Flat Rate VAT Scheme – overview for contractors
The VAT Flat Rate Scheme started way back in 2002 but it’s intricacies are still not fully grasped by contractors, as suggested by this post on the ContractorUK Forum, writes Martin McKechnie, director of The Low Tax Group.
Most crucially for contractors, those of them who work through their own limited company in certain sectors – including IT - can significantly reduce their administrative burden and, in some cases, even end up with a cash surplus, thanks to the FRS.
What’s in the FRS for me; an IT contractor?
Normally, the VAT paid to HM Revenue & Customs is, in its most simplest terms, the difference between the VAT charged to customers and the VAT paid on purchases. But by using the VAT Flat Rate Scheme, businesses pay VAT as a fixed percentage of their VAT inclusive turnover. The actual percentage used depends on the type of business. For example, an IT sector business receives £30,000 plus VAT from their client during their VAT quarter. VAT at 20% on this turnover would be £6,000, so turnover plus the VAT into the business is £36,000.
The VAT to pay out to HMRC using the FRS is 14.5% of total income including VAT (14.5% is the HMRC rate for Computer and IT consultancy or data processing - other types of contractor will have different rates). This works out as 14.5% of £36,000 which is £5,220.
So the contractor pays £5,220 to HMRC at the end of the month following the quarter end stated on their flat rate VAT return, which leaves £780. For most contractors with reasonable expenses, this amount more than compensates for the VAT paid out in company purchases.
Look before you leap
Generally-speaking, the scheme is especially useful for businesses with minimal VAT on business expenses to reclaim. Before applying to use the scheme, businesses should compare the amount of VAT they would be required to pay to HMRC using the scheme as compared with how much would otherwise be payable. Your accountant should be able to make this deduction on your behalf, as CUK has recommended.
But consider: businesses can only apply to use the FRS if they expect their annual taxable turnover in the next 12 months to be no more than £150,000, excluding VAT. The annual taxable turnover is the total of everything that a business sells during the year. It includes standard, reduced rate or zero rate sales and other supplies. It excludes the actual VAT charged, VAT exempt sales and sales of any capital assets. Special rules apply to the sale of capital assets worth more than £2,000.
Flat rate exceptions and allowances
Bear in mind, the FRS can work against contractors who do have a large number of VAT-rated transactions, as the returns they can expect are limited because of the flat rate. However, there is a mechanism to account for large purchases of capital goods.
New contractors who opt for the flat rate also benefit from a one per cent reduction in the flat rate percentage for the first year of their VAT registration, irrespective of whether HMRC changes the rate during the first year of registration.
First-time contractors enticed by this reduction should think about how much they plan to earn in their first year of trading and, if this is likely to exceed the current VAT threshold of £77,000 turnover per year, then joining could be a good move.
A full breakdown of the flat rate VAT scheme percentages can be found on the HMRC website. This also includes a catch-all rate for ‘Business services that are not listed elsewhere’ of 12%, but it would be unusual for the average contractor to fit into that catch-all category.
With a fresh 12 month-period looming, we recommend that contractors consider the ins and outs of the FRS – often overlooked by independent limited company owners but potentially worth their while.