Flat rate VAT and freelancer VAT issues explained
Over the past few months a number of VAT queries have been raised by UKTECH users. This article, by Kevin Miller and Qdos's VAT expert, Barry Hincks, looks at some of the common issues.
Flat rate VAT
Flat rate VAT was introduced in 2002. It works on the basis of users no longer being required to account in detail for their output VAT (VAT on sales) or their input VAT (on expenses). Instead they continue to charge the normal rate of VAT on their sales and then account to Customs and Excise for VAT on the basis of paying over to Customs and Excise a flat rate percentage of their VAT inclusive turnover (including non-taxable turnover). The aim of the scheme is to simplify VAT administration for small businesses.
When the scheme was first introduced the applicable flat rate for IT consultants, who make up the majority of UKTECH users, was 14.5%, which meant, in effect, that for most IT consultants the scheme was unattractive. However changes were made to the scheme at the end of 2003 (effective 1 January 2004) when the flat rates were amended - generally by a reduction of around 1% and a further 1% reduction was introduced for all businesses in the first year of VAT registration.
The flat rate for IT consultants actually fell by 1.5% to 13%. The rate for management consultants and accountants is also 13%. Engineers could use the 12.5% rate applicable to civil and structural engineers or could argue that they fall into the category of "business services not listed elsewhere" and use that rate of 11%.
These levels of rate, plus the additional 1% reduction for the first year of registration make the scheme much more attractive. To be eligible to use the scheme your annual taxable turnover, before VAT, must not exceed £150,000 pa with your total annual turnover (including exempt and non-taxable income) not exceeding £187,500 before VAT.
Applying flat rate VAT
To use the scheme you have to apply to Customs and Excise for permission using a form VAT600 (FRS). Once permission is received you can no longer recover VAT on expenses and purchases although there are exceptions relating to purchases of certain fixed assets where you can still reclaim the VAT on items that cost in excess of £2000 (inc VAT).
You will still charge VAT at the usual rate on all sales that are subject to VAT, including any expenses that you recharge to clients.
How does the flat rate work?
The following example illustrates how the flat rate scheme would apply for an IT contractor using the introductory rate of 12%.
Assume sales of £100,000. VAT at 17.5% on this = £17,500 output VAT collected from customers.
Assume expenses subject to VAT of £5000 a year. Normal input VAT at 17.5% = £875.
Net payment to Customs and Excise in a year = £16,625.
Using flat rate VAT scheme:
Output VAT as before = £17,500 collected from customers.
Flat rate 12% on VAT inclusive turnover = 12% X £117,500 = £14100
This is the amount payable to Customs and Excise. Hence there is a 'Profit' for the consultant of £17,500 VAT collected less £14100 paid over to Customs and Excise less £875 VAT paid on expenses = £2525.
Accounting for flat rate VAT
In your company accounts the Inland Revenue confirms that for businesses who are using the VAT Flat Rate Scheme, it is expected that accounts will be prepared using gross receipts less flat rate VAT percentage for turnover and that expenses will include the irrecoverable input VAT. This is similar in form to accounts prepared by non VAT registered businesses who cannot recover VAT they are charged. Any VAT advantage gained by using the Flat Rate Scheme will form a part of taxable profits. Any VAT loss incurred by using the scheme will constitute an expense that reduces profit and therefore reduces direct tax.
For more details on flat rate VAT look at the VAT information sheet 17/2003 and Notice 733.
VAT on mileage claims
Readers have queried if and how you claim VAT on mileage claims?
The answer is yes. When paying a mileage rate to an employee there is an element of VAT included within that can be reclaimed as input tax if the required conditions are met. The costs have to have been for business purposes and the employee should keep a mileage record detailing the business journeys undertaken - for example office to site B, 20 miles.
To calculate how much VAT is recoverable you apply the VAT fraction of 7/47 to the fuel rates. The AA fuel rates are acceptable. If, for example, the fuel rate for a particular employee's car was 12p per mile the VAT recoverable would be:
Number of Business Miles (supported by mileage record) x 12p x 7/47 (the VAT fraction).
e.g if the business miles are 500 business miles the VAT = 500 x 12p x 7/47 = £8.94 recoverable VAT.
VAT on recharged expenses
Where you incur expenses while providing your service to the client and are able to recharge these to your client the liability of this recharge shall follow the liability of the main supply.
In other words if your main supply falls subject to VAT, VAT output tax must be added to the recharge. The VAT position is generally neutral as you will recharge the same amount of VAT as you have suffered. However if train or flight fares are recharged VAT has to be added to these also even though they will have been charged to you at the zero rate of VAT.
Working overseas and VAT
Freelancers sometimes have the opportunity to work overseas - where the issue of whether to charge VAT arises. There are special rules that relate to the provisions of services such as consultants and engineers, which may be treated as being supplied where they are received. These are covered by the provisions of Schedule 5 VATA 1994.
These provisions apply where the services covered (see below) are supplied:
(1) to any person belonging outside the EC; or
(2) to a person belonging outside the UK, but elsewhere in the EC, who is registered for VAT or otherwise receives the supply in a business capacity (the legislation specifies that the customer must be registered for VAT, but Customs have acknowledged that this is incorrect, and changes are to be made).
Where the supply is made to a person belonging outside the EC, no VAT liability arises.
Where a supply under Schedule 5, for example of consultancy, is made to a person belonging in another EC member state and that person falls under (2) above although the supply is treated as being supplied where received there is generally no requirement for the UK supplier to register in that member state.
This is because the liability to account for the VAT on the supply is transferred to the overseas customer under what is known as the reverse charge procedure. The customer must account for output tax as if it had made the supply, but can treat an equivalent amount as input tax if entitled to do so in accordance with the rules of the EC member state concerned.
Similarly where a UK registered customer receives Schedule 5 services in the UK from an overseas supplier, who is not UK VAT registered, the customer is liable to account for the VAT on the supply under these reverse charge procedures.
For detailed advice on these and any other VAT issues call Barry on 01455 850000
Kevin Miller, MA FCA,
(Kevin Miller Consulting Limited)
Barry Hincks, (Qdos Consulting)