The Fizz! Blog

The VAT Flat Rate Scheme, and why it’s fallen more or less into disuse

From its creation in 2002, the VAT Flat Rate Scheme (FRS) was flawed.  The aim of it sounded alright on paper.  Rather than taking the trouble of figuring out how much VAT you’d paid on costs, deducting that from the VAT you’d collected from customers, and giving HMRC the balance (which is how you’d normally prepare a VAT return), you could forget about costs, and just give HMRC some of the VAT you’d collected from customers and keep the rest as a proxy for the VAT you could have deducted if you totted it up.  The amount of VAT you could keep depended upon the industry you were in - the table of rates attempted to approximate the typical VAT incurred on costs in various industries.  The scheme wasn’t intended to make anyone better or worse off - it was intended to put them in the same position that proper VAT returns would, with a bit less work.

To say the least, there were some problems with this:

1. It was based on the idea that keeping basic, accurate accounting records is somehow red tape that you only do because you’re legally obliged to.  It’s not.  It’s how you know what’s going on with your business, what you could be doing better, and whether you’re throwing your life away and should get a job instead.  The fact that it helps you discharge your tax compliance obligations is a happy by-product.
2. People got very confused about what they should apply the percentage rate to.  Since you work out the VAT to charge on your invoice based on the net invoice amount, many taxpayers quite reasonably assumed you worked out your flat rate payment based on the net also.  You don’t, it’s on the gross amount, including VAT.  Countless businesses underpaid VAT as a result, and more than once the first thing we had to tell a new client was that they owed a load of VAT to HMRC.
3. Crucially, the table of rates was totally rubbish.  There were some big winners from the scheme, but it wasn’t intentional.  It was because they could claim to be part of a category that wasn’t intended for them.  For example, the vehicle repairs category was very generous, as it was modelled on a garage paying  for loads of parts and so on.  But there was nothing to stop a labour-only contractor maintaining aeroplanes and incurring virtually no costs from using it.

In the end HMRC addressed that last problem.  They created a new category called a “Limited Cost Trader”, basically for service businesses that weren’t buying or selling goods or using up a meaningful quantity of consumables in their work.  If you fell into that category, you didn’t get to look at the industry rates.  You just had to use a rate of 16.5% when working out your FRS payment. 

Still, you got to keep 3.5% of the VAT, right?  No.  Remember point 2 above - the FRS payment is based on the *gross* collected from customers, not the net.  So if you receive £20,000 plus £4,000 VAT in a quarter, you apply the 16.5% to the £24,000 total.  That means you give £3,960 to HMRC, which is effectively all of the VAT - you’re only getting to keep £40 as a proxy for the VAT on your costs.  More or less any business like that is going to be incurring more than £40 a quarter in VAT on its costs.  That means that for Limited Cost Traders (which was probably a majority of businesses in the scheme), overnight the FRS really did just become something you’d only rationally do if you simply couldn’t bring yourself to keep proper records of VAT incurred on costs.  But for anyone willing to keep basic, conventional VAT records, coming out of the scheme was obviously best.

From our perspective on accounting, this is good!  As we said, keeping accounting records isn’t something you should do for tax purposes, it’s something you should do for information purposes, and for most small businesses things can really be set up pretty efficiently to get that done without too much manual effort.  But if you remained on the FRS, do check if it’s the right thing to do.  You can guarantee that there are lots of Limited Cost Traders who don’t realise they’re Limited Cost Traders, and HMRC are quite likely to catch up with them in the end.

www.fizzhq.com

December is for December things, January is for January things

We were talking with a potential client a few weeks ago.  We’d closed the door to accepting new limited company clients with 31 March 2021 year-ends at that point – they need their accounts and tax returns done by the end of December, and we’re comfortable that we’ve enough to fill the month as it is.  We’ve some existing clients with that year-end where everything still needs to be finished and signed off before the end of the month.  We’ve clients where we need to help them prepare for their approaching 31 December year-end.  There are Self-Assessment Tax Returns to do (we’re pretty good at getting those done well before the 31 January deadline, but end up doing plenty in December and January anyway).  And we’ve got other underlying work too.  So, if we took anything new on, we’d have to drop or delay something that we’re currently intending to do in favour of the new commitment, or work overtime, and we don’t want to do either of those things.

In this case, the potential client didn’t mind if we didn’t do his accounts in December.  He was happy for us to do them late, in January, and he was willing to pay any fines that arose as a result.  The problem is, we’ve January things to do in January.  Self-Assessment Tax Returns are a big thing of course.  Well, can’t we do it in February or March?  We’re doing February and March things in February and March (the first week of February is very committed to VAT return work because of the tax return focus in January, and then we’re spending a lot of time both on preparing our clients with 31 March 2022 company year-ends (which is most of them) for their year-end, and checking in on their tax planning for this year to check that they’re going to be where they want to be by 5 April.

And in April, guess what?  We’re doing April things, and so on and so on.

From the outside, it’s a completely understandable and reasonable request to chuck a bit of work into the machine at a point where it doesn’t naturally fit.  There are certainly accountants who do see their work as more of a transactional conveyor belt where the work is the work, and you can just add it to the queue.  But for firms like us, accompanying clients through the year in a considered way, then – unless the firm happens to be running below capacity - it unfortunately just doesn’t work.  You need to try and jump into the machine at the right time (which, for a limited company, is very likely to be before its year-end, not after it!).

www.fizzhq.com