Innocent small businesses may suffer from crackdown on VAT abuse
The Chartered Institute of Taxation (CIOT) is concerned that HMRC’s new measure to crackdown on abuse of a VAT simplification scheme may be ineffective and have unwelcome consequences for tax compliant small businesses.
The CIOT accepts that the Government must tackle abuse of the VAT Flat Rate Scheme (FRS) but believes that changes to the proposed measure are needed, to avoid excessive collateral damage to compliant small traders.
Peter Dylewski, Chairman of the CIOT’s Indirect Taxes Sub-committee, said:
“Targeted action against abuse of the FRS, which is masterminded by a relatively small number of businesses, is preferable to such wholesale changes. We are concerned that HMRC has significantly underestimated the collateral impact of these changes, both in terms of the number of businesses affected and the financial impact.”
The FRS is a simplification measure for small businesses, which enables them to pay to HMRC a fixed rate of VAT, that is determined by their type of business, rather than keep detailed records of input and output VAT. HMRC estimates that 411,000 businesses use FRS.
At the Autumn Statement, the Chancellor announced changes to the FRS which mean that a business that falls into a new definition of a ‘limited cost trader’ during an accounting period will pay a higher 16.5 per cent rate.1 HMRC’s intention is to tackle allegations of widespread abuse of the scheme by some employment agencies and similar businesses which set up thousands of two-employee companies, to both benefit from a favourable FRS percentage, as well as the NIC Employment Allowance. 2
If the changes go ahead, businesses using or thinking of joining the FRS will need to determine, typically quarterly, whether they are also a limited cost trader and, if they are, will pay HMRC 16.5 per cent of their takings, rather than a potentially lower percentage applicable to their activity. Because of the way the limited cost trader is defined, most businesses in the FRS will need to consider whether they fall into its definition during a particular accounting period, and could be caught by fluctuating in and out of the 16.5 per cent rate.
The CIOT also believes far more than the 4,000 businesses estimated by HMRC will move back into standard VAT accounting, so as not to be affected by the new 16.5 per cent rate, and that the costs of businesses doing this could be significantly higher than the £180 per annum suggested by HMRC. The proposed changes are also complicated, and could negate the simplification aims of the FRS.
The CIOT has urged HMRC to rethink its view that existing legislation and legal principles cannot tackle the VAT abuse. The Institute has suggested that HMRC further investigate alternative approaches, such as to restrict the FRS to businesses required (rather than eligible) to be registered for VAT, or tighten up the associated business rule.3
Peter Dylewski, said:
“HMRC will face difficulties building in effective anti-tax avoidance measures, to prevent traders side-stepping the new measure, for instance by buying and selling small amounts of goods to take them over the limited cost trader thresholds. We strongly suspect gaps will remain in the legislation and will be exploited, and we are also concerned that some users might simply ignore the changes, and just liquidate any businesses subsequently assessed by HMRC.”
The changes are likely to cause administrative problems for FRS users; any business which might conceivably fall within the definition of a limited cost trader will need to check its position for each VAT accounting period, typically quarterly, using a planned online tool on Gov.uk. To properly use the online tool, the business will need to know the value of its purchases of goods during that period, effectively meaning that the business will need to have recorded most of its transactions during that period anyway, thus negating some of the simplification elements of the FRS.
Peter Dylewski said:
“The proposed changes add a significant level of complexity on small business owners who will need considerable guidance from HMRC. Many will have to pay for additional accounting advice. One of the main challenges will be for businesses to understand whether they have acquired goods or services, which is often unclear for expenses such as computer software, electricity and gas and professional subscriptions.”
Notes for editors
1. With the Flat Rate Scheme:
· you pay to HMRC a fixed percentage of your VAT inclusive turnover.
· you keep the difference between the VAT you charge your customers and the amount which you pay to HMRC, this difference being intended to compensate for the lack of entitlement to VAT recovery on normal expenditure (except for certain capital assets over £2,000)
To join the scheme your turnover must be £150,000 or less (excluding VAT), and you must apply to HMRC to start using the scheme.
From 1 April 2017, if the proposed changes go ahead, FRS businesses must also determine whether they meet the definition of a limited cost trader (LCT), which will be included in new legislation. It is possible that a business can fall into being defined as LCT for one accounting period and then out of it the next.
A limited cost trader will be defined as one whose VAT inclusive expenditure on goods is either:
· less than two per cent of their VAT inclusive turnover in a prescribed accounting period
· greater than two per cent of their VAT inclusive turnover but less than £1000 per annum if the prescribed accounting period is one year (if it is not one year, the figure is the relevant proportion of £1000)
Goods, for the purposes of this measure, must be used exclusively for the purpose of the business but exclude some items: for more information about what makes a limited cost trader click here.
2. HMRC has stated that thousands of VAT FRS registrations have been established for labour only businesses, or other businesses with limited costs. These businesses use the flat rate appropriate to their trade sector (none of which are higher than 14.5 per cent), but have significantly lower costs than most small businesses in that sector and so gain a financial benefit. The new 16.5 per cent flat rate aims to remove the monetary advantage for those businesses with limited costs, according to HMRC’s website. A newspaper investigated this matter in November 2016 – link here.
3. There is a specific provision in the FRS (Reg 55L(1)(d)(iii)), that a taxable person cannot join the FRS if he is ‘associated with another person’. For more information see section 3.8 on the link here.
4. The CIOT’s recent formal submission on the changes to FRS can be read here.
5. The Chartered Institute of Taxation (CIOT)
The CIOT is the leading professional body in the United Kingdom concerned solely with taxation. The CIOT is an educational charity, promoting education and study of the administration and practice of taxation. One of our key aims is to work for a better, more efficient, tax system for all affected by it – taxpayers, their advisers and the authorities. The CIOT’s work covers all aspects of taxation, including direct and indirect taxes and duties. Through our Low Incomes Tax Reform Group (LITRG), the CIOT has a particular focus on improving the tax system, including tax credits and benefits, for the unrepresented taxpayer.
The CIOT draws on our members’ experience in private practice, commerce and industry, government and academia to improve tax administration and propose and explain how tax policy objectives can most effectively be achieved. We also link to, and draw on, similar leading professional tax bodies in other countries. The CIOT’s comments and recommendations on tax issues are made in line with our charitable objectives: we are politically neutral in our work.
The CIOT’s 18,000 members have the practising title of ‘Chartered Tax Adviser’ and the designatory letters ‘CTA’, to represent the leading tax qualification.
Contact: Hamant Verma, External Relations Officer, 0207 340 2702 HVerma@ciot.org.uk (Out of hours contact: George Crozier, 07740 477 374)