The move follows Chancellor Philip Hammond’s announcement 

The VAT Flat Rate Scheme (FRS) is a simplified accounting scheme for small businesses. Currently businesses determine which flat rate percentage to use by reference to their trade sector.

From 1 April 2017, FRS businesses must also determine whether they meet the definition of a limited cost trader, which will be included in new legislation.

HMRC’s guidance says 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; or greater than 2% of their VAT inclusive turnover but less than £1,000 per annum if the prescribed accounting period is one year (if it is not one year, the figure is the relevant proportion of £1,000).

Goods must be used exclusively for the purpose of the business but exclude capital expenditure, food or drink for consumption by the flat rate business or its employees, and 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 says 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%.

Anti-forestalling legislation was published on 23 November 2016 and is designed to prevent any business defined as a limited cost trader from continuing to use a lower flat rate beyond 1 April 2017.

This will affect a business that supplies a service on or after 1 April 2017 but either issues an invoice or receives a payment for that supply before 1 April 2017. When considering the limited cost trader definition, any such supply must be treated, for VAT purposes, as taking place on 1 April 2017. Any invoice or payment that covers continuous supplies of services that cross this date must be apportioned.

HMRC says draft secondary legislation will be published on 5 December 2016 and there will then be an eight-week consultation period. Its analysis suggests there will be a £195m increase in the tax take in 2017-18, dropping to a £115m uplift by 2021-22.

Treasury analysis suggests there will be a £195m increase in the tax take in 2017-18, dropping to a £115m uplift by 2021-22.

The Association of Taxation Technicians (ATT) is concerned that the planned changes to FRS will introduce complexity for small businesses.

Michael Steed, co-chair of ATT’s technical steering group, said: ‘While we wholeheartedly support action against aggressive abusers, we are mystified as to what mischief this is intended to correct. The FRS is a workaday scheme that allows for some simplification of the VAT rules and has been around for a long time. Taxpayers and their agents select the closest trade sector to the business. This can be difficult given the limited range of flat rates that the VAT regulations provide.

‘The introduction of a definition of what constitutes a “limited cost trader” will inevitably complicate the FRS. How for example will it deal with the situation where a trader’s cost base changes significantly between years?

‘We look forward to the consultation in which we hope HMRC will fully justify why after many years it wishes to complicate a very straightforward and practical scheme.’

There are concerns that the new measures will capture people who are legitimately using the system, which the Treasury says is being abused by some micro businesses.

Ian Carpenter, VAT partner at RSM warned: ‘Unfortunately, the provisions will seemingly impact not only abusive arrangements but also a broad range of legitimate businesses which currently benefit from it.

‘This is bad news for many small businesses. Not only will this affect those who set out to abusively exploit the scheme but its broad-brush definitions will impact any business which falls foul of the tests. This seems to run counter to the small business facilitation spirit of the scheme.

‘The provisions will come in from 1 April 2017. Potentially affected businesses will want to assess the financial impact and consider the extent that remaining in the Scheme is likely to offer a continuing benefit.’