Many small businesses choose to use the VAT Flat Rate scheme to keep things simple. Rather than adding up the VAT you pay on all your purchases and deducting it from the VAT you collect on sales to work out how much you owe, you simply take a flat percentage of your VAT inclusive turnover and that’s what you pay to HM Revenue & Customs.
However, from the 1 April 2017 the VAT Flat Rate scheme isn’t going to be as simple. A new ‘limited cost business’ rate will come into force and if this applies to you then you’ll pay a higher rate of 16.5%. As this is based on your VAT inclusive turnover it equates to 19.8% of your net turnover. This is 0.2% below the standard rate of VAT leaving you with almost no benefit for VAT incurred on purchases. It is likely you’d be better off on normal VAT accounting so that you can reclaim VAT paid on business-related goods and services.
How is a limited cost business defined?
You will be considered a limited cost business if your cost of goods is less than either:
- 2% of your turnover
- £1,000 a year (if your costs are more than 2%)
What are cost of goods defined as?
Goods are items or materials exclusively used in your business. You can include gas and electricity.
What is excluded?
Goods counted towards the 2% or £1000 do not include:
- Any services (e.g. your eBay shop design or new website)
- Expenses like travel and accommodation
- Food and drink eaten by yourself or your staff
- Vehicle costs including fuel unless you’re in the transport business using your own, or a leased vehicle
- Rent, internet, phone bills and accountancy fees
- Gifts, promotional items and donations
- Goods you will resell or hire out unless this is your main business activity
- Training and memberships
- Capital items for example office equipment, laptops, mobile phones and tablets
Who is this likely to affect?
If you provide labour only services on the VAT Flat Rate Scheme, there’s practically nothing you’ll be able to claim as purchases towards your 2% of turnover so you are likely to be defined as a limited cost business and be paying 16.5% VAT from the 1st of April.