The VAT Flat Rate Scheme - Pitfalls to Watch Out For

The VAT Flat Rate Scheme - Pitfalls to Watch Out For
The Flat Rate Scheme (‘FRS’) is designed as an administrative simplification for businesses with a turnover of less than £150,000 p.a.  Depending on the business sector, the business applies a fixed VAT percentage to its turnover and pays this to HMRC.  It can be useful for some businesses, but it does have problems to watch out for.

Choose your category with care

To decide the flat rate percentage a business must use, it chooses the trade sector which most closely reflects its business. If it makes supplies in more than one sector, it may choose the one in which its sales are largest.  You will need to monitor the balance of your business and if it changes you will need to change your category. 

In a recent example, a pub joined the flat rate scheme and put down its category as ‘public house’ with a flat rate percentage of 6.5%,  however, the pub also sold food and these were greater than the bar sales.  HMRC said that it should be using the category for catering and restaurants with flat rate percentage of 12.5% which resulted in a large assessment plus interest and penalties.

Another problem area is the building and construction trade.  There are two different categories, one for businesses that are labour only (HMRC allows up to 10% of turnover to cover materials) with a flat rate percentage of 14.5%, and general building and construction services with a flat rate percentage of 9.5%.  

Selling a company car

The sale of a company car creates an unwelcome complication – the car must be included in the flat rate takings for the period. This means that although there is no VAT charged on the sale, and no VAT would have been reclaimed on the purchase of the vehicle, the business must account for VAT at their normal flat rate on the proceeds of sale. Accordingly if you sell a car for £1,000 and your VAT flat rate percentage is 10%, you will have to pay £90.91 to HMRC (i.e. £1,000 x 110/100 as the amount is tax inclusive).

Staying on the scheme

If your turnover goes over £230,000 then you have to leave the FRS.  However, HMRC has allowed some latitude so that providing the business can satisfy them that its turnover in the next year will be under £191,500 it can stay on it. So if you have a one-off increase in turnover, or sell an expensive piece of equipment, you can still stay on the FRS if you expect your turnover to fall again.  In terms of measuring the turnover, this is based on its historic turnover in the previous 12 months from the anniversary of starting to use the FRS. 

Example - Projected turnover 

If a business started the scheme on 1 October 2008 its turnover will be from 1 October 2012 to 30 September 2013 – the projected turnover for the next year will be to 30 September 2014. The business then contacts HMRC on the anniversary of starting the scheme to get permission to stay on it.

Bank interest

HMRC originally said that bank interest had to be included in the turnover when accounting for the flat rate percentage. However, in case of Fanfield Ltd & Thexton Training Ltd v Revenue & Customs Commissioners [2011] UKFTT 42 (TC) the taxpayers challenged HMRC’s view that bank interest should be included in the amount subject to the Flat Rate percentage and won, so it no longer has to be included. 

Practical Tip :  

If you are on the FRS make sure you understand the rules and pick the correct business catagory.  If you have a one- off increase in turnover you may still be able to stay on the scheme.

Andrew Needham