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Is Making Tax Digital and the VAT Flat Rate Scheme Still Beneficial for Small Businesses?
19 July 2023
With the recent extension of Making Tax Digital (MTD) to all VAT registered businesses – requiring digital records to be kept – small business owners now face the decision of whether to continue utilising the VAT Flat Rate Scheme (FRS).
UNDERSTANDING MAKING TAX DIGITAL
In a nutshell, Making Tax Digital for VAT came into play on 1st April 2019, requiring VAT registered businesses above the current turnover threshold of £85k, to do away with manual recording systems to submit VAT data to HMRC.
Instead, returns are to be submitted digitally.
Since April 2022, VAT-registered businesses with a taxable turnover below the £85K also went digital. Self-employed businesses and landlords with annual business or property income above £50,000 will be required to submit digital quarterly information to HMRC from April 2026. Those with an income between £30,000 and £50,000 will be required to do this from April 2027.
For businesses, the aim of MTD is to simplify ‘getting tax right’. Whilst that sounds ideal, in reality, there’ll be a lot of learnings and new procedures to follow as HMRC progresses its Making Tax Digital roadmap.
For more information on Making Tax Digital, visit the .gov website.
Useful Tip: Check if you can sign up for Making Tax Digital for Income Tax using this helpful tool.
WHAT’S THE VAT FLAT RATE SCHEME?
Simply put, VAT FRS is an alternative option for small businesses to calculate their VAT liability. Instead of accounting for VAT on each individual sale and purchase, you can apply a fixed flat rate percentage to your total VAT-inclusive turnover.
The intention of the FRS is to ease the admin burden of record keeping, saving time and resource, whilst allowing small businesses to pay less VAT in some circumstances.
SHOULD SMALL BUSINESSES CONTINUE USING THE VAT FLAT RATE SCHEME?
If you’re small business with straightforward VAT, the FRS can be cost-effective.
The percentages paid range from 4% for businesses retailing food, newspapers, or children’s clothing to 14.5% for IT consultants and labour only builders, unless the “limited cost trader” rules apply.
There is also a 1% reduction in the first year of business as an incentive to use the scheme.
However, we now need to evaluate if the retained percentage justifies the costs associated with MTD compliance…
Simplicity vs. Digital Compliance
The key advantage of the FRS is its simplicity, allowing eligible businesses to calculate VAT based on a fixed percentage.
However, with the introduction of MTD, the flat rate percentage is no longer sufficient for submitting VAT returns digitally. Details of the VAT rate must be applied to each transaction, along with gross and net amounts.
Changes in procedures and new software may deter some owners from continuing with the VAT FRS due to the increased risk of making errors.
The Amount of VAT Payable
If you’re dealing with zero-rated or exempt supplies, or regularly receiving VAT repayments under standard VAT accounting methods, the FRS may not be the best option for your business.
One of the limitations of the VAT FRS is that businesses using this scheme are unable to reclaim VAT on purchases, except for certain capital assets over £2,000.
Standard VAT accounting methods are likely to provide a more accurate representation of your VAT position, making them a better choice under MTD.
Find out more about the VAT Flat Rate Scheme here.
HELPING YOU MAKE THE RIGHT CHOICE
Ultimately the choice may vary from one business to another.
Whilst the VAT Flat Rate Scheme can offer you simplicity and potential cost benefits, if you’re classed as a “limited cost trader” or if you’re seeing the MTD compliance requirements start to outweigh the benefit of FRS, then standard VAT accounting may be the better route for you.
We’re here to help support you with this decision and guide you through your MTD requirements.
Contact us today for more information on the VAT Flat Rate Scheme and your business.