Can readers put my mind at rest with regards to the following point, which might be a VAT, tax and/or accounting problem? I have a client who uses the flat-rate VAT scheme. He charges output VAT to his clients at the normal VAT rate and, of course, pays input VAT in the usual way. However, for VAT return purposes he pays a flat rate of 7% on the services that his business supplies.
Can readers put my mind at rest with regards to the following point, which might be a VAT, tax and/or accounting problem? I have a client who uses the flat-rate VAT scheme. He charges output VAT to his clients at the normal VAT rate and, of course, pays input VAT in the usual way. However, for VAT return purposes he pays a flat rate of 7% on the services that his business supplies.
Let us say that he charges a customer £100 plus VAT and receives £117.50. He incurs costs of £50 plus VAT and thus pays £58.75. He pays flat-rate VAT of £7 to Customs on that transaction. As a newcomer to the world of VAT and accounts, can readers explain to me what happens to the other £1.75? (That is the £17.50 — £8.75 — £7.)
How is this shown in the accounts, and am I correct in assuming that it is taxable?
Readers' advice on this matter would be gratefully received.
(Query T16,567) — New Boy.
There is plenty of anecdotal evidence to suggest that New Boy is not alone in misunderstanding the VAT flat rate scheme (FRS). Those used to conventional VAT accounting must forget what they have learnt and adopt an entirely new method of accounting.
A key point is that VAT is added to sales in the normal way, but is not regarded as output VAT. The total VAT inclusive price is recorded as sales, and this is the amount to which the flat rate percentage is applied to arrive at the VAT due for the period. Thus, if goods are sold for £100 plus VAT of £17.50, the total sale value of £117.50 is used to work out the VAT due by applying the flat rate percentage. Using 7% in this example gives VAT due of £8.22 and not £7 as New Boy assumes. Carrying on the example, if the client has inputs of £58.70 (inclusive of VAT), the gross profit will be: £117.50 — £58.75 — FRS VAT of £8.22, which gives £50.53. This contrasts with a gross profit of £51.75, which the incorrect example assumes, and £50 given by the conventional non-FRS VAT method.
It is still mandatory to keep a VAT account, but under the FRS, it will record simply the VAT payable as calculated above, with no need to record other detailed VAT listings.
Income tax will be payable based on the accounting profit, which will now be based on the gross profit shown in the accounts of, in the example, £50.53. This reduces the net of tax benefit of using the FRS method by the marginal rates of income/corporation tax (and class 4 NIC for a sole trader).
Only traders with less than £100,000 of 'VATable' turnover or £125,000 of 'total income' can use the FRS.
Traders need not be concerned that input VAT on an unexpected capital purchase may not be recoverable. Input tax on capital assets of more than £2,000 or more (VAT inclusive) is recoverable; but any subsequent disposal of those assets must have VAT accounted for separately outside the FRS. When completing a sole trader's self assessment tax return, it will be worth recognising that the FRS will affect the reported gross profit, and this may create an anomaly to be picked by the Revenue's risk assessment procedures. Use should be made of the white spaces to provide the additional information that an FRS has been used.
Who should use the FRS? There may be advantages for those who do not want to be involved in detailed VAT accounting (although if a computerised system is used, it should be checked to see if it can cope with the FRS). However, the FRS has been slow to catch on. In fact, Customs reduced the percentages in January 2004 and introduced a 1% incentive for the first year in which traders converted to the scheme. In practice, experience has shown that few traders have moved to the scheme unless a clear numerical advantage arose. Each trader will need to examine their own records to see whether there is an advantage. An example where there may be an advantage would be a consultant working from home with minimal VATable inputs. Another case may be a pension scheme with let property which has opted to tax and has few VATable inputs (as the sponsoring company bears many of the costs).
