Headline:
Pros and cons of the VAT Flat Rate Scheme
Description:
In her recent article, Rebecca Benneyworth highlighted a potential problem of mixed supplies and the FRS. Members added comments to highlight further problems and advantages of the scheme. There is a lot more to the Flat Rate Scheme than meets the eye, VAT expert A St John Price takes a look at more of its pros and cons.
The VAT Flat Rate Scheme (FRS) is potentially good for some traders. However, it contains serious possible traps and pitfalls. Moreover, as publicity to generate use of it, HMRC have put out a promotional leaflet. That leaflet is so one-sided that a commercial business promoting a service that way would be at serious risk of prosecution!!
Firstly, anyone who wishes to use FRS or to advise a client about it must spend at least an hour understanding the rules. If you don’t, you are taking a gamble! Notice 733 Flat rate scheme for small businesses would probably take you longer than that because it is anything but clear and does not highlight the problems.
The supposed benefit of the scheme
The supposed benefit of the scheme is that, by applying the fixed % for the trade sector, one calculates the output tax due in a single figure and has simple VAT records. HMRC have claimed feedback from traders pleased to abandon input tax. Yet, if one is using an accounting system on a computer, the VAT recording is only a minor aspect. Even hand written, it is not a major task!
Moreover, not recording the output and input tax means one will have no idea of the difference between the payment under the ordinary system and that under the FRS: that leads me to the real potential benefit – or loss.
The real benefit or loss
The real benefit occurs if the output tax due under the FRS is significantly less than one would pay under the ordinary rules. That is not supposed to be a common benefit; HMRC acknowledge that it can happen but maintain that it will be compensated by losses by traders, who are prepared to pay more in return for not keeping a full VAT accounting system!
Well, I suppose that there are some people who have no bookkeeping support and are so clueless about accounting records that they do love the FRS. However, I trust that the majority of users use it intelligently; ie because there is a cash benefit, just as Simon wrote about his clients.
I am a VAT consultant, not a local accountant so I do not know to what extent my profession is providing efficient VAT accounting support to its clients. If I am right that FRS is mostly used by traders themselves, a problem has been created by HMRC through weak explanations and with pitfalls in what is supposed to be a small trader benefit.
The turnover pitfalls
The turnover limit for using the scheme is not just £150k. That is taxable turnover – which includes zero rated and reduced rated sales. The second limit of £187.5k is the total turnover including any exempt outputs, which adds a complication – admittedly often minor or nonexistent.
Now suppose the turnover is £100k standard rated, £30k zero rated and £35k exempt. What do you suppose the turnover value is to which the FRS % must be applied?
It is £182.5k. Firstly, the standard rated turnover must be grossed up to include the output tax. Of course, that is straightforward for a retailer but anyone issuing tax invoices must use the gross figure, not the net. Then one must add both the zero rated and the exempt outputs.
Ouch! Quite! Firstly, an FRS user must get used to applying the % to the gross figure -something not natural. Secondly, anyone with significant zero rated or exempt sales will probably pay considerably more VAT under FRS than under normal accounting.
The % pitfalls
The % to be used is that applicable to the trade sector. However, businesses vary and it may not be obvious which sector applies. Rebecca’s article pointed out the possibilities of 5.5% for a pub, 9.5% for a hotel and 12% for restaurants and take-aways. If a small hotel had a bar and a restaurant with total turnover below £150k, it would have to separate the takings from its bedrooms, the bar and the restaurant in order to show – and continue to show – which was the largest of the three sets of turnover.
It would be unusual for such a business to be so small that the bar takings were the biggest and yet have such efficient profit management that it carefully recorded the different takings!
Rebecca also pointed out a trap for building contractors – the difference between labour only services at 13.5% and the 8.5% for those billing for materials - least 10% of the building turnover. As she said, many contractors do a variety of work, which alters from time to time.
Of course, to gain the most, a contractor would need to ensure that he did enough jobs supplying materials to exceed the 10% barrier whilst not going much higher! However, there is another potential to trap – the zero rated work. I assume that many contractors do a mix of zero rated subcontractor work on new house projects and standard rated repairs or extensions to existing buildings. A contractor using the FRS could suffer severely from having to pay output VAT on zero rated sales under the scheme and not be able to recover any input tax.
About the author
A St John Price FCA is a leading VAT expert and lecturer and author of Tottel’s VAT Annual 2006-07.
Details of more of the Flat Rate Scheme’s traps are covered in greater detail in John's book. Written in plain English, it offers guidance and planning points throughout VAT. The book is one of Tottel’s six Core Tax Annuals and retails at £19.50. The whole set of six costs £99.50.
source: accountingweb
The VAT Flat Rate Scheme (FRS) is potentially good for some traders. However, it contains serious possible traps and pitfalls. Moreover, as publicity to generate use of it, HMRC have put out a promotional leaflet. That leaflet is so one-sided that a commercial business promoting a service that way would be at serious risk of prosecution!!
Firstly, anyone who wishes to use FRS or to advise a client about it must spend at least an hour understanding the rules. If you don’t, you are taking a gamble! Notice 733 Flat rate scheme for small businesses would probably take you longer than that because it is anything but clear and does not highlight the problems.
The supposed benefit of the scheme
The supposed benefit of the scheme is that, by applying the fixed % for the trade sector, one calculates the output tax due in a single figure and has simple VAT records. HMRC have claimed feedback from traders pleased to abandon input tax. Yet, if one is using an accounting system on a computer, the VAT recording is only a minor aspect. Even hand written, it is not a major task!
Moreover, not recording the output and input tax means one will have no idea of the difference between the payment under the ordinary system and that under the FRS: that leads me to the real potential benefit – or loss.
The real benefit or loss
The real benefit occurs if the output tax due under the FRS is significantly less than one would pay under the ordinary rules. That is not supposed to be a common benefit; HMRC acknowledge that it can happen but maintain that it will be compensated by losses by traders, who are prepared to pay more in return for not keeping a full VAT accounting system!
Well, I suppose that there are some people who have no bookkeeping support and are so clueless about accounting records that they do love the FRS. However, I trust that the majority of users use it intelligently; ie because there is a cash benefit, just as Simon wrote about his clients.
I am a VAT consultant, not a local accountant so I do not know to what extent my profession is providing efficient VAT accounting support to its clients. If I am right that FRS is mostly used by traders themselves, a problem has been created by HMRC through weak explanations and with pitfalls in what is supposed to be a small trader benefit.
The turnover pitfalls
The turnover limit for using the scheme is not just £150k. That is taxable turnover – which includes zero rated and reduced rated sales. The second limit of £187.5k is the total turnover including any exempt outputs, which adds a complication – admittedly often minor or nonexistent.
Now suppose the turnover is £100k standard rated, £30k zero rated and £35k exempt. What do you suppose the turnover value is to which the FRS % must be applied?
It is £182.5k. Firstly, the standard rated turnover must be grossed up to include the output tax. Of course, that is straightforward for a retailer but anyone issuing tax invoices must use the gross figure, not the net. Then one must add both the zero rated and the exempt outputs.
Ouch! Quite! Firstly, an FRS user must get used to applying the % to the gross figure -something not natural. Secondly, anyone with significant zero rated or exempt sales will probably pay considerably more VAT under FRS than under normal accounting.
The % pitfalls
The % to be used is that applicable to the trade sector. However, businesses vary and it may not be obvious which sector applies. Rebecca’s article pointed out the possibilities of 5.5% for a pub, 9.5% for a hotel and 12% for restaurants and take-aways. If a small hotel had a bar and a restaurant with total turnover below £150k, it would have to separate the takings from its bedrooms, the bar and the restaurant in order to show – and continue to show – which was the largest of the three sets of turnover.
It would be unusual for such a business to be so small that the bar takings were the biggest and yet have such efficient profit management that it carefully recorded the different takings!
Rebecca also pointed out a trap for building contractors – the difference between labour only services at 13.5% and the 8.5% for those billing for materials - least 10% of the building turnover. As she said, many contractors do a variety of work, which alters from time to time.
Of course, to gain the most, a contractor would need to ensure that he did enough jobs supplying materials to exceed the 10% barrier whilst not going much higher! However, there is another potential to trap – the zero rated work. I assume that many contractors do a mix of zero rated subcontractor work on new house projects and standard rated repairs or extensions to existing buildings. A contractor using the FRS could suffer severely from having to pay output VAT on zero rated sales under the scheme and not be able to recover any input tax.
About the author
A St John Price FCA is a leading VAT expert and lecturer and author of Tottel’s VAT Annual 2006-07.
Details of more of the Flat Rate Scheme’s traps are covered in greater detail in John's book. Written in plain English, it offers guidance and planning points throughout VAT. The book is one of Tottel’s six Core Tax Annuals and retails at £19.50. The whole set of six costs £99.50.
source: accountingweb
Date:
04.12.2006
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