The CIOT has voiced concern that new government measures to target abuse of a VAT simplification scheme may have “unwelcome consequences” for small businesses.
The institute agreed that abuse of the FRS scheme must be tackled, but urged HMRC to investigate alternative approaches “to avoid excessive collateral damage to compliant small traders”.
Under the VAT flat rate scheme (FRS), businesses with turnover of £150,000 or less pay to HMRC a fixed percentage of VAT inclusive turnover, and keep the difference between the VAT charged to customers and the amount paid to HMRC. The difference is intended to “compensate for the lack of entitlement to VAT recovery on normal expenditure,” said CIOT.
Changes entering into force on April 1 this year will require FRS businesses to determine if they meet the definition of a limited cost trader (LCT). Businesses may define as an LCT for one accounting period, but not be classified as such for the next period.
A business will fall under the definition of an LCT if their VAT inclusive expenditure is either:
- less than 2% of their VAT inclusive turnover in a prescribed accounting period; or
- 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).
Businesses that meet the LCT definition will be subject to a higher 16.5% rate. Under this measure, HMRC aims to curb abuse of the FRS scheme by employment agencies and businesses that set up two-employee companies to benefit from the scheme.
HMRC has estimated that 4,000 businesses will move back into standard VAT accounting as a result of the changes. The CIOT said that it believed that the figure would be much higher. It also said that the HMRC’s estimate of £180 costs would be “significantly higher”.
The institute also warned of the administrative burden that would come with the need for businesses to check their position each VAT accounting period – typically on a quarterly basis. This would involve recording of transactions, “thus negating some of the simplification elements of the FRS”.
Chairman of the CIOT Indirect Taxes Sub-committee Peter Dylewski 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.
“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 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,” Dylewski added.
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