VAT flat rate scheme and bad debts

If you use the flat rate cash-based turnover scheme you may still be due a VAT reclaim even though you will not have paid a VAT contribution to HMRC.

Section 14 of the VAT Notice 733 spells it out:

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The following is extracted from HMRCs notice:

If you use the cash turnover method of accounting you may be eligible for bad debt relief if:

  • you have not been paid by your customer and it has been six months since you made the supplies
  • you have not accounted for and paid tax on the supply
  • you have written off the debt in your accounts.

If you meet all these conditions, your claim will be for the difference between the VAT you charged to your customer and the amount you would have declared to us had you been paid. As with businesses that use the basic and retailer’s methods, this is because your flat rate takes account of input tax that you would otherwise have been entitled to, if you had been paid by your customer.

You can make the adjustment as follows:

  1. Identify the VAT in the unpaid supply – eg Total price = £1,200
    VAT= £200
  2. Calculate the VAT that would have been paid under the flat rate scheme if your customer had paid you – £1,200 × (say) 12% = £144. That is the total owed (including VAT) multiplied by your flat rate scheme percentage.
  3. Subtract the sum of step 2 from the sum of step 1 – £200-£144 = £56
  4. Step 3 is your special allowance under the flat rate scheme. Include it in your VAT account in your next return.

Note: if you apply for bad debt relief on a supply made while using the FRS you should make the adjustment as above, even if you have withdrawn from the scheme.

VAT scale charge where fuel is used for private motoring

Most limited companies do not provide fuel for private use, as the tax charge is normally greater than the cost of the fuel. So the following applies more often to partnerships and sole traders, where there is an apportionment between business and private use.

VAT fuel scale charges, for taxing private use of road fuel, have been changed for periods commencing on or after 1 May 2013.

The scale charge for a particular vehicle is now determined by its CO2 emissions figure. Where the CO2 emissions figure of a vehicle is not a multiple of five, the figure is rounded down to the next multiple of five to determine the level of the charge. For a bi-fuel vehicle which has two CO2 emissions figures, the lower of the two figures should be used.

For cars which are too old to have a CO2 emissions figure HM Revenue & Customs (HMRC) have prescribed a level of emissions by reference to the vehicle’s engine capacity (cc) as follows:

  Cylinder   capacity            CO2 band
  1,400cc or less   140
  1,401cc to 2,000cc   175
  Over 2,000   225 or above

The HMRC website has details of the CO2 emissions amounts and the related fuel scale charges. The tables on the HMRC website show VAT inclusive scale charges applicable in each accounting period, depending on whether it is a 12 month, three month or one month accounting period.

VAT flat rate scheme

The VAT Flat Rate scheme provides smaller businesses with a number of options that can often create real cash savings. Benefits include:

  • Simplified administration, quicker to produce returns.
  • Depending on the market sector your business operates within, you may be able to reduce your overall VAT payments.

To qualify, your annual turnover must not exceed £150,000, excluding VAT. Once you are in the scheme you are not required to leave until your annual turnover exceeds £230,000.

If you register for this scheme you still add VAT to your sales in the usual way. Instead of calculating the amount you need to pay to HMRC as the difference between your output VAT (the VAT you add to your sales) and your input VAT (the VAT added to the goods or services you buy), you simply calculate the total of your sales including VAT and multiply this figure by the flat rate percentage. Income for these purposes, your flat rate turnover, includes:

  • VAT inclusive sales at standard rate, zero rate and reduced rate supplies.
  • Sales of exempt supplies such as rent or lottery commission.
  • Sales of capital expenditure goods – unless you have previously reclaimed VAT when the goods were purchased, in which case you have to pay VAT at the standard rate and not the flat rate.
  • Sales to other EU countries.
  • Sales of second hand goods. If you have a lot of turnover in this category you may be better off using a margin scheme.

Obviously, the higher the flat rate percentage, the less beneficial the scheme will be in reducing your overall VAT payments.

Flat rate percentages vary between 4% and 14.5%.

For example a business repairing personal or household goods would save £2,000 per year in the following scenario:

  1. Flat rate that applies 10%.
  2. Turnover £100,000.
  3. Turnover including VAT £120,000.
  4. Purchases of parts and services £30,000, VAT input tax added £6,000.
  5. Annual VAT bill without applying Flat Rate Scheme, £14,000 (£20,000 – £6,000).
  6. Annual VAT bill applying Flat Rate Scheme, £12,000 (£120,000 x 10%).

Additionally you can reclaim the input tax charged on capital assets bought where the total single invoice value (including VAT) is £2,000 or more.

As a bonus, in the year following the registration of your business for VAT, you can deduct 1% from the flat rate percentage. So in our example, if a full year’s discount was available, the savings in year one would actually be £3,200. (£14,000 less £120,000 x 9%).

(Please note: This 1% reduction in the flat rate would not apply to businesses who had been VAT registered for more than a year when they join the Flat Rate Scheme.)

The scheme does not suit businesses that have a high proportion of zero rated sales or that have high levels of input tax reclaimable on purchases of goods and services. And it may not be possible to produce real cash savings if your business falls into one of the higher flat rate percentages.

You have to make a formal application to join the scheme and it is well worth crunching the numbers to see if you would benefit. As always we would be happy to do this for you.

VAT flat rate and cash schemes

Two of the VAT special schemes can provide particular advantages for smaller businesses.

  • The Flat Rate Scheme (reviewed in our June 2012 newsletter) can reduce overall VAT payable, especially for traders that are subject to the lower Flat Rate percentages.
  • Cash Accounting allows you to defer payment of VAT added to your sales until the invoices are paid. This can have significant cash flow benefits for businesses with amounts owed from customers that are higher than amounts due to suppliers.

In order to register for either of these schemes, your projected business turnover for the year following registration needs to be below certain limits.

  • Under the Flat Rate Scheme rules you can register as long as your projected turnover for the next twelve months does not exceed £150,000 excluding VAT.
  • The equivalent turnover limit to join the Cash Accounting Scheme is £1.35m.

Once you are in the scheme you can continue to enjoy the benefits until your turnover exceeds the exit turnover limits. For both of these schemes these turnover limits are higher than the amounts required for registration.

  • You will need to leave the Flat Rate Scheme when your annual turnover exceeds £230,000 excluding VAT.
  • The equivalent amount to leave the Cash Accounting scheme is £1.6m.

Planning note

From a planning point of view it is therefore wise to consider registration for these schemes when a smaller business commences trading or shortly thereafter, when turnover limits will be at their lowest levels in most cases.

The Flat Rate rules allow you to stay in the scheme and exceed the turnover registration limits by £80,000 before you need to exit.

Charities and VAT

Charities only need to account for VAT on those parts of its activities that are within the scope of VAT. A quick checklist follows:

* Sale of donated goods from a charity shop – zero rated supply
* Investment income, bank interest etc – outside the scope of VAT
* Donations from general public – outside the scope of VAT
* Fundraising events – exempt from VAT
* Grants, see below

The VAT status of the charity shops is advantageous. Even if the zero rated sales are below the current registration limit of £73,000, it would be worthwhile registering the trade voluntarily as any associated costs that include VAT can be reclaimed.

Grants received

Although most grants received by a charity are outside the scope of VAT, occasionally grant providers will require the charity to provide services to individuals or groups as a direct condition of grants made. If this is the case the grant is a standard rated transaction. In most cases this will not cause difficulties as most grant providers are Local Authorities that are VAT registered and can claim back any VAT charged.

Nevertheless charities should take care to seek advice and ensure that they charge VAT on grant income when appropriate.

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VAT on salary sacrifice schemes

Due to a recent European Court of Justice ruling, HMRC now consider that the provision of a benefit via salary sacrifice to employees constitutes a supply of services for consideration and is therefore subject to VAT.

Benefits that will be affected include:

* Cycle to work schemes.
* Face value vouchers.
* Childcare vouchers.
* Food and catering provided by employers.

To give employers time to make the necessary changes to their record keeping HMRC will not require output tax to be accounted for on salary sacrifice supplies until 1 January 2012.

VAT clampdown

HMRC believe that there are a number of businesses that should be registered for VAT, and so far, they have not registered. They are in the process of sending out 40,000 letters to traders who they believe may be in this category.

HMRC are offering businesses that “come clean” and notify HMRC of an intention to register before the end of September 2011, reduced or nil penalties. Subsequently formal applications have to be submitted on VAT form 1 before 31 December 2011.

The current VAT registration threshold is £73,000. If you have already passed this annual limit in the last twelve months, are about to, or expect to in the next 30 days, you might like to respond to this offer.

Penalties for late registration can be up to 100% of additional VAT due.

Fast Food Outlets

HMRC believes that there are a number of fast food outlets that are deliberately falsifying their records and miss-declaring their true sales levels in order to avoid paying their correct taxes.

They have set up yet another specialist task force to tackle this avoidance.

Penalties will be levied in addition to recovery of unpaid taxes. Those businesses discovered may also face criminal prosecution.

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HMRC announce VAT disclosure opportunity

H M Revenue & Customs (HMRC) is launching a new disclosure opportunity, this time aimed specifically at businesses evading VAT.

The initiative is aimed at businesses not registered for VAT but who are in fact been trading above the turnover threshold, currently £73,000 in a 12 month period.

In a similar vain to previous facilities, beneficial terms are on offer. HMRC states that most (but interestingly, not all) businesses making a full disclosure of under-declared VAT will pay a lower than normal penalty rate of 10% in addition to the tax and interest. Businesses must notify their intention to disclose by 30 September 2011 and then actually make a full disclosure and pay the additional liabilities, including the penalty, by 31 December 2011.

HMRC, in time-honoured fashion, has promised to begin investigating those who fail to come forward after the initial deadline passes on 30 September 2011, where it suspects evasion.

The announcement also promises to look favourably on the disclosure of other taxes associated with the trade, citing lower than normal, albeit unspecified, levels of penalties.

VAT on hot food

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At present the more you prepare food for consumption, the more likely the supply will be considered a standard rated supply for VAT purposes.

HMRC turned their nose up when an EU case recently came to a different conclusion. A German trader succeeded in having the supply of a hot sausage treated as a supply at a reduced rate rather than a catered supply which would have been subject to the standard rate in Germany.

HMRC continues to view food sold on a takeout basis as a standard rated supply. However a recent UK case has drawn a further distinction:
•    Food sold and delivered hot, to be consumed hot, was held to be a standard rated supply, for instance a curry.
•    Food sold and delivered hot as part of its preparation, but it is not necessary that they be consumed whilst hot, were considered to be a zero rated supply. For example naan breads, salads etc.

So affected traders could now consider that they are making a split supply, some standard rated, some zero rated.

Now may be a good time to check and make sure that you are not including VAT for the supply of takeaway goods that can now be treated as zero rated. These could also include:

•    Cold sandwiches
•    Cakes
•    Biscuits (without chocolate covering)
•    Milkshakes
•    Frozen meals
•    Yoghurt

At present the more you prepare food for consumption, the more likely the supply will be considered a standard rated supply for VAT purposes.

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Flat rate VAT scheme – potential pitfalls

Selling a car, watch out for VAT sting

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If your business accounts for VAT under the flat rate scheme, the sale of a second hand car creates an unwelcome complication – the car must be included in the flat rate takings for the period. This means that although there is no VAT charged on the sale, and no VAT would have been reclaimed on the purchase of the vehicle, the business must account for VAT at their normal flat rate on the proceeds of sale. Accordingly if you sell a car for £1,000 and your VAT flat rate percentage is 10%, you will have to pay £100 to the VAT man!

If the sale price of the car is considerable, the only possible solution is to exit the flat rate scheme before sale, but this extreme step would only be appropriate if enough cash was at stake. It is not possible to rejoin the scheme for 12 months.
If you use the flat rate scheme and will be selling a second hand car in the near future please call, so that we can examine the best strategy for you.
Please be aware that sales of other ‘out of the ordinary’ items may also cause problems. For example the sale of a property or an export sale.
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