelancers using the Flat Rate VAT scheme might be vulnerable to such pressures, again depending on their end-user's ability to recoup VAT. However the changes to the relevant percentages on the Flat Rate scheme, which also come into effect on 4th January, should mean that the effect of the increase is largely neutral when purchases are being considered.

However, where an IT consultant is invoicing for his/her services, such a professional might even be slightly better off under the new Flat Rate Scheme percentages.

From January 4th 2011, an IT consultant will charge 20% on his invoice rather than 17.50% and account for VAT under FRS at 14.5% instead of 13%.

So in real terms, the consultant should be marginally better off. Currently, the consultant invoices for £1000 + 17.5% = gross receipt of £1175.00 x FRS13% = £152.75 = net retained £1022.25. Taking that same invoice on or after January 4th - £1000 + 20% = gross invoice £1200.00 x FRS14.5% = £174.00 = net retained £1026.00.

The experts were Paul Mason, manager of the contractor division, and Mark Burke, senior VAT consultant, at Abbey Tax Protection, a tax and compliance specialist.