Article by Stanley Dencher, Senior Technical Editor at Croner.CCH Group Ltd.
Published in October 2001 issue of Tax Adviser.
VAT practitioners already need to know of several, special schemes on VAT, including the following:
- the cash accounting scheme;
- the annual accounting scheme;
- the second-hand goods scheme;
- the tour operators’ margin scheme (TOMS);
- several retail schemes (statutory or bespoke and agreed with Customs in writing);
- the scheme for gold supplies;
- the capital goods adjustment scheme;
- the do-it-yourself housebuilders’ scheme;
- the retail export scheme; and
- the flat-rate scheme for farmers.
In June 2001, Customs issued a consultation document on a proposed, optional scheme: a flat-rate scheme for small firms. The scheme aims to encourage the growth of enterprise and productivity by cutting the tax and regulatory burdens for small firms both when they start and as they expand by, for example, improving the firms’ cash-flow. Many persons have problems when they exceed a VAT registration threshold and have to comply with the VAT system. This compliance burden is worse if the person makes both exempt and VATable supplies.
VAT aims to tax the final consumption of goods and services and so VAT is generally accounted for at every stage of production and distribution. Persons charge VAT on the VATable goods and services they supply, either to a final consumer or to the next business person in the production and distribution chain. That next business person can often reclaim all the VAT charged to it and so much VAT appears in many instances to go around in a circle before finally sticking.
Calculation and payment of net VAT due
Under a flat-rate scheme, traders avoid having to account internally for VAT on all their purchases and supplies, and instead they calculate the net VAT liability as a percentage of their total turnover, including all their reduced, zero-rate and exempt supplies. This figure also includes the value of any supplies to other member states. Customs claim that this would cut annual, compliance costs for over 300,000 persons by up to £1,000.
Persons using the flat-rate scheme could to choose:
- whether to account for VAT on a quarterly basis; and
- whether to combine the flat-rate scheme with the annual accounting scheme or the cash accounting schemes or both.
Thus the record of turnover could be based on:
- cash receipts;
- daily gross takings; or
- invoices issued.
On the VAT return, this turnover figure is declared in Box 1 and the VAT-exclusive total value in Box 6.
Traders, who use the flat-rate scheme, would:
Conditions for joining
- pay VAT by electronic means;
- have an extra seven days beyond the normal due date to file VAT returns and pay any VAT;
- still issue VAT invoices where the customer is VAT-registered, showing VAT at the normal rate for the supply (i.e. not at the flat rate). Such customers treat these as normal VAT invoices and so they are unaffected by whether or not they deal with a user of the flat-rate scheme; and
- still retain all sales and purchase invoices for six years.
The conditions for joining the flat-rate scheme include the following:
- the person’s annual taxable turnover, including reduced and zero-rated supplies, must not exceed £100,000 in the year of entry to the scheme, and with total VAT-exclusive turnover, including the value of exempt supplies and/or other non-VATable income, of no more than £125,000 a year. The turnover threshold differs from that for the annual and cash accounting schemes, which is based on VATable income only;
- the person’s registration is not in the name of a VAT group (VATA 1994, s. 43(1));
- the person’s registration is not in the name of a division (VATA 1994, s. 46(1));
- the person runs a stand-alone business, i.e. the business is not part of a larger undertaking; and
- the person is not a dealer in second-hand goods, an auctioneer or required to use the tour operators’ margin scheme.
Persons with exempt income are treated as fully taxable, because the flat-rate calculation for their trade category takes irrecoverable VAT into account.
Leaving the scheme
Persons cease to be authorised to use the scheme at the end of an accounting year if they exceed the turnover limit: the VAT-exclusive turnover threshold is £125,000 a year, and the total VAT-exclusive turnover limit, including exempt and non-business income, is £150,000.
If a person has reason to believe that the turnover will exceed the limit in the accounting year, they should in writing notify Customs who would terminate the authorisation to use the flat-rate scheme from an appropriate date.
A person can leave the scheme at any time, by notifying Customs in writing. However, a person cannot rejoin the scheme for at least one year.
Repayment traders should only use the scheme if the value of the potential administrative savings exceeded the value of the likely VAT repayment.
The scheme does not aim to affect significantly the amount of VAT collected by Customs. Thus, depending on the trade sectors, the range of flat-rate percentages varies from as low as five per cent to 15 per cent which is just short of the standard rate of 17.5 per cent. Generally, the percentage for a trade sector is based on the VAT declared on VAT returns for the trade sector compared to the value of supplies declared. For example, the five per cent rate applies to food retailers and children’s clothing retailers. The seven per cent rate applies to public houses. The ten per cent rate applies to construction services. Almost top at 14 per cent are accountants, bookkeepers and lawyers. However, the top rate of 15 per cent applies to computer-providers and IT service providers.
A person uses the percentage for the main business if he also has a subsidiary business with a different flat-rate percentage to the main business. If the main trade category changes during the accounting period, the revised flat-rate percentage applies from the date of the change.
The calculation of the rates for the flat-rate scheme allows for low-value capital purchases. However, VAT on VAT-inclusive expenditure over £2,000 should be recoverable outside the flat-rate scheme. Traders reclaim this by declaring the input tax in Box 4 on the VAT return and declaring the value of the capital purchase in Box 7. Such separate treatment does not cover items such as cars where the VAT on purchases is blocked. However, where capital purchases were dealt with outside the flat-rate scheme, output tax on their disposal (or deemed disposal in the case of an asset held as at the time of de-registration) is also dealt with outside the scheme. In these circumstances, traders show the output tax due, together with that due under the flat-rate calculation, in Box 1 of the VAT return and the value of both in Box 6.
At present, traders account for output tax due on supplies of goods received from other member states, and then recover input tax under the normal rules depending on whether they are fully taxable or partly exempt. Most persons involved in supplies and acquisitions to and from other member states are ineligible for the flat-rate scheme. Presumably because few persons would be affected and because any such transactions would generally be low-value, such persons deal with the transactions as at present, i.e. they record separately the supplies and acquisitions to and from other member states, in order to declare the relevant figures in Boxes 2, 8 and 9 of the VAT return. As all eligible traders using the flat-rate scheme are treated as though they are fully taxable, they declare the equivalent VAT amount as input tax in Box 4.
Reverse charges arise on supplies of services where the recipient of the supply has to account for the VAT due. Fully-taxable traders also then recover the equivalent amount as input tax. The output tax on reverse charges is included with other output tax in Box 1 of the VAT return and the value is included with that of other outputs and inputs. As there would be no legal requirement under a flat-rate scheme to record details of reverse charges for services, persons involved in such charges for services would no longer record any details of output or input tax or of the values of such transactions on the VAT return. The flat-rate scheme’s calculations would exclude the value of reverse charges for services.
Assessments and avoidance
Any VAT assessment where VAT was properly calculable under the flat-rate scheme is based on the appropriate flat-rate percentage. In other circumstances (e.g. where VAT was underdeclared on capital disposals), VAT would be assessed under the normal VAT system. Tax-geared penalties are calculated on the same basis as a VAT assessment.
Customs could try to counter VAT avoidance by:
Improvement to the annual accounting scheme
- denying entry to, or expelling persons from, the flat-rate scheme; and
- enabling Customs to clawback an unfair advantage gained through the flat-rate scheme.
In addition, because few persons use the annual accounting scheme, Customs are considering simplifying that scheme, which allows persons to file VAT returns annually rather than quarterly, thereby improving cash flow and reducing compliance costs.
Customs sought comments on the flat-rate scheme by
7 September 2001 and may have been disappointed by
For years VAT has been a successful exercise in job creation for many accountants and bookkeepers. Also, some accountants will not want their clients to use the scheme because the regular discipline of complying with detailed, quarterly VAT accounting helps certain persons keep better and more up-to-date records. Those more experienced practitioners with long memories can recall that generally bookkeeping improved significantly during the mid and late 1970s after VAT took effect in the UK.
Before recommending the scheme, an accountant would want to be confident that the client would be better off by using the scheme. Some of the fixed flat-rate percentages will be as unpopular with some persons as they already are in the case of certain retail schemes: there will be winners and losers especially as traders cannot always join, leave and rejoin the flat-rate scheme at will or retrospectively.
The only way to be sure whether a person is winning or losing is to monitor the position, but keeping the necessary, detailed records to monitor the position would negate a major benefit of the flat-rate scheme. Furthermore, the scheme proposes no fewer than 18 flat-rate percentages, which in itself does not appear simple. Cynics may claim that there is nothing as complex as a simple scheme and nothing as expensive as a cost-cutting proposal. If implemented, the proposed flat-rate scheme for small firms could have as low a usage as apparently applies to the farmers’ flat-rate scheme.
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October 2001 by