- The new limited trader category of the flat rate scheme comes into force on 1 April 2017.
- Timing of invoices to ensure optimum VAT is paid on leaving the flat rate scheme.
- Treatment of assets and stock when deregistering.
- Scope to claim bad debt relief using form VAT 427.
I did something five times last week that I had only done about three times in the previous 20 years. No, not carrying out rigorous exercise or buying a round of drinks for friends, but deregistering five clients for VAT purposes. Readers who have read Mike Thexton’s and my articles in Taxation (‘That simple tax’, 2 March 2017, page 10, ‘Flat rate dilemma’, 12 January 2017, page 11, and ‘Get on with the game!’, 8 December 2016, page 8) will know why: to escape the flat rate scheme before the ‘limited cost trader’ category and its draconian 16.5% rate takes effect on 1 April. All five applications were completed online, with a requested deregistration date of 31 March.
Background to deregistration
There are two basic rules to remember when deregistering a trading business:
- A business can apply to deregister if taxable sales in the next 12 months are expected to be less than £81,000. See Consider future sales.
- The date of deregistration is based on the date the application has been received by HMRC or a later date – not on a retrospective basis. See Date of deregistration.
Flat rate scheme
A strategy decision of the board of my accountancy company (just me) is that no clients will be advised to use the limited cost trader category (16.5%) that takes effect on 1 April. If they would definitely be classed as limited cost traders because they spend less than £250 a quarter or 2% of total sales on ‘relevant goods’, or are likely to be classed as limited cost traders, there will be one of two outcomes suggested to them:
- Leave the flat rate scheme on 31 March and revert to normal VAT accounting, namely output tax less input tax.
- If annual taxable sales are less than £81,000 and some or all clients cannot claim input tax, we will evaluate the commercial benefits of deregistration.
All five of my clients that have deregistered from 31 March had some customers who could not claim input tax. They will therefore seek to increase their fees by 10% to these customers to share the VAT saving. This will compensate them for the loss of input tax they will incur by leaving the VAT club.
Without going into detail about the limited cost trader category (excellently covered by Mike Thexton in ‘That simple tax’), my reason for avoiding it is because I think that most service businesses will have few purchases that will be accepted by HMRC as ‘relevant goods’. Let me give an example: I recently booked tickets for a squash tournament in Hull (the UK’s 2017 city of culture). I also booked my train ticket and hotel for the same trip. What did I then do? I printed all of the tickets and hotel confirmations on my company printer, which means that my paper and print cartridge purchases would not qualify as relevant goods for the 2% limited cost trader test because they were being partly used for my private activities and not wholly for business purposes. There is no de minimis limit for private use. With the other exclusions in place highlighted in Mike’s article, it is fair to say that the chances of most service businesses finding enough relevant goods to pass the 2% test and avoid the 16.5% rate will be remote.
So here is the quirk of the rules: when a flat rate scheme user deregisters, he is deemed to be leaving the scheme on the day before, so 30 March in the case of my five clients (Notice 733, para 12.4). What does this mean in practical terms? See Multiple choice challenge.
There is another twist. If any flat rate scheme user makes zero-rated or exempt sales, it makes sense to invoice these sales on 31 March rather than earlier because they will be subject to 0% tax, not the flat scheme rate. This is because the flat rate scheme captures these sales as well as 5% and 20% sales.
In the case of the five clients I have deregistered, whose sales are all standard rated, I have told them to put a big, red message in their diaries for 30 March with the words ‘Invoice clients today who can claim VAT’. The entry for 31 March will say ‘No invoicing today’. And for 1 April – yes, you’ve guessed it – ‘Invoice clients today who cannot claim VAT’.
These clients all supply services rather than goods and it is these businesses that are affected by the new limited cost trader category. The invoicing arrangements for service providers are flexible: a tax point is created only when payment is received or an invoice raised in the case of continuous supplies of services; for non-continuous supplies, an invoice must be raised within 14 days of completing the work (assuming no tax point has been created by an earlier receipt of payment).
In the case of flat rate scheme withdrawals (30 March 2017), there is a requirement to account for flat rate scheme tax on closing debtors on the date of leaving the scheme if the business has been using the ‘cash-based turnover method’ (Notice 733, para 9). The invoice date is the default position for a business using the basic turnover method (Notice 733, para 8).
Here is another twist to the tale. I will invoice the five clients I am deregistering for my services carried out to date, but when will I do this? The answer is 31 March. The clients can then claim input tax on my fees because they left the flat rate scheme the day before. So they are reverting to normal VAT accounting for one day only. What a game it all is.
My clients should encourage this approach from all of their suppliers. A purchase invoice dated 30 March would not be good enough because the business is input tax blocked on that date with the flat rate scheme. So, overall, a bit of VAT planning has created a ‘win win’ outcome for both input tax and output tax.
As a separate point, is 31 March a good day for a flat rate scheme user deregistering then to buy their next business laptop? It would make sense because input tax can be claimed on the purchase, as long as the cost (plus value of other relevant stock and assets) does not breach the £5,000 de minimis limit and create an output tax problem.
Asset and stock on hand
A common question about the flat rate scheme relates to paying output tax on stock and assets still owned by a business at the time of deregistration – 31 March. This is important since output tax will be due at 20% on these assets because the business left the flat rate scheme the day before. The basic rules are:
- Stock and assets are excluded if no input tax was claimed when they were purchased – for example, a computer bought from a friend or supplier who was not VAT-registered.
- There is no output tax to pay on zero-rated or exempt items, such as most food stock for a restaurant or a motor car if input tax was blocked on purchase (the latter is exempt under VATA 1994, Sch 9 group 14).
- If the total market value of the remaining stock and assets is less than £5,000 (VAT payable is less than £1,000), no output tax is payable on the final VAT return.
The key question is: if I bought a computer for £1,500 plus VAT while I was using the flat rate scheme but did not claim input tax on the purchase because it was less than £2,000 including VAT (input tax can be claimed by flat rate scheme users on ‘capital goods’ costing more than this figure – see Notice 733, para 15), can I exclude it from the value of stock and assets liable to output tax when I deregister?
The answer is ‘yes’ because I did not claim input tax on the purchase of the asset. This makes sense because the reduced record-keeping requirements of the flat rate scheme would make it difficult to track these items (Notice 700/11, para 7.3).
Here is a final tip which saved one of my five clients £280. A quirk of the flat rate scheme is that, even if a user adopts the cash-based turnover method and pays VAT only when payment has been made by a customer, there is a cash windfall if a bad debt occurs. In VAT terms, bad debt relief can be claimed if an invoice is more than six months overdue for payment and has been written off in the business accounts.
Bad debt relief is automatic if a business is not in the flat rate scheme and uses the cash accounting scheme but not if it uses the flat rate scheme and cash-based turnover method. So it is a good idea to review the collectability of old debtors before deregistering and remember that there is scope to claim bad debt relief if other debts go bad after deregistration by using form VAT427 (Notice 700/11, para 9). See Bad debt windfall.
According to HMRC estimates, about two-thirds of all flat rate scheme users are voluntarily registered for VAT (annual taxable sales are less than £83,000). It anticipates that the new limited cost trader category will result in many of them deciding to deregister. I have got the show on the road by deregistering five of them.
The issues I have raised in this article about the deregistration process have produced more twists and turns than an episode of ITV’s Broadchurch. My view is that it is now time to call it a day and knock it on the head – the flat rate scheme that is, not Broadchurch.