All Change for the VAT Flat Rate Scheme

VAT Flat Rate Scheme | Making Tax Digital

Philip Hammond’s Autumn Statement came with several surprises that could potentially set many small business owners back a few paces. However, one announcement stood out particularly more than the rest; that is the imminent changes to the VAT Flat Rate Scheme (FRS).

The VAT FRS was designed to make VAT reporting less complicated for smaller businesses. However, due to misuse of the scheme by low cost traders, at the Autumn Statement a new 16.5% VAT FRS was announced for businesses with limited costs.

Currently, a business is classified as a low cost trader if its VAT inclusive expenditure on goods is:

  • less than 2% of their total expenditure; OR
  • greater than 2% but less than £1,000 per annum;

Businesses must be aware that the amounts spent on goods cannot include:

  • Food and drink ( e.g. covering the cost of employee lunches)
  • Capital expenditure (e.g. new equipment for the business)
  • Vehicles (This excludes businesses that run a vehicle hiring business)

Often, businesses use HMRC’s trade sector reference to determine their flat rate percentage, which is used to govern the amount of VAT that businesses pay to the taxman. With the percentages being slightly advantageous for several sectors, small businesses frequently benefit from a cash gain. Therefore, businesses that qualify for the VAT FRS will benefit from paying less VAT to HMRC than if they were to use any other reporting model.

Yet, since being introduced, a growing number of small businesses have been abusing the scheme. Businesses have been known to register for the scheme when they just meet the registration threshold in order to make a small saving and a number of agencies and firms have moved their employees to self-employment as a way to exploit the scheme further.

As a result, on 5 December 2016, the government confirmed that there will be a standardised flat rate of 16.5%, which will commence on 1 April 2017. The new flat rate will apply to all businesses with limited costs and should prevent the abuse of the system.

This begs the question as to what is a “good”. The Autumn Statement included certain exclusions but did not clarify the definition of goods. The update on Monday was also silent on this point. The best we can do at the moment therefore is to refer to the definition of goods in the VAT legislation (section 4.4 of VAT Notice 700), which in short is anything tangible (a moveable item). So if you purchase a software licence online, that is a service however if you go into Curry’s and purchase a software licence in a box, that is a tangible good. One further point to remember is that water, gas and electricity are classified as goods for VAT purposes.

All businesses, current and prospective users, will be required to complete a test to determine their eligibility. This is particularly bad news for many industries, such as estate agents who currently use a rate of 12% or consultants who currently use a rate of 14%. Though, what is more frustrating about the imminent terms is that the 16.5% standard flat rate of the gross turnover is really equivalent to 19.8% of net, meaning that there is no real saving when compared to the standard VAT accounting model.


Any users or prospective users of the VAT FRS are likely to be affected. All businesses should be aware of the changes and I urge you to speak to us as soon as possible to evaluate if the VAT FRS is still the most cost effective option for your business. If you would like to discuss this in further detail, please contact me directly at