VAT special schemes – can your business benefit?

There are various VAT special schemes that businesses can use to improve cash flow, reduce administration and even reduce the amount of VAT payable. From 1 April 2007 HM Revenue & Customs (HMRC) has increased the size of business that can use one of these schemes, and it is worthwhile reviewing whether you can benefit from any of the schemes available.

The three special schemes that we are looking at here are:

• Cash accounting;
• Annual accounting; and
• The flat rate scheme.

Each scheme has its own rules, advantages and disadvantages. The emphasis in each case is on helping the smaller business, and so the schemes are limited to businesses with turnover below set limits.

There is an online tool to help you identify whether you can use any of the special schemes on the Business Link web site. Start from the home page at www.businesslink.gov.uk and follow the links “Taxes, returns & payroll > VAT > Identify which VAT scheme your business is eligible to use”.

Cash accounting

Under the cash accounting scheme you pay VAT to HMRC only when your customer pays you. This means you have automatic relief for bad debts and late payments. The downside is that you can’t reclaim VAT on purchases until you pay your suppliers. Cash accounting is particularly useful if your customers take longer to pay you than you take to pay your suppliers, and can usually help your cash flow.

With effect from 1 April 2007, you can use this scheme if your annual turnover (excluding VAT) is not more than £1,350,000 and you meet certain conditions. Basically this means having a clean VAT record.

You can continue to use the scheme until your annual turnover (excluding VAT) reaches £1,600,000. You look at this at the end of each VAT quarter (or month, if you are on monthly returns), considering turnover in the past 12 months. If your turnover is over the limit, you have to move onto the normal basis from the next quarter (or month) onwards. You may have outstanding debtors and creditors on the date you leave the scheme. You can account for the VAT on those outstanding balances on a cash basis for six more months, but any VAT still outstanding at the end of the six-month period must be accounted for then.

Some sales and purchases are outside the cash accounting scheme, such as hire purchase and extended credit transactions.

You don’t need to apply to use cash accounting. You can start using it at the beginning of any tax period. If you are already registered for VAT when you start, make sure you do not account for VAT twice on any supplies made or received previously.

You can use cash accounting and annual accounting together. There is also a cash-based version of the flat rate scheme, which can be used as an alternative to cash accounting.

You can find more details about the cash accounting scheme in Notice 731 “Cash accounting”.

Annual accounting

Under the annual accounting scheme you pay VAT in monthly or quarterly instalments during the year, based on an estimate of your total annual VAT bill. At the end of the year you submit a single annual return and pay any balance due.

The benefits of this scheme are:

• you spread your payments throughout the year, so you don’t have big VAT bills to pay when cash flow is tight;
• you know how much your instalments are from the start, making budgeting and cash flow planning easier;
• you only have to fill in one return a year instead of the usual four;
• you have two months, instead of just one, to complete and send in your annual VAT return and balancing payment; and
• you can choose a VAT return year end to suit your business.

This scheme won’t be suitable if you usually get repayments of VAT, as annual accounting means you will have to wait a whole year for your money.

The turnover limits for annual accounting went up on 1 April 2006. Since then you have been able to use annual accounting if your annual turnover (excluding VAT) is not expected to exceed £1,350,000. You have to go back to quarterly VAT returns if your annual turnover (excluding VAT) reaches £1,600,000.

You can find more details about the annual accounting scheme in Notice 732 “Annual accounting”.

You have to apply to HMRC to use the annual accounting scheme using form VAT 600 AA, which is available from the HMRC web site at www.hmrc.gov.uk.

You can use the annual accounting scheme together with the cash accounting, flat rate or retail schemes.

The flat rate scheme

The flat rate scheme lets you calculate your VAT payment as a flat rate percentage of your turnover. There is a list of percentages according to the trade sector you operate in. With certain exceptions, you will not be able to reclaim any of the VAT you pay on purchases or expenses, as this is taken into consideration as part of the percentage calculation. The exceptions are for capital items costing £2,000 or more (say, for example, a new delivery van) and for stock and assets you have on hand when you register for VAT.

The main benefit of this scheme comes from saving time accounting for VAT, because you don’t have to record the VAT charged on each individual purchase and sale. However, you may also find that the amount of VAT you pay is reduced, depending on whether your business is “typical” for its sector. In comparing the rate of VAT you pay with the list of flat rate percentages, remember that the flat rates are applied to gross, VAT-inclusive turnover. By comparison, at the standard VAT rate of 17.5% the percentage of gross turnover that consists of VAT is 17.5/117.5, or about 14.9%.

To help new businesses, a 1% reduction in the flat rate applies for the first year of VAT registration. For example, if your business belongs to a sector that has a flat rate of 10%, you should apply a flat rate of 9% for the first year. Note that this applies for the first year of registration, not for the first year of using the flat rate scheme if you are already registered.

You are eligible for the flat rate scheme if you meet both the following conditions:

• your annual turnover (excluding VAT) will be £150,000 or less; and
• your annual total turnover (including VAT) will be £187,500 or less.

For the second test above, ‘total turnover’ is the value (including VAT) of all your business’s income, including any VAT-exempt and “non-business” income such as educational and charitable income. Non-business income is only included for deciding whether you can join the scheme. You don’t need to include it in working out how much VAT you need to pay once using the scheme.

There is a “Ready Reckoner” on the HMRC web site that will give you a rough idea of whether you are better or worse off using the flat rate scheme. It will also give you some help in choosing your trade sector.

You need to apply in advance to use the flat rate scheme, using form VAT 600 FRS, which you can download from the HMRC web site.

As noted above, you can use the flat rate scheme together with the annual accounting scheme. There are also retail and cash-based versions of the flat rate scheme.

You can find more details about the flat rate scheme in Notice 733 “Flat Rate scheme for small businesses”.

For help with any of these schemes, please either consult your usual Garbutt & Elliott contact or speak to tax director Adrian Widdowson.