How a flat-rate VAT scheme would work
In this week's pre budget report it has been proposed that small businesses with a turnover of less than £100,000 might have a flat rate of VAT. How would this work? Would I have to charge clients a new rate of VAT – say 10%?
Answer
No. The first thing to appreciate is that use of a flat rate would be optional not compulsory. Secondly, what seems to be envisaged is that businesses would pay over to Customs and Excise a flat rate of VAT based on their sales rather than taking their output tax and deducting input tax suffered on expenses.
Any form of flat rate scheme will have to reconcile two wide extremes. On the one hand there is the typical knowledge based contractor who has relatively few expenses that bear VAT – say £10K. At the other extreme is a business like a small jobbing engineering company, which buys in a lot of raw materials and other VATable expenses - say £50,000 over a year. Any scheme has to reach a compromise between these two extremes.
For example using these two businesses let's see what might happen.
Let's assume that both the contractor and the engineering business have sales of £90,000 plus VAT of £15750. But the contractor has input tax of £1750 while the engineer has input tax of £8750.
So the contractor pays over a net £14,000 to C&E i.e. a rate of 15.6% of turnover, while the engineer pays over £7,000 – a net of 7.8%. A flat rate scheme has to be a compromise between these two extremes and is most likely to favour a contractor. For example, if a flat rate of, say, 12.5% were set then it would make sense for the contractor to opt for it and pay over £11,250 in VAT rather than the net £14,000 as at present. It would also mean that in future any VAT inspection would only look at sales to ensure that they were complete (and not in excess of the limits) and would not be concerned about whether all input tax was valid.
So this sounds potentially promising but we will have to wait and see what emerges from the consultation. Devising the optimum flat rate will be difficult when the range of businesses it has to encompass is so varied.
Also, when Government realises that a flat rate might be of benefit to contractors they may decide to exclude some forms of business from using it!
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Kevin Miller MA FCA
Kevin brings Big 5 Accountancy experience, together with an understanding of Contracting. Educated at Oxford, his analytical skills and attention to detail are of prime importance in advising PCG members. Kevin is responsible for the overall finances of the group and provides much needed accountancy advice to members. Kevin has been responsible for much of the financial analysis supplied to the Government and contractors since the PCG was founded.