The government’s new measures to crackdown on abuse of a scheme to simplify VAT could damage small businesses that remain tax compliant, a leading tax industry body has warned.
According to the Chartered Institute of Taxation (CIOT), the planned HMRC crackdown to tackle abuse of the VAT flat rate system (FRS) needs a major rethink, and the department has significantly underestimated the impact of its intended changes.
At the last Autumn Statement, chancellor Philip Hammond announced new measures to the FRS that would see businesses which fall into a new definition of a “limited cost trader” being required to pay a VAT rate of 16.5 per cent.
However, following recent allegations of widespread abuse of the scheme by some UK employment agencies and other types of business, HMRC intends to tackle the problem by changing the scheme.
It has been claimed some business owners have sought to set themselves up as a “limited cost trader” deliberately to benefit from both the more affordable FRS percentage as well as the NIC Employment Allowance, a tax break which saves businesses engaging in certain types of work as much as £3,000 a year in national insurance contributions.
If the HMRC crackdown goes ahead, business owners using or thinking of joining the FRS scheme will need to determine, probably quarterly, whether they are a limited cost trader and, if they are, will be required to pay the government 16.5 per cent of their earnings, as opposed the potentially lower rate applicable to their sector dictated by the NIC allowance.
Due to its definition, most FRS businesses will need to determine whether they fall into the bracket of being a “limited cost trader” or not, with many at risk of fluctuating in and out of the 16.5 per cent rate.
Chairman at the CIOT, Peter Dylewski, warned of the complexities the government’s planned changes posed for small firms. “Small business owners will need considerable guidance from HMRC,” he said.
“Many will need 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.”
In a report, the CIOT predicted that to avoid being affected by the new 16.5 per cent VAT rate, many more business owners than the 4,000 anticipated by HMRC will choose to switch back to standard VAT accounting, and that the cost of doing this could be much more than the estimated £180 per business.
HMRC has been urged to rethink its position. Dylewski suggested that further investigation into alternative approaches, such as to restrict the FRS to businesses required to be registered for VAT, rather than those eligible, or tighten up the associated business rule, could protect small businesses.
“Targeted action against abuse of the FRS, which is masterminded by a relatively small number of businesses, is preferable to such wholesale changes,” he added.
“HMRC has significantly underestimated the collateral impact of these changes, both in terms of the number of businesses affected and the financial impact.”
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