You’re currently using the flat rate scheme (FRS) and are trading below the exit threshold. But what changes to your trading structure could make it worthwhile to leave voluntarily and is there an optimum way to do this?
You can join the flat rate scheme (FRS) if you expect your taxable sales in the next 12 months will be less than £150,000 excluding VAT. Once you’re in, you only need to check your annual sales once a year on the anniversary date of when you first joined. As long as your gross sales, including VAT, have not exceeded £230,000 you can stay in for at least another year.
Tip. If you exceed the exit threshold because of a one-off sales “blip”, you can write to HMRC and ask to remain in the scheme. But you can only do this if you expect your total VAT-inclusive sales in the next twelve months will be less than £191,500.
Zero-rated and exempt sales
If your business has mainly standard-rated sales, there is a reasonable chance that you will pay less VAT by using the FRS. But if your business model is altered, or your mix of customers changes, you might suddenly have an increase in your exempt and zero-rated sales. You will then pay more tax with the FRS because your scheme percentage is applied to both zero-rated and exempt sales and you are not collecting any VAT from your customers on these sales.
Tip. You can leave the scheme at any time, including partway through a VAT period. However, in most cases, your chosen exit date will be the end of a period. You must notify HMRC of your decision.
Increase in input tax
If you trade as a service business, and only use in-house labour under the PAYE scheme, you are not sacrificing any input tax on labour. But if you use more VAT-registered subcontractors, you will not be able to claim input tax on their fees with the FRS. This will increase your subcontractor costs by 20%. You might be better off leaving the scheme.
Tip. The FRS is best suited to a business with standard-rated sales and minimal input tax on its expenses. Even though the flat rate percentages are adjusted to reflect the loss of input tax, this adjustment will not compensate every business.
You can claim input tax with the FRS if you buy capital goods costing at least £2,000 including VAT. But you cannot claim input tax on capital services. So, for example, an accountant cannot claim input tax on the costs of building an office extension. The fact that the extension will consist of goods – wood, glass, bricks, etc. – is irrelevant.
Limited cost businesses
HMRC reduced the VAT windfalls enjoyed by many users from April 2017 by introducing a new category for a limited cost business, with a high FRS percentage of 16.5%. The category must be considered on a quarter-by-quarter basis and will apply if you do not buy many goods for your business.
Tip. If you are at risk of being a limited cost business in some or all of your quarters, it is probably best to leave the FRS. This will avoid the need to make quarterly calculations, which can often be complicated in terms of goods that are included or excluded.
If you have a lot of zero-rated, exempt or reduced-rated sales, you will pay more tax with the FRS.
If your business model changes so that your input tax increases, you might also want to leave.
The risk of being caught by the 16.5% rate for a limited cost business is also an incentive to leave.