VAT Flat Rate Scheme – are you a limited cost trader?

The VAT Flat Rate Scheme has been designed to simplify the way a business accounts for VAT and in so doing reduce the administration costs of complying with the VAT legislation. The scheme is open to businesses that expect their annual taxable turnover in the next 12 months to be no more than £150,000.

A limited cost trader check was introduced in April 2017 and can increase the VAT flat rate percentage used by VAT registered businesses that use the Flat Rate scheme. If you meet the definition of a 'limited cost trader' you are required to use a fixed rate of 16.5%. The highest 'regular' rate is 14.5%.

A limited cost trader is defined as one whose VAT inclusive expenditure on goods is either:

  • less than 2% of their VAT inclusive turnover in a prescribed accounting period;
  • greater than 2% of their VAT inclusive turnover but less than £1,000 per annum if the prescribed accounting period is one year (if it is not one year, the figure is the relevant proportion of £1,000).

For some businesses – for example, those who purchase no goods, or who make significant purchases of goods – the outcome of the test will be self-evident. Other businesses need to complete a simple test, using information they already hold, to work out whether they need to use the higher 16.5% rate. If so, the use of the flat rate scheme will probably not be beneficial.

VAT – discounts and free gifts

When you issue an invoice to your customer, you must ensure that you charge the correct rate of VAT. Whilst most businesses in the UK charge VAT at the standard rate of 20% there are a number of different VAT rates and exemptions that you should be aware of. 

In the UK, there are three separate VAT rates, the standard rate @ 20%, the reduced rate @ 5% and the zero rate @ 0%.

There are special rules when charging VAT where there are discounts or free gifts. The rules are complex, but we have summarised the main aspects below.

Discounts and free gifts

Offer  

How to charge VAT

Discounts     

Charged on the discounted price (not the full price)

Gifts  

Charged on the gift’s full value. There are some specific exceptions on gifts given to the same person if their total value in a 12-month period is less than £50.

Multi-buys  

Charged on the combined price if all the items have the same VAT rate. If not, VAT is ‘apportioned’ as mixed-rate goods

Money-off coupons, vouchers etc

No VAT due if given away free at time of a purchase. If not, VAT due on the price charged

‘Face value’ vouchers that can be used for more than one type of good or service

‘Face value’ vouchers that can be used for more than one type of good or service No VAT due, if sold at or below their monetary value

Redeemed face value vouchers

Charged on the full value of the transaction

Redeemed face value vouchers sold at a discount

Charged on the discounted value of the transaction

Link-save offers (buy one get one free or discounted)

VAT is apportioned as mixed-rate goods – there are exceptions

Builders – when you may not have to charge VAT

VAT for most work on houses and flats by builders and similar trades, like plumbers, plasterers and carpenters, is charged at the standard rate of 20%. However, there are a number of exceptions where special VAT rules apply and a reduced or zero rate of VAT may apply. 

A builder may not have to charge VAT (zero rate) on some types of work if it meets certain conditions, including:

  • building a new house or flat
  • work for disabled people in their home

A builder may be able to charge the reduced rate of 5% for some types of work if it meets certain conditions, including:

  • installing energy saving products and certain work for people over 60
  • converting a building into a house or flats or from one residential use to another
  • renovating an empty house or flat
  • home improvements to a domestic property on the Isle of Man

There are also special VAT rules for work on certain types of buildings that are not houses or flats, including approved alterations and substantial reconstructions to protected buildings and converting a non-residential building into a house or communal residential building for a housing association. 

In addition, there are certain other types of communal residential building that builders do not have to charge VAT. These include children’s homes, residential care homes, hospices and student accommodation.

In all cases, it is the supplier’s responsibility to charge VAT correctly and to ensure they hold proper evidence to support the fact that a customer is eligible for a supply at the reduced or zero VAT rate.

Reclaiming VAT

For most fully taxable businesses, VAT can be reclaimed on goods and services used in the course and furtherance of their business activities. This means that businesses must consider where there is personal or private use of goods or services bought for the business and can usually only reclaim the business proportion of any VAT charged.

For example, VAT is recoverable on all the costs of mobile phones provided to employees where no personal use is allowed. Where businesses allow private calls to be made at no charge the VAT recovery must be apportioned on a fair and reasonable basis. Where employees pay for the private use of their phones the business is allowed to reclaim the input tax in full provided an output tax charge is accounted for in respect of private use.

You cannot reclaim VAT for:

  • anything that is only for private use;
  • goods and services your business uses to make VAT-exempt supplies;
  • business entertainment costs;
  • goods sold to you under one of the VAT second-hand margin schemes;
  • business assets that are transferred to you as a going concern.

There are different rules for a business that incurs expenditure on taxable and exempt business activities. These businesses are partially exempt for VAT purposes and are required to make an apportionment between their activities using a 'partial exemption method' in order to calculate how much input tax is recoverable.

Definition of VAT partial exemption

A business that incurs expenditure on taxable and exempt business activities is partially exempt for VAT purposes. This means that the business is required to make an apportionment between the activities using a 'partial exemption method' in order to calculate how much input tax is recoverable.

HMRC’s guidance explains that as a VAT-registered business, you can recover the VAT on your purchases which relate to taxable supplies that you make or intend to make. There are some items where input tax recovery is ‘blocked’. Supplies that are made outside the UK that would be taxable if in the UK and certain exempt supplies to non-UK customers also give the right to recover VAT, but there are special rules. In principle, you cannot recover VAT that relates to any exempt supplies, although you may be able to if the VAT is below certain limits.

There are a number of partial exemption methods available. The standard method of recovering any remaining input tax is to apply the ratio of the value of taxable supplies to total supplies, subject to the exclusion of certain items which could prove distortive. The standard method is automatically overridden where it produces a result that differs substantially from one based on the actual use of inputs. It is possible to agree a special method with HMRC. The VAT incurred on exempt supplies can be recovered subject to two parallel de-minimis limits.

Revoking VAT option to tax land and buildings

There are special VAT rules that allow businesses to standard rate the supply of most non-residential and commercial land and buildings (known as the option to tax). This means that subsequent supplies by the person making the option to tax will be subject to VAT at the standard rate.

The ability to convert the treatment of VAT exempt land and buildings to taxable can have many benefits. The main benefit is that the person making the option to tax will be able to recover VAT on costs (subject to the usual rules) associated with the property including the purchase and refurbishment of the property.

However, any subsequent sale or rental of the property will attract VAT. Where the purchaser or tenant is able recover the VAT charged this is not normally an issue. However, where the purchaser / tenant is not VAT registered or not fully taxable (such as bank) the VAT can become an additional (non-recoverable) cost.

Once an option to tax has been made it can only be revoked under limited circumstances so proper consideration of the issue is important. This includes:

  • within a specified 'cooling off' period in the first 6 months,
  • an automatic revocation where no interest has been held for more than 6 years, and
  • after 20 years has elapsed.

Range of supplies affected by VAT reverse charge

The VAT domestic reverse charge accounting mechanism was put in place to help prevent criminal attacks on the UK VAT system by means of sophisticated fraud.

The domestic reverse charge procedure applies to the supply and purchase of the certain specified goods and services.

The specified goods that the reverse charge applies to are:

  • mobile phones 
  • computer chips 
  • wholesale gas 
  • wholesale electricity 

The specified services are:

  • emission allowances 
  • wholesale telecommunications 
  • renewable energy certificates 
  • construction services 

Under the domestic reverse charge rules, it is the responsibility of the customer, rather than the supplier, to account to HMRC for VAT on supplies of the specified goods or services. It should be noted that there are exceptions within each category, and it is important to check carefully if the domestic reverse charge is required on a transaction or not. 

The domestic reverse charge should not be confused with reverse charge for cross-border services which applies to certain services from abroad. 

MTD for VAT – digital records required

The MTD for VAT regime started in April 2019 when businesses with a turnover above the VAT threshold of £85,000 became mandated to keep their records digitally and provide their VAT return information to HMRC using MTD compatible software.

From April 2022, MTD for VAT will be extended to all VAT registered businesses with turnover below the VAT threshold of £85,000. Many businesses with turnover below the VAT threshold have already voluntarily chosen to use MTD for VAT.

If you are using MTD for VAT or will soon begin to do so, here is a reminder of the records you must keep digitally:

  • your business name, address and VAT registration number
  • any VAT accounting schemes you use
  • the VAT on goods and services you supply, for example everything you sell, lease, transfer or hire out (supplies made)
  • the VAT on goods and services you receive, for example everything you buy, lease, rent or hire (supplies received)
  • any adjustments you make to a return
  • the ‘time of supply’ and ‘value of supply’ (value excluding VAT) for everything you buy and sell
  • the rate of VAT charged on goods and services you supply
  • reverse charge transactions – where you record the VAT on both the sale price and the purchase price of goods and services you buy
  • your total daily gross takings if you use a retail scheme
  • items you can reclaim VAT on if you use the Flat Rate Scheme
  • your total sales, and the VAT on those sales, if you trade in gold and use the Gold Accounting Scheme

You also need to keep digital copies of documents that cover multiple transactions made on behalf of your business by:

  • volunteers for charity fundraising
  • a third-party business
  • employees for expenses in petty cash

Option to tax (VAT) land and buildings

There are special VAT rules that allow businesses to standard rate the supply of most non-residential and commercial land and buildings (known as the option to tax). This means that subsequent supplies by the person making the option to tax will be subject to VAT at the standard rate.

The ability to convert the treatment of VAT exempt land and buildings to taxable can have many benefits. The main benefit is that the person making the option to tax will be able to recover VAT on costs (subject to the usual rules) associated with the property including the purchase and refurbishment of the property.

One interesting aspect of the rules concerns what happens if you make changes to a building after you have opted to tax. HMRC’s guidance sets out the following basic principles that apply to the most changes made:

Extensions. If you have opted to tax a building and you extend it at a later date, upwards, downwards or sideways, your option to tax will apply to the whole of the extended building.

Linked buildings. If prior to their completion buildings are linked by an internal access or covered walkway they are treated as a single building and an option to tax will apply to both parts. If a link is created after both buildings are completed, the option to tax will not flow through with the link.

Forming a complex. If you have a group of units that have been treated as separate buildings for the option to tax and you later decide to enclose them so as to form a complex, and which meets the description of what constitutes a building, then the option to tax will not spread to the un-opted units.

Charging charities at lower rates of VAT

There are special rules, under which a VAT-registered business can sell certain goods and services to charities at the zero or reduced rate of VAT. Before charging VAT at a lower rate, you must be able to show evidence that the charity is eligible. This is usually done by obtaining suitable evidence of the charity’s status and a written declaration or ‘certificate’ confirming they meet the conditions for a particular VAT relief.

Charities are legally required to provide an eligibility certificate when you supply qualifying building or construction services to them at zero VAT. A declaration is not required for other supplies but is recommended to prove the charity is eligible for the relief. Completed declarations should be held for at least 4 years.

The reduced VAT rate applies on the sale of fuel and power in certain circumstances to an eligible charity. The zero VAT rate applies on a wider range of supplies including the aforementioned construction supplies and items including certain medical and veterinary equipment, aids for disabled people, advertising and items for collecting donations, drugs and chemicals and equipment for making ‘talking’ books and newspapers.