Top Tax Tips: VAT Flat Rate Scheme

Top Tax Tips: VAT Flat Rate Scheme

The majority of contractors choose to become VAT registered, even if they are not yet earning the threshold amount for registration, as it can give a very professional impression to prospective clients.  HMRC offers several types of VAT accounting schemes which are suited to different sizes and types of businesses. Choosing the best matched VAT accounting system for your business can make a big different to the ease of administering your contractor accounts as well as offering the possibility of making tax savings. Many limited company contractors choose the Flat Rate VAT scheme as it makes their limited company accountancy much easier. Its more straightforward rules also mean errors are less likely which gives welcome peace of mind.

The Flat Rate Scheme

The Flat Rate Scheme for VAT came into force in 2002 as a way to help make VAT accounting much simpler for the smaller business. If you’re a contractor limited company with sales of up to £150,000 (excluding VAT) across any individual tax year you can be eligible to join this Scheme. Once you have registered, even if your VAT inclusive sales go over this amount you can still reap the benefits, up to a cap of £230,000. If you go over this amount though you will no longer eligible and will have to leave the Scheme.

Under the Flat Rate Scheme a contractor must still charge the relevant rate of VAT on invoices to their clients for the products or services sold (eg: 20%) but the VAT payment owed is calculated as a set ‘flat’ percentage of the contractor company’s total VAT inclusive turnover. The ‘flat’ percentage applied varies from industry to industry, for example:

 

Category of business Applicable percentage
Computer and IT consultancy or data processing 14.5
Computer repair services 10.5
Financial services 13.5
Management consultancy 14

 

 

You cannot claim back VAT on your purchases unless you buy an asset for over £2,000, as the set percentage charged takes this into account. However, you save time because you don’t need to work out which purchases you can and can’t claim VAT back for and you don’t need to record the VAT you charge on your sales or purchases in your contractor accounts. Other potential benefits to contractors of using the Flat Rate Scheme include:

  • Although you need to show the rate of VAT applicable separately on your invoices, unlike standard VAT accounting you are not required to record the VAT amounts of every sale and business purchase made. This means the paperwork and admin involved is simpler and less time consuming.
  • In your first year of VAT registration you are eligible for a 1% discount in your flat rate percentage. This applies up to the day before your first anniversary of becoming VAT registered. This offers a welcome tax break.
  • It’s a simpler scheme to follow as there aren’t so many rules as standard VAT.  This makes it easier to get it right, which makes it less stressful.
  • As the Flat Rate Scheme is a set percentage of your sales you have a much better idea of how much VAT you’ll owe to HMRC.

 

For many contractors these benefits offer very worthwhile advantages and the potential for tax savings. However, check with a contractor accountant to make sure that this is the best option tax-wise for your own contractor limited company. For some business types there can be potential disadvantages of using the Flat Rate Scheme which might make it unsuitable. This may be the case for you if:

  • You make a lot of standard rate business purchases – as you generally can’t claim back the VAT on these purchases.
  • You’re currently registered under standard VAT accounting and frequently get a VAT repayment.
  • You issue a lot of zero-rated or VAT exempt invoices – as you won’t be able to charge any VAT to the client, but will effectively be paying it out from your total sales income.
  • You have rental income as the flat rate will be payable on it too.

 

At Intouch our clients can easily keep up to date with contractor tax issues which affect their contractor limited company. Our experienced personal accountants are also on hand to provide personalised advice to ensure our clients take home the maximum possible post-tax income. Contact us to find out more.

 

This blog has been prepared by Intouch Accounting. While we have made every attempt to ensure that the information contained in this blog has been obtained from reliable sources, Intouch is not responsible for any errors or omissions, or for the results obtained from the use of this information. This blog should not be used as a substitute for consultation with professional accounting advisers. If you have any specific queries, please contact Intouch Accounting.

New contractors’ guide to VAT

New contractors’ guide to VAT

One area that new Limited Company contractors need to think about from the start is the on-going tax liabilities of their company. Getting it wrong can potentially result in hefty financial penalties or worse, so it’s advisable to consult an experienced contractor accountant  to get the best advice for your circumstances. One type of tax which will be relevant to most Limited Company contractors is Value Added Tax (VAT).

 

VAT – what it is and where it applies

VAT is charged on the final consumption of a variety of HMRC specified goods and services and is applied to every stage of production and distribution. Most business-related goods and services fall under VAT so the majority of Limited Company contractors are likely to be subject to VAT charges.

 

How VAT is calculated

At its simplest a contractor VAT bill is the balance of the VAT you have charged to clients, minus the VAT you have claimed back on allowable items you purchased. If you have paid out more in VAT than you have charged, HMRC will refund the difference. The standard UK VAT rate is currently 20%. However, there are other rates which could apply depending on the type of goods or services being sold and where (in the world) they’re consumed.

 

VAT Accounting Schemes

HMRC offers schemes designed to help contractors in terms of how VAT is calculated and administered.

There are two options for accounting for VAT available to companies with a taxable turnover of up to £1.35million these are:

  • Cash Accounting – with this option the company only accounts for VAT when their invoice is actually paid. This can be helpful for the cashflow of the business. (Under this scheme you can also only claim back VAT on purchases once you’ve actually paid the invoice.)
  • Annual Accounting – with this option the company only submits one VAT Return a year. Monthly payments of the VAT bill amount are made to HMRC throughout the year. This too can be helpful for cashflow.

 

The Flat Rate Scheme

HMRC offers the Flat Rate Scheme which is designed to make VAT administration easier for many contractors. Rather than claiming VAT on each invoice you pay a percentage of your company turnover. For example 14.5% for an IT consultancy. There are main advantage to this scheme you can continue to charge clients 20% while you give a smaller percentage to HMRC. One downside is that you cannot claim the VAT back on your own business purchases unless they are capital purchases over £2000, which could be an issue for some business types. Another is that if you make a lot of zero rated or VAT exempt sales you’ll still be charged VAT on those sales, even though you’re not charging the client.

 

When you should register for VAT

VAT registration is mandatory for companies who have made taxable sales in the last 12 months above the current VAT registration threshold amount. For the 2013/14 tax year this is £79,000. HMRC usually increases the threshold by around £1,000 each year so for the 2014/15 tax year the threshold is likely to be higher. Even if your sales are unlikely to reach this level you can still voluntarily register your company for VAT. Many contractors choose to do this as it can offer several advantages as claiming back VAT on invoices they receive. If you decide not to register but you believe you’ll exceed the threshold in the near future (if you win a huge contract for example) you should register as soon as possible to remain within HMRC rules.

 

How to register for VAT

You need to apply directly to HMRC to register your company for VAT. This can be done online using their website or by post. You can do this yourself or your Intouch accountant can do this for you on your behalf.

 

Quarterly VAT returns at Intouch

At Intouch we offer Quarterly VAT return administration as a standard part of our comprehensive monthly service package (£98 + VAT per month). Contact us to find out more about our services and how we can help take the stress out of running your business.

 

This blog has been prepared by Intouch Accounting. While we have made every attempt to ensure that the information contained in this blog has been obtained from reliable sources, Intouch is not responsible for any errors or omissions, or for the results obtained from the use of this information. This blog should not be used as a substitute for consultation with professional accounting advisers. If you have any specific queries, please contact Intouch Accounting.

Expenses and disbursements

Expenses and disbursements – what’s the difference?

As a contractor you may incur costs in the process of supplying services to your clients. Where the costs are relevant you can pass these on by including them in your invoice. If you are VAT registered it’s important to understand the difference between HMRC’s definition of ‘expenses’ and ‘disbursements’ to ensure:

  • your invoices to clients show the correct VAT treatment
  • you are only claiming back VAT on allowable items

 

Expenses

For invoicing purposes you must charge VAT on expenses you pass on to your clients.  If you are using the flat rate VAT scheme you must also pay a percentage over to HMRC as you would with a normal invoice, so you may want to consider whether it’s worth staying on the scheme if you have a large amount of expenses.

 

HMRC defines expenses as ‘incidental costs that your business might incur’ when supplying goods or services to clients. These include goods or services purchased for your own use as a normal business cost. The key point in the definition is that a cost is defined as an expense only if you have not purchased the goods or services on behalf of your client, for the client’s use and benefit.

 

HMRC examples of an expense are:

  • Travel to visit a client or travel to a job
  • Postage costs when sending items to clients

 

If you have incurred expenses you can choose to itemise these separately on your invoice as ‘recharges’. These are subject to VAT. You will have to charge VAT on these even if you yourself did not pay VAT on the items.

 

You can claim back the VAT on items you purchased for you and not your client, even if you passed the costs on as a recharge. You must provide a VAT invoice for each item you claim. Your client can also claim back the VAT you charged them on your invoice if they are VAT registered.

 

Disbursements

For invoicing purposes costs incurred for disbursements are left out of the VAT calculation.

 

HMRC defines disbursements as costs you incur when buying goods or services on behalf of your client, for their use and benefit. In this respect you are deemed as acting as an agent for your client.

 

For the cost to be a disbursement it must be clear that the purchase was made on behalf of the client and must include the following HMRC criteria:

  • you paid the supplier on your customer’s behalf acting as the agent of your client
  • your customer received, used or had the benefit of the goods or services you paid for on their behalf
  • it was your client’s responsibility to pay for the goods or services, not yours
  • you had permission from your customer to make the payment
  • your customer knew that the goods or services were from another supplier, not from you
  • you show the costs separately on your invoice
  • you pass on the exact amount of each cost to your customer when you invoice them
  • the goods and services you paid for are additional to the services you’re invoicing your client  for performing yourself

 

If you paid VAT for goods and services you purchased on behalf of your client and treated it as a disbursement on your invoice you cannot claim back the VAT. Your client can only claim back the VAT if they have a valid VAT invoice.

 

In many cases the difference between an expense and a disbursement will be quite clear. However, if you are unsure of the correct VAT treatment for any items, contact your contractor accountant for guidance.

 

This blog has been prepared by Intouch Accounting. While we have made every attempt to ensure that the information contained in this blog has been obtained from reliable sources, Intouch is not responsible for any errors or omissions, or for the results obtained from the use of this information. This blog should not be used as a substitute for consultation with professional accounting advisers. If you have any specific queries, please contact Intouch Accounting.

VAT – Could you be paying too much? Flat Rate VAT?

The benefits and burdens for contractors of the flat rate VAT scheme

Paul Gough, Managing Director of Intouch Accounting, the personal online accounting adviser for contractors and freelancers, looks at the pros and cons of adopting a flat rate scheme, and explains more about how the scheme could affect contractors’ take home pay.

The flat rate scheme, or FRS, was introduced by HM Revenue and Customs (HMRC) in 2002, as a way to simplify accounting for small businesses. In short, in order to calculate the amount of VAT paid to HMRC, the income of a business, including any output tax, is applied to a flat rate percentage. With a few exceptions, input VAT on purchases is ignored.

And the result: a very simple VAT accounting process, making completion of the VAT return easy to do, and easy to verify.

 

Who uses the flat rate scheme and why?

The scheme is open to businesses whose annual taxable turnover or estimated turnover is less than £150,000. Once you’ve joined the scheme you can stay until your turnover exceeds £230,000 including VAT.

It was very quickly established that, for many contractors (those who fit within the threshold), accounting for VAT on the flat rate scheme actually produced a lower VAT liability than when VAT was accounted for on the normal basis. And so, an opportunity to “profit” from the simplified scheme quickly emerged and the scheme became the norm – with most contractors adopting it as their chosen method for accounting for VAT.

But, as with many aspects of accounting and tax, a standard solution is not always the right solution.

Too often advisers adopt a standardised approach to dealing with contractors and fail to consider, on an individual case basis, whether or not the standard solution is in fact appropriate. Providers of accounting software solutions may not raise this issue with you at all.

 

1. Are you exporting goods or receiving rental or investment income?

Under the FRS, with a few exceptions all of your income is included in the calculation. This means that income that may not be normally subject to VAT output is still included in the flat rate calculation.

A good example is if you work abroad for a non-business customer (such as an individual) and zero- rate your services. In this case, there is no VAT. However, under the FRS you would still calculate the percentage on that zero rated income and pay that to HMRC.

But it’s worth noting that when you provide your services to a “commercial entity” it is the place of supply that is important. The place of supply is where the customer belongs, and if that is outside of the UK then this work is outside the scope of VAT and is not included.

Similarly, other zero-rated sales and exempt sales are included. So, make sure you watch out where you export goods, or receive rental and some investment income; you could end up paying more VAT on the flat rate scheme than under the standard scheme.

And, if you sell capital assets and you previously reclaimed VAT, then you must account for the VAT on sales on the standard basis even though you use the flat rate scheme.

 

2. Do you know if the right rate of VAT is being applied to you?

The second danger is that, too often, the percentage selected as the flat rate is a default rate, without thought to the nature of the services being supplied. This is often the fault of the accounting services provider who packages a service together, without applying thought to the individual circumstances of a contractor, and the work undertaken. With the flat rate varying, sometimes the standard flat rate applied is not the right rate, leading to a higher level of VAT liability.

We have seen flat rates as low as 10.5%, when the “norm” applied to contractors is 14.5%. The difference could amount to thousands every year.

 

3. Are you sure that VAT is being recovered when it should be?

The third danger is that input VAT is not recovered when it could be. Where contractors purchase capital assets and the cost exceeds £2,000 (including VAT), the input tax can still be recovered and deducted from the flat rate calculation. Attention to the detail is important. This can often be overlooked because such purchases don’t happen very often.

And, if you buy items and sell them on – which does sometimes happen when you incur costs for your client and recharge them – the VAT on the costs you incur cannot be reclaimed.

 

4. Do you incur unusually high volumes of input VAT on purchases?

The final danger is that if you incur higher than usual volumes of input VAT, by hiring other contractors (who are VAT registered) as sub-contractors for example, then this will significantly increase your VAT suffered. Under the FRS you will be unable to reclaim this back from the VAT man, as it does not qualify for inclusion. The “lost” VAT element will increase your costs and reduce your profitability.

 

Are there any benefits to using the flat rate scheme?

While we have mentioned some of the disadvantages to using this system for VAT, the good news is that there are also significant advantages to using the flat rate scheme:

 

1. Less VAT payable in your first year

If you’re in the first year of VAT registration, you get a one per cent reduction in your flat rate percentage – and this applies until the day before your first anniversary of being VAT registered.

 

2. More time to spend on your business

Because you don’t need to record VAT suffered on every purchase (as with standard VAT accounting), you’ll incur lower administration and processing costs – giving you more time to focus on your business, rather than on the onerous VAT administration process.

 

3. Fewer risks and less chance of making a mistake

Also, with fewer rules, there’s less chance of making mistakes on your VAT return using the scheme, reducing the risk of accidentally claiming input VAT which you’re not entitled to – and, therefore, reducing the risk of an investigation by HMRC.

 

4. You could even profit from the scheme

With FRS you pay a percentage of turnover whereas, with standard VAT accounting, you pay VAT on the difference between sales and purchases. So, while you continue to charge clients the standard rate of 20% VAT, you don’t have to give that percentage to the VAT man. For IT contractors, for example, the norm is 14.5% VAT, but the FRS rate differs from sector to sector.

 

But, make sure you calculate your flat rate turnover correctly and avoid paying a penalty to HMRC

 If you accidentally leave items out and end up paying too little VAT, you could incur a penalty from HMRC.

So, make sure you work out your flat rate turnover correctly – or speak to a specialist personal online accounting adviser who will help you to avoid any tricky situations with HMRC.

 

This blog has been prepared by Intouch Accounting. While we have made every attempt to ensure that the information contained in this blog has been obtained from reliable sources, Intouch is not responsible for any errors or omissions, or for the results obtained from the use of this information. This blog should not be used as a substitute for consultation with professional accounting advisers. If you have any specific queries, please contact Intouch Accounting.

Two advantages of being new to contracting

New to contracting

If you are new to contracting and trade through a Limited Company you should be aware of two advantages open to you of being registered for VAT under the Flat rate scheme and the potential savings of Employer’s National Insurance contributions, if you qualify under the Regional Employer holiday rules.

Most new to contracting – contractors or freelancers operating under the Flat rate VAT scheme (FRS) derive a benefit from the simplified rules of VAT accounting and collect more than they have to pay over each year, especially when the VAT they actually suffer on costs is low. When the VAT rates change on 4th January 2011 this advantage will become even greater so make sure you take full advantage of it.

From 22 June 2010 until September 2013 qualifying new businesses can claim for reduced national insurance payments of up to £5000 (for each of the first 10 new employees of the business for a period of a year). This is due to become law in January 2011- If it is withdrawn you would be back to square one provided you pay any arrears by April 2011

These are examples of the Government supporting investment in new and small businesses which seem to work. I am all in favour of that ! Intouch Contractor Accountants love giving you good news.

Paul Gough

 

This blog has been prepared by Intouch Accounting. While we have made every attempt to ensure that the information contained in this blog has been obtained from reliable sources, Intouch is not responsible for any errors or omissions, or for the results obtained from the use of this information. This blog should not be used as a substitute for consultation with professional accounting advisers. If you have any specific queries, please contact Intouch Accounting.