Limited Cost Trader Test: Impact on Flat Rate VAT

If you’re a small business owner in the UK, you’re likely familiar with the Flat Rate VAT scheme, designed to simplify VAT accounting for small businesses by allowing them to pay a fixed rate of VAT on their sales. However, nuances, including the Limited Cost Trader Test, require attention. For those navigating VAT for the first time or needing a refresher, our comprehensive VAT returns service offers guidance and support to ensure compliance and optimisation of your tax obligations.

The Limited Cost Trader Test, a critical aspect of the Flat Rate VAT scheme, impacts businesses with minimal spend on goods. If your expenditure on goods is less than 2% of your VAT-inclusive turnover or under £1,000 annually, you’re deemed a Limited Cost Trader. This classification necessitates a higher flat rate of 16.5%, as opposed to your sector-specific rate.

This adjustment can significantly affect businesses in sectors like printing, where a standard lower rate would otherwise apply. Understanding the Limited Cost Trader Test is crucial for managing your VAT liability effectively. For businesses seeking tailored financial advice, our Limited company accountants provide sector-specific guidance to navigate these regulations.

Understanding the Flat Rate VAT Scheme

In the UK, VAT is a tax charged on most goods and services. The standard VAT rate is 20%, with certain items eligible for reduced rates or exemptions. Our Small business accountants specialise in guiding small businesses through the VAT landscape, ensuring you pay the correct rate for your products and services.

Basics of VAT

VAT registration requires you to charge VAT on sales and reclaim VAT on purchases. This includes charging VAT to non-VAT registered customers, adding a layer of responsibility to your pricing and accounting practices.

Key Features of the Flat Rate Scheme

The Flat Rate Scheme simplifies VAT calculations by applying a fixed percentage to your gross turnover, a method that often results in a lower overall VAT payment. Eligibility is based on an annual turnover of £150,000 or less, excluding VAT. Our services extend to assisting businesses in determining eligibility and maximising the benefits of the scheme.

Eligibility for Flat Rate VAT

To be eligible for the Flat Rate Scheme, your business must have a turnover of £150,000 or less (excluding VAT) per year. You must also be VAT registered, or have applied to register for VAT. If you are eligible for the scheme, you can choose to join it at any time.

When you join the Flat Rate Scheme, you will be given a percentage to apply to your gross turnover to calculate your VAT liability. This percentage is usually lower than the standard rate of VAT, but it varies depending on your business sector. You must apply this percentage to your gross turnover, including VAT, and pay the resulting amount to HM Revenue and Customs (HMRC) each quarter.

Defining Limited Cost Trader

As a VAT-registered business, it’s essential to understand the implications of being classified as a limited cost trader. This classification, based on the minimal expenditure on goods, leads to a higher VAT rate of 16.5%. For an in-depth explanation of allowable and non-allowable goods for this calculation, refer to our extensive guide on expenses for limited companies and directors, which can help you navigate these restrictions and potentially avoid the limited cost trader classification.

Criteria for Limited Cost Trader

A limited cost trader is a business that spends less than 2% of its VAT inclusive turnover, or less than £1,000 per year, on goods (not services) for its business. If your business meets this criteria, you must use the limited cost trader rate for your VAT returns.

Goods that are excluded from the limited cost trader calculation include:

• Capital expenditure
• Food and drink for you or your staff
• Vehicles, vehicle parts, and fuel (except for transport services)
• Rent, internet, and phone bills
• Printing and advertising costs
• Training costs

Impact on Business Accounting

The limited cost trader test can have a significant impact on your business accounting. If your business is classified as a limited cost trader, you will have to use a higher flat rate of 16.5% instead of the rate that applies to your sector. This can result in a higher VAT bill for your business.

To avoid being classified as a limited cost trader, you should consider increasing your purchases of goods for your business. This can help you meet the 2% of turnover or £1,000 per year threshold and allow you to use the lower flat rate for your sector.

It is important to keep accurate records of your purchases and turnover to ensure that you are meeting the criteria for the Flat Rate Scheme and the limited cost trader test. You should also consult with a qualified accountant or tax advisor to ensure that you are meeting your VAT obligations and taking advantage of any available tax breaks.

Calculating the 16.5% Rate

If your business is a limited cost trader, you must use a higher flat rate of 16.5% instead of the rate that applies to your sector. To calculate the VAT you need to pay, you will need to determine the applicable goods and calculate your VAT inclusive turnover.

Determining Applicable Goods

Firstly, you need to determine if your business falls under the category of a limited cost trader. A limited cost trader is a business that spends less than 2% of its VAT inclusive turnover, or less than £1,000 per year, on goods (not services) for its business. If your business falls under this category, you will need to use the 16.5% rate.

To determine if your business falls under this category, you need to calculate the cost of the goods you have purchased in the relevant VAT period. Remember that not all goods are applicable. Goods that are not applicable include:

• Capital expenditure goods, such as computers or office furniture
• Food and drink for you or your staff
• Vehicles or parts for vehicles, unless you run a vehicle hiring business
• Goods you intend to resell or hire out unless selling or hiring is your main business activity

Calculating VAT Inclusive Turnover

Once you have determined the applicable goods, you need to calculate your VAT inclusive turnover. This is the total amount of money you have invoiced your customers, including VAT, in the relevant VAT period.

To calculate your VAT inclusive turnover, you can use the following formula:

VAT inclusive turnover = (VAT exclusive turnover x VAT rate) + VAT

For example, if you have invoiced your customers for £10,000, excluding VAT, and the VAT rate is 20%, your VAT inclusive turnover would be:

VAT inclusive turnover = (£10,000 x 0.20) + £10,000 = £12,000

Once you have determined your applicable goods and calculated your VAT inclusive turnover, you can use the 16.5% rate to calculate the VAT you need to pay.

Implications for Different Business Types

Service-Based Companies

If you run a service-based business, you may be affected by the Limited Cost Trader Test if you spend less than 2% of your VAT inclusive turnover or less than £1,000 per year on goods for your business. This means that you may have to use a higher flat rate of 16.5% instead of the rate that applies to your sector.

However, service-based companies are less likely to be affected by the Limited Cost Trader Test as they tend to spend more on services than goods. This means that they are more likely to meet the criteria for the standard flat rate VAT.

Trade Sector Variations

Different trade sectors may be affected differently by the Limited Cost Trader Test. For example, the printing industry is expected to have quite a lot of ‘applicable goods’, such as ink or paper for printing. This means that most printers would have a cost of goods that is more than 2% of their turnover, and they would not be affected by the Limited Cost Trader Test.

On the other hand, businesses that do not have many applicable goods, such as consultancy or marketing services, may be more likely to be affected by the Limited Cost Trader Test. They may have to use the higher flat rate of 16.5% instead of the rate that applies to their sector.

Small Business Considerations

Small businesses may be particularly affected by the Limited Cost Trader Test, as they may have lower annual costs and may therefore spend less than 2% of their VAT inclusive turnover on goods for their business. This means that they may have to use the higher flat rate of 16.5% instead of the rate that applies to their sector.

However, small businesses may also benefit from the Flat Rate Scheme, as it simplifies their records of sales and purchases. It allows them to apply a fixed flat rate percentage to their gross turnover to arrive at the VAT due to HMRC.

It’s important to note that the Limited Cost Trader Test is not intended to penalise small businesses. Rather, it is designed to ensure that businesses that have low costs and spend little on goods are not able to benefit from the Flat Rate Scheme in the same way as businesses that have higher costs.

Expenses and Purchases

Under the Flat Rate VAT scheme, most purchases do not allow for VAT reclaim, except for certain capital expenditures over £2,000. Our guide to bookkeeping services offers insights into effectively managing these and other business expenses, ensuring compliance and optimising your financial strategy.

Allowable Expenses

Allowable expenses are expenses that you can claim back VAT on, even when you are registered under the Flat Rate VAT scheme. These expenses include:

• Rent, rates, power and water
• Phone bills and internet costs
• Accountancy fees
• Advertising and marketing costs
• Bank charges and interest
• Insurance
• Postage and stationery

Capital Expenditure

Capital expenditure refers to the purchase of assets that will be used in your business for more than one year. Examples of capital expenditure include:

• Computer equipment
• Furniture and fittings
• Vehicles
• Machinery

You can claim back VAT on capital expenditure that costs £2,000 or more, including VAT. However, if you purchase an asset that costs less than £2,000, you cannot claim back the VAT.

Significant Purchases of Goods

If you make a significant purchase of goods, you may be able to claim back VAT on that purchase. A significant purchase of goods is a purchase of goods that costs more than £2,000, including VAT. To claim back the VAT, you must have a valid VAT invoice that shows the amount of VAT that you paid.

It is important to note that if you make a significant purchase of goods, it will affect the amount of VAT that you pay under the Flat Rate VAT scheme. If the purchase of goods is less than 2% of your total turnover in a VAT period, you will have to use the limited cost trader rate of 16.5%.

Accounting Period and VAT Returns

Managing VAT involves understanding your accounting period and meeting VAT return deadlines. Accurate record-keeping is crucial for compliance and for making informed decisions about your business finances. For assistance with accounting and ensuring accurate VAT submissions, our tax returns service can provide the expertise you need.

VAT Periods

VAT periods are the intervals in which you submit your VAT returns. The standard VAT period is usually three months, but you can apply to HMRC to have a different period if you need to. It is important to keep track of your VAT periods, as this will affect when you need to submit your returns and when you need to pay any VAT due.

Prescribed Accounting Period

The prescribed accounting period is the period for which you need to keep records for VAT purposes. This is usually the same as your VAT period, but it can be different if you have applied to HMRC for a different period. You need to keep records of all your sales and purchases during this period, as well as any other relevant information such as invoices and receipts.

Record-Keeping Requirements

As a limited cost trader, you need to keep records of your purchases to determine whether you meet the 2% threshold. You must also keep records of your sales and any other relevant information for VAT purposes. It is important to keep these records up to date and accurate, as this will make it easier to complete your VAT returns and ensure that you pay the correct amount of VAT.

Accountancy Fees

If you need help with your accounting and VAT returns, you may need to pay for the services of an accountant. The fees for these services can vary depending on the complexity of your business and the amount of work involved. It is important to shop around and compare prices to find an accountant who can provide the services you need at a reasonable price.

Compliance and HMRC Interaction

Navigating the complexities of VAT compliance and HMRC interactions is a critical aspect of managing your business. For specialised accounting advice, particularly for contractors facing unique VAT challenges, our Contractor accountants are here to help.

Contacting VAT Helpline

If you have any questions or concerns about the Limited Cost Trader Test or the Flat Rate VAT scheme, you can contact the VAT Helpline. They will be able to provide you with guidance and support on any issues you may be facing.

You can contact the VAT Helpline by phone on 0300 200 3700, or by using the online contact form on the HMRC website.

Deregistration Process

If you are no longer eligible for the Flat Rate VAT scheme, you will need to deregister. This can be done by logging into your HMRC online account and following the steps provided.

It is important to note that if you deregister from the Flat Rate VAT scheme, you will no longer be able to benefit from the reduced VAT rate. You will also need to ensure that you are complying with all other VAT regulations.

HMRC’s Role and Guidance

HMRC is responsible for ensuring that businesses are complying with the regulations set out in the Flat Rate VAT scheme. They provide guidance and support to businesses to help them understand their obligations and ensure that they are not in breach of the regulations.

It is important to keep up to date with any guidance or changes to the regulations that HMRC may issue. This will help you to ensure that you are complying with the regulations and avoid any penalties or fines.

Transitioning from Standard Rate VAT

If you are currently registered for Standard Rate VAT, you may be considering switching to the Flat Rate Scheme. This could be a great option for you if your business has a low cost base and you do not claim back much VAT on your purchases.

Switching to Flat Rate Scheme

Switching to the Flat Rate Scheme is a straightforward process. You need to inform HMRC that you want to join the scheme, and they will confirm your eligibility. Once you are registered, you will need to start charging VAT at the relevant flat rate percentage on your sales.

Comparing Standard Rate and Flat Rate

One of the main differences between Standard Rate and Flat Rate VAT schemes is the way in which VAT is calculated. With Standard Rate VAT, you calculate the amount of VAT you owe based on the difference between the VAT you charge your customers and the VAT you pay on your purchases. With the Flat Rate Scheme, you pay a fixed percentage of your gross turnover as VAT.

While the Flat Rate Scheme can simplify your VAT accounting, it may not be the best option for all businesses. If you have a high cost base and claim back a lot of VAT on your purchases, you may find that you are worse off under the Flat Rate Scheme.

It is important to carefully consider the pros and cons of each scheme before making a decision. You may want to seek advice from a professional accountant to help you make an informed choice.

Advanced Topics and Further Questions

Q&A for Complex Scenarios

If you have a complex business structure and want to know how the Limited Cost Trader Test will affect your Flat Rate VAT, you may have some questions. Here are some answers to common questions:

• Q: I have multiple business activities, some of which are not eligible for the Flat Rate Scheme. How will the Limited Cost Trader Test apply to my business? A: If you have multiple business activities, you will need to identify the activity that generates the most turnover and apply the relevant sector rate. If you are a Limited Cost Trader, you will need to apply the 16.5% rate to this activity.
• Q: I have a business that sells goods and services. How do I calculate the Limited Cost Trader Test? A: If you sell both goods and services, you will need to identify the VAT inclusive turnover for each category separately. You will then need to apply the 16.5% rate to the category that falls under the Limited Cost Trader Test.
• Q: I have a seasonal business. How will the Limited Cost Trader Test affect my VAT returns? A: If you have a seasonal business, you will need to calculate the Limited Cost Trader Test based on the relevant VAT period. If you are a Limited Cost Trader, you will need to apply the 16.5% rate to your sector for that period.

Seeking Professional Advice

If you have a complex business structure or are unsure about how the Limited Cost Trader Test will affect your Flat Rate Scheme, it may be worth seeking professional advice. An accounting expert can help you navigate the complexities of the scheme and ensure that you are paying the correct amount of VAT.

Online accounting software can also be a useful tool for managing your VAT returns. Many software providers have built-in calculators that can help you determine the correct VAT rate for your business. However, it is important to note that these tools are not a substitute for professional advice and should only be used as a guide.