VAT - 21.09.2011

Taxman backs down on VAT flat-rate scheme

Flat-rate scheme

Around ten years ago the Taxman created the VAT flat-rate scheme (FRS). The idea was to simplify VAT record keeping for businesses which met certain conditions (see The next step). The scheme works by allowing registered traders to charge their customers the standard rate of VAT, currently 20%, but pay over a lower percentage to the Taxman. The quid pro quo for this is that the trader isn’t allowed to reclaim VAT paid on purchases. The trouble is the scheme has some quirks which has led to businesses paying more VAT than they bargained for.

Investment trap

The small print of the FRS rules say that when a business calculates the VAT payable to the Taxman it must do so on all business “turnover”, not just that from sales to its customers. According to the Taxman, turnover includes interest earned from the bank etc. This means businesses have to stump up VAT on income which it wouldn’t have to if it hadn’t joined the FRS. This equals a real and often unexpected cost for businesses opting to use the scheme.

Example. Acom Ltd is a family run building firm and during a routine visit the Taxman encouraged the directors to adopt the FRS, which it did in January 2011. It accepted the Taxman’s sales pitch extolling admin benefits of the FRS and were assured it was cost-neutral. However, it wasn’t made aware of turnover rule until it was too late. In March 2011 Acom received annual interest of £5,000 on its bank deposit account and, based on the Taxman’s rules at the time, it was required to account for VAT at 20% on this, i.e. £1,000.

Trap. We’ve heard of cases where the Taxman has encouraged traders to sign up for the FRS with only a limited knowledge of the business. In practice, the admin advantages perceived and promoted by the Taxman are negligible. The only real incentive for joining is potential VAT savings.

Tip. Before applying to use the FRS we suggest you rework your last four VAT returns using the FRS rules. This should give you a good insight into whether the scheme will really save on admin and if it will save or cost you money.

Wrong in law

Last year two leading tax experts challenged the Taxman’s view on whether deposit interest was VATable under the FRS rules. They thought he was wrong in law and decided to take a test case to the tax tribunal - they won. However, this didn’t stop the Taxman continuing to publish guidance stating that interest was subject to VAT. It was only after the Institute of Taxation challenged the Taxman over the incorrect advice that, just two months ago, they put it right. It’s now accepted that VAT never applied to deposit interest.

Tip. If, during the four years prior to your current VAT quarter, you’ve accounted for VAT on interest, you can now reclaim this. Unless the amount involved is more than £10,000, all you need to do to get your money back is amend your next VAT return (see The next step).

For more information on the FRS (TX 11.22.07A)and on how to reclaim VAT (TX 11.22.07B), visit http://tax.indicator.co.uk.