is a “limited cost trader”?

In an attempt to cut back on aggressive
use of the FRS, the Chancellor announced the introduction of a 16.5% VAT flat
rate for businesses with limited costs.

In practice, many traders that
currently use the FRS actually pay less VAT than if they had used the standard
method (output tax less input tax). Businesses that make the most profit tend
to be those that have very low costs subject to VAT.

For example, a business with an annual
turnover of £100,000 with no costs subject to VAT and registered for the FRS
(using a 14% rate) will be adding £20,000 output tax to their sales invoices
but only paying £16,800 (£120,000 x 14%) to HMRC – a cash profit of £3,200. As
noted above, HMRC see this as aggressive use of FRS.

From 1 April 2017, FRS traders who meet
the following definitions will be considered “limited cost traders” and will be
obliged to use a new 16.5% rate. A limited cost trader will be 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 £1000 per annum if the prescribed accounting period is
one year (if it is not one year, the figure is the relevant proportion of

Goods, for the purposes of this
measure, must be used exclusively for the purpose of the business but exclude
the following items:

capital expenditure

food or drink for consumption by the flat rate business or its employees

vehicles, vehicle parts and fuel (except where the business is one that carries
out transport services ,for example a taxi business – and uses its
own or a leased vehicle to carry out those services)

HMRC explain: These exclusions are part of
the test to prevent traders buying either low value everyday items or one off
purchases in order to inflate their costs beyond 2%.

Extending our example quoted above,
16.5% of £120,000 is £19,800, still a cash profit of £200 from using FRS, but
only if there is no lost VAT input tax on costs or capital purchases…