CIOT urges HMRC to reconsider new VAT classification
As if the IR35 public sector changes are not enough for contractors to contend with, last year’s Autumn Statement announced a new 16.5% VAT flat rate which will apply to businesses with limited costs, such as labour-only businesses, to be applied from 1st April 2017.
HMRC believes this step is necessary as businesses are abusing use of the VAT flat rate scheme (FRS). The truth is that the move was driven by a minority number of employment businesses using the FRS as part of aggressive tax avoidance schemes, for example, Premier Payco, whom the Guardian exposed in 2016. Such agencies set up thousands of two-employee companies to benefit from a favourable FRS percentage, in addition to the NIC Employment Allowance.
The legislation
A limited trader will be defined as one whose VAT inclusive expenditure on goods is either:
- less than 2% of their VAT inclusive turnover in a prescribed accounting period
- greater than 2% of their VAT inclusive turnover but less than £1,000 p.a if the prescribed accounting period is one year (if it is not one year, the figure is the relevant proportion of £1,000)
Goods, for the purposes of this measure, must be used exclusively for the purpose of the business but exclude the following items:
- capital expenditure
- food or drink for consumption by the flat rate business or its employees
- vehicles, vehicle parts and fuel (except for transport services businesses)
HMRC estimates that 411,000 businesses use FRS but that only 4,000 businesses will move back into standard VAT accounting so as to avoid the new 16.5% rate and that the costs of doing so will be £180 per annum. The Chartered Institute of Taxation (CIOT) disagrees and believes that far more businesses will abandon the FRS because the costs of remaining in it will prove prohibitive.
Peter Dylewski, Chairman of the CIOT’s Indirect Taxes Sub-committee, said:
“Targeted action against abuse of the FRS, which is masterminded by a relatively small number of businesses, is preferable to such wholesale changes. We are concerned that HMRC has significantly underestimated the collateral impact of these changes, both in terms of the number of businesses affected, and the financial impact.”
The proposed changes are also complicated which contradict the simplification aims of the FRS, causing Dylewski to add further:
“The proposed changes add a significant level of complexity on small business owners who will need considerable guidance from HMRC. Many will have to pay for additional accounting advice. One of the main challenges will be for businesses to understand whether they have acquired goods or services, which is often unclear for expenses such as computer software, electricity and gas and professional subscriptions.”
The Chartered Institute of Taxation (CIOT) is concerned that these new measures may be ineffective and have unwelcome consequences for those small businesses who play by the rules. Whilst the CIOT accepts that the Government must tackle abuse of the FRS, it believes that changes to the proposed measure are needed to avoid “excessive collateral damage” to small traders who act compliantly.
HMRC is therefore being urged by the CIOT to rethink its view that existing legislation and legal principles cannot be used to tackle the VAT abuse. They have suggested that the department further investigate alternative approaches, such as to restrict the FRS to businesses required (rather than eligible) to be registered for VAT, or tighten up the associated business rule. This rule prevents a taxable person joining the FRS is they are ‘associated with another person’.
Dylweski commented:
“HMRC will face difficulties building in effective anti-tax avoidance measures, to prevent traders side-stepping the new measure, for instance by buying and selling small amounts of goods to take them over the limited cost trader thresholds. We strongly suspect gaps will remain in the legislation and be exploited, and are also concerned that some users might simply ignore the changes, and just liquidate any businesses subsequently assessed by HMRC.”
Administrative problems are also likely to be caused by the changes. Any business which may possibly fall within the definition of a limited cost trader will be required to check their position for each VAT accounting period, typically quarterly, using an online tool which HMRC plans to make available. A business will therefore need to know the value of its purchased goods during that period, which will no doubt require a record to be maintained of transactions and thereby nullifying some of the simplifying principles of the FRS.
Just another example of HMRC using a sledgehammer to crack the tax nut!
As a small consultancy in renewable energy I have been a user of FRS for many years, however I have no need to be VAT registered and will withdraw from VAT.
Rather than listing common types of contractor expenditure that falls into the capital expenditure bucket, it would be good to see a list that doesn’t fall into it. That way, your average contractor could bump up this sort of expenditure until it hits 2% of VAT-inclusive turn, thereby allowing them to stay at their existing flat rate.
I thought there was about 90k contractors in the UK that use Ltd Companies, and will therefore probably use FRS – so where on earth does HMRC get it’s 1% figure from?
Or it that just the assumption that everyone will just put up with it?
My Limited company operates outside of IR35 and has been in the flat rate VAT scheme since it was started.
It is clear the increased VAT rate of 16.5% will cost my business more in VAT than if it opts out of the flat rate scheme, so that is what it has already done, although after nearly a month I’m still waiting for HMRC to respond to my opt out letter!
I don’t believe my business was one of those targeted (it doesn’t use a scheme), but as you say, HMRC have used a sledgehammer….
I’m not surprised HMRC consider my business to be abusing the flat rate VAT scheme as according to HMRC it is also abusing lots of other rules and is avoiding paying tax – a perfectly legitimate activity!