VAT flat rate scheme: revised HMRC guidance

29 May

VAT flat rate scheme: revised HMRC guidance

An update to VAT Notice 733 ‘Flat rate scheme for small businesses’ was issued on 4 May 2016. According to HMRC the purpose of this was to ‘make the notice more suitable for publication on GOV.UK’.

The update includes some minor amendments to various paragraphs. However, there are also three specific changes which will be of interest to small businesses in determining which trade sector they have to choose for the scheme and hence how much VAT they pay.

Revised guidance on trade sectors
In the 2013 version paragraph 4.4 gave guidance on the trade sector to be chosen in various circumstances particularly where the business activity was that of ‘consultant’.  The original version gave the following advice:

4.4 Business activities that are the source of common enquiry
The table below gives the trade sector for particular business activities, which have been the subject of common enquiries to our VAT Helpline.

Business activity Trade sector
Engineering consultants and designers Architects, civil and structural engineers
Agents Business services that are not listed elsewhere
Barristers Lawyers or legal services
Florists Retailing that is not listed elsewhere
Agronomists Management consultancy
Television cameramen Film, radio, television or video production


Note
: if you act as a consultant and you do not fit into another specific sector, you should choose management consultancy. This sector is not restricted to businesses that fit the traditional idea of management consultant.

This paragraph 4.4 has now been removed (and not replaced) in the May 2016 update.

This has the immediate affect that businesses which do not describe themselves as management consultants are free to choose the category ‘business services not listed elsewhere’ which has a lower flat rate of 12% (as opposed to 14% for management consultants).

In addition, the removal of this paragraph means that the previous guidance that all engineering consultants and designers should choose the category for ‘architect, civil and structural engineer or surveyor’ (flat rate 14.5%) has now gone. This fits in with the first tier tribunal case decisions: SLL Subsea Engineering Ltd (TC4256) and Idess Ltd (TC3638) where it was found that mechanical engineers were not civil engineers, so mechanical engineers could choose the category ‘business services not listed elsewhere’ (flat rate 12%).

This updated VAT notice now reflects comments made by judges in tax tribunal cases that businesses should ‘use ordinary English’ in choosing the flat rate trade category. Where businesses are making their trade sector choice they can gain comfort from the advice contained in the notice:

What if I get the sector wrong?
If you have made a mistake choosing an incorrect sector you may pay too much tax or too little. Paying too little could mean that you are faced with an unexpected VAT bill at a later date. HMRC will not change your choice of sector retrospectively as long as your choice was reasonable. It will be sensible to keep a record of why you chose your sector in case you need to show HMRC that your choice was reasonable.

Note: Some business activities can reasonably fit into more than one sector. So changing your sector does not automatically make your original choice unreasonable.

HMRC revised guidance on ‘connected’ and ‘associated’ businesses
There is a general rule which stops ‘associated’ businesses joining the Flat Rate Scheme. The original guidance gave some examples on this:

3.9 I have a close connection with another business – does this mean we are ‘associated’?
Not necessarily. Businesses are not generally ‘associated’ in this special sense where a normal commercial relationship exists.

Example 1
A business is not associated with its customer’s company just because it supplies them with the goods they request in the form they request them.

Example 2
A husband and wife are each separately VAT registered in different types of business. Even if they share premises, provided this is charged at a market rate, they will not be ‘associated’.

The paragraph has been removed from the May 2016 update. The reason for this is not clear but it is obviously very important that the business looks at the remaining guidance in section 3 before registering.

Revised threshold for leaving the scheme
Paragrah 3.5 has been altered slightly which may be useful to businesses which have an increase in turnover once registered for the flat rate scheme. The 2013 version had the following guidance:

3.5 What if my turnover rises once I have joined the scheme?
You may stay in the scheme provided your total income (including VAT) for the year just gone has not risen above £230,000. Make this check on each anniversary of your business joining the flat rate scheme. You must leave the scheme if your turnover increases so that there are grounds for believing that the total value of your income will rise above £230,000 in the next 30 days alone.

Important note: you become eligible for the scheme based on the level of your taxable turnover, but the test of continuing eligibility for the scheme is based on all income (including exempt income). This could mean that, if you have a very high level of exempt income, in extreme cases you could be eligible to join but have to leave immediately. This is unlikely to happen in practice because the scheme is not suitable for businesses with high levels of exempt turnover. See paragraph 6.2 for further details.

This has now been revised to state:

3.5 What if my turnover rises once I have joined the scheme?
You will cease to be eligible to use the scheme if the total value of your income for the year ending is more than £230,000. However, if HMRC are satisfied that the total value of your income in the next 12 months will not exceed £191,500, you may be eligible to remain in the scheme.

The figures above include VAT inclusive income of all taxable and exempt supplies.

See section 12 for further details about leaving the scheme.

The above change is more ‘user friendly’ and gives more flexibility.