IT freelancers are worse off under flat rate VAT
Government legislation introduced in the Budget to simplify VAT accounting for small businesses has meant higher running costs for freelance businesses in the IT sector.
Under the new measures, introduced on April 24, a flat rate of VAT is applied to income including VAT, ending the need to record and calculate the tax due on every purchase and sale.
VAT on capital purchases can only be recovered separately if the purchase is over £2,000.
VAT charged on the contract
£40,000 x 17.5 per cent £7,000
Less VAT recovered on expenses
£2,400 x 17.5 per cent £420
Total Paid to HM Customs £6,580
Under the Flat Rate Scheme (flat rate applies to income including VAT)
VAT charged on the contract
£40,000 x 17.5 per cent £7,000
VAT paid to HM Customs on gross amount
£40,000 + £7000 x 14.5 per cent £6,815
*The freelancer pays £235 more under the flat rate scheme*
What the VAT rate of 14.5 per cent means to a freelancer with a net contract value of £40,000 and VATable expenses of £2,400
The amendments were supposed to reduce red tape and help small businesses calculate the VAT owed. However, the 14.5 per cent rate of VAT that applies to IT freelance workers under the scheme has achieved exactly the opposite, according to accountants.
Matthew Brown, Managing Director of giant, a specialist accountancy firm, explained: "IT freelancers face the highest rate under the scheme of 14.5 per cent as it is assumed that they have few expenses on which they need to reclaim VAT. But this assumption means that most contractors are worse off under the scheme. Freelancers may find it unfair that the Treasury treats them more harshly than lawyers and estate agents!
"To make matters worse, most larger capital purchases such as computer equipment needed for IT contracts are unlikely to cost more than £2,000, meaning contractors cannot reclaim the VAT and face higher tax bills than under the old VAT schemes.
"Freelancers are better off under the quarterly cash accounting scheme. They can reclaim VAT on all their expenses and gain from only recording VAT on their sales invoices once they have received the cash, rather than being forced to repay VAT to Customs before they have received their money."
Retail of food, confectionery or tobacco - 5 per cent
Postal and courier service - 6 per cent
Retail of vehicles and fuel - 8 per cent
Personal or household goods repair services - 10 per cent
Advertising - 11 per cent
Estate agencies - 11.5 per cent
Hairdressing - 13 per cent
Lawyers - 13.5 per cent
IT freelancers - 14.5 per cent
Flat rate scheme and applicable rates by profession giant also pointed out that the legal record-keeping requirements as they apply to limited companies would mean the reduction in workload from maintaining full VAT records would be minimal. 'As a result, the Government's attempt at reducing their red tape burden will be lost,' it said.
Kevin Miller, tax expert and Financial Director of Webtastic, added: "It was clear when the first flat rate proposals came out for discussion that the Government had little intention of offering real incentives to the IT sector to take this flat rate proposal up as the rate they first proposed for IT services was 15 per cent, which meant that on the figures used in this example the output VAT rose from £7,000 to £7,542: a ludicrous state of affairs.
"I made this point strongly when I drafted the PCG's response to the proposals and we at least saw a slight improvement with the rate falling to 14.5 per cent in the final legislation. But it's no surprise that few if any in the IT sector have made use of this flat rate as it has no real incentives in terms of savings of time or money."
A Treasury spokesman said the flat rate VAT scheme will be extended to an extra 200,000 firms with a turnover of up to £150,000 next April.