Flat Rate Scheme for VAT
The Flat Rate Scheme (FRS) for VAT can be a very convenient option for smaller businesses, which is why many Limited Company contractors choose this method. The FRS makes it much easier to work out how much VAT is payable and it simplifies administration. However, if you’re currently looking at registering for VAT, it’s worth spending some time ensuring that you’re registering under the most appropriate VAT percentage rate for the actual activities you perform for your clients. With rates ranging from 4% – 14.5% depending on the business activity – referred to by HMRC as a ‘trade sector’ – registering under the wrong rate for what you actually do could result in paying either too little or too much VAT.
VAT Flat Rate Scheme – trade sectors
HMRC has over 50 trade sector definitions to select from. Although HMRC will give a suggestion for the most appropriate sector to choose based on the information given to them, this does not have to be followed. The contractor, as owner of their company, has the final decision on which sector to register under. This makes sense as you, the contractor, know specifically what you actually do for your clients.
Choosing a trade sector
For contractors who have reasonably defined functions, such as accountants and IT consultants, selecting a trade sector that matches their business activities is likely to be easy and clear-cut. If, however, the business activity is more unusual or specialised it may prove difficult to find a ‘best fit’ from the definitions available. Where this is the case and there is an element of consultancy in the contractor’s role, HMRC advice under VAT Notice 733 is that the Management Consultancy sector should be selected. This would apply even if the contractor’s activities don’t fit ‘the traditional idea of a management consultancy’. The current rate for this sector is 14%. While many will opt for this as a ‘safe’ choice, in practice this does not fit all contractors’ activities, so there is an alternative. The work some contractors do may legitimately fall into ‘Business services that are not listed elsewhere’. If it does, the current rate for this sector is 12%, which is a 2% difference from the higher Management Consultancy rate. This demonstrates that it is important to choose exactly the right sector.
This slightly grey area has, unsurprisingly, been the subject of contention and court cases with HMRC. If you’re in doubt about which sector to choose, seek expert advice from your contractor accountant.
Only one rate can apply
For contractors who do a range of activities, the sector chosen should match the main functions the contractor gets paid for performing. This means that, even if earnings come from a variety of activities which could be described under different sectors, only one rate can be applied. This must be the rate for the sector which constitutes the majority of business income.
Remember, under the FRS, all income, from whichever source, will have the same VAT rate applied to it. This is another incentive to ensure the rate you’re registered under isn’t higher than it should be.
Changing trade sectors
If the sector chosen on initial registration no longer fits, as long as the original choice can be seen as reasonable at the time, HMRC are unlikely to have an issue. They won’t demand back-payments of VAT either, so it’s not disastrous. All they will expect is that the new rate is applied in future.
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.