Tips And Traps Of The Flat Rate Scheme For VAT

Andrew Needham offers some tips on the operation of the flat rate scheme (FRS) for VAT, and looks at some of the traps to avoid.

When a business joins the VAT flat rate scheme (FRS) for small businesses, it need only account for the relevant flat rate percentage applicable to its trade category on its sales; however, it cannot normally recover VAT on its purchases.

The rules for the FRS can be complicated, so businesses need to be aware of them when joining and leaving the scheme to make sure they maximise the benefits and don’t fall into any traps!

Joining the FRS

If a business registers for VAT and immediately joins the FRS, the normal pre-registration input tax rules apply. So even though you cannot normally claim back input tax when you are on the FRS, newly-registered businesses can reclaim the VAT on all the stock and goods on hand at the time of registration that were bought within the last four years and on services purchased in the six month prior to registration.

Trap :

If a pre-registration purchase costs more than £2,000 inclusive of VAT, it qualifies as a capital purchase and VAT has to be accounted for at the full 20% if it is sold.

Tip:

A business that is already VAT registered has, of course, already reclaimed VAT incurred on the stock and assets held. If there is a substantial stock of goods for resale, there may be a marginal gain under the scheme. The flat rate percentage is reduced to take account of input tax which will not be recoverable on future purchases, but which has already been recovered on the stock. However, a small business would not usually have enough stock for this to be a significant advantage unless the flat rate percentage happens to be favourable too.

Capital purchases

Under the FRS businesses cannot recover the VAT on purchases; however, there is one exception to this when a business purchases a capital asset. Normally, capital purchases cover goods which are bought to be used in the business but are not consumables such as stock or raw materials (for example a van, a computer or a production machine).

A business on the FRS can reclaim the VAT on a single purchase of capital goods where the VAT inclusive amount is £2,000 or more.

Specifically excluded from being classified as a capital purchase are any goods bought to:

resell;
incorporate into other goods for onward supply;
consume (or completely use) within one year; or
generate business income by being leased, let or hired.

Importantly, you cannot reclaim the VAT if your purchase is of services or if the purchase consists of more than one item.

Example: Multiple purchases

You decide to refurbish your café, and buy chairs and tables from a furnishing store for £1,500 and new flooring from a DIY store for £1,000.

The total is more than £2,000, but the individual items are less than £2,000, so you cannot reclaim the VAT.

Tip:

HMRC will accept that it is a single item purchase where you buy a package of items from the same supplier, for example you purchase a computer package (computer, printer, camera, scanner, speakers, etc.) bought as one package so it is treated as one purchase of capital expenditure goods. If the package costs £2,000 or more (incl. VAT), then input tax can be claimed.

Trap :

Where capital goods are bought with the intention of generating income from them (e.g. boats for hire on a boating lake or hire of bouncy castles or marquees), then they are not treated as capital expenditure goods no matter how much they cost.

What counts as services?

It is important to remember that a purchase of services is not covered by the concession for VAT recovery on capital purchases. This means that the VAT on some capital purchases for your business is not recoverable. For example, a computer software licence is a supply of services and not goods, but there are other purchases which might at first glance appear to be goods but are actually classed as services.

Trap :

You decide to get a new van for your business. The best deal you can get is a three year lease. The lease counts as one continuous supply of services, as ownership will never transfer to your business so you cannot recover the VAT.

Tip:

However, if you buy a van on hire purchase it is treated as a supply of capital expenditure goods because ownership will eventually transfer to your business, so you can reclaim the VAT if it costs more than £2,000.

Trap :

A further problem can occur when a business has building work undertaken (e.g. putting on a new roof, or having an extension built to its premises). Even if the building work comes to more than £2,000 and the builder supplies all the materials, the building work is considered to be a supply of services, not goods. As such, none of the VAT can be reclaimed!

Tip:

If you buy the building materials from a builder’s merchant (on a single purchase order) and they come to more than £2,000, you can recover the VAT on the building materials but not on the services of the builder for his services.

Leaving the FRS

If your turnover exceeds £230,000 you have to leave the FRS.

Tip:

However, you only have to check your turnover annually on the anniversary of joining the FRS. If you exceed the threshold, you then have to leave the scheme at the end of the VAT quarter containing the anniversary. If you are on annual returns, you have to leave the FRS at the end of the month following the anniversary.

Example: Leaving the FRS

If you are on annual accounting and you joined the FRS on 23 March 2010, you check your annual turnover every 23 March.

In 2015, the check shows you are over the limit, so you have to leave the FRS on 1 May 2015.

If you are on annual accounting and you joined the FRS on 23 March 2010, you check your annual turnover every 23 March.

In 2015, the check shows you are over the limit, so you have to leave the FRS on 1 May 2015.

Traps :

You have to leave the FRS if you purchase an asset covered by the capital goods scheme – most commonly a commercial property over £250,000 - or if you join a VAT group or use a second-hand scheme.

Trap :

If your turnover is growing fast and you have reason to believe that your turnover will exceed £230,000 in the next 30 days, you will need to leave the FRS from the start of the 30 day period.

Tip:

You may be able to make a stock adjustment and claim input tax when you leave the scheme if your stock of standard rated items increases. To do this, you will need to value your stock. You do not need to do a formal stock take for the purpose of valuing your stock, but your figures must be reasonable. It makes sense to keep a record of how you valued your stock in case HMRC query the figures. For details of the calculation, see VAT Notice 733, para 12.9.

Practical Tip :

If you join the FRS you can claim back the VAT on your stock on hand when you register for VAT. You may also be able to reclaim more VAT on stock adjustments when you leave the FRS!