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VAT Flat Rate Scheme
Businesses who use the VAT flat-rate scheme (FRS) can't reclaim VAT on most purchases, but they can keep a small slice of the VAT they charge to customers.
If the business has limited input costs, the VAT retained will more than compensate for the input VAT they can't reclaim.
From 1 April 2017, such limited cost traders who use the FRS will need to perform a few more steps before completing each VAT return.
Step 1: Work out what has been spent on goods, as opposed to services. Goods are generally anything physical, but supplies of electricity, gas and water are treated as goods. Publications received in paper form are goods, but electronic publications are services. Professional advice and subscriptions are services.
Step 2: Remove from the list of goods any capital items; expenditure on food or drink consumed by the owner or employees; and motor fuel and parts. Taxi businesses can include motoring expenses.
Step 3: Compare the allowable expenditure on goods with the total sales including VAT for the quarter. If the value of this expenditure amounts to 2% or more of sales and is at least £250, complete the VAT return using the FRS percentage for the trade sector normally used.
Step 4: Where the value of the allowable expenditure on goods is less than 2% of turnover, you must use an FRS percentage of 16.5%. This means the financial benefit of using the FRS is effectively removed.
You may want to opt out of using the FRS from 1 April 2017 and use normal VAT accounting instead. If your sales for the next twelve months are expected to be less than the deregistration threshold (currently £81,000), you may also consider deregistering from VAT.