It is no secret that the 2016 Autumn Statement carried on the ‘noose tightening’ that the contracting sector has felt in recent times. Contractors have long since realised that HMRC was gunning for them and the last couple of years have confirmed that as the May / Hammond double act have made it clear that they are keen on all limited company contractors, self-employed individuals and regular employees being in the same boat when it comes to tax and national insurance. In other words, this government and HMRC are fully intent, it would seem, on removing all perks for contractors working via limited companies over the next few years. They have proven this with the ever-stricter IR35 legislation and a crack down on expenses over the last decade.
First, They Increased National Insurance
Last year they announced an increase in national insurance for contractors. HMRC and the Treasury are trying to decrease the gap between regular salaries and the combination of salary and dividends. Their first move was to raise type 4 national insurance up to 11% from its previous rate of 9%. They also, incidentally, decreased the dividend allowance from £5000 to £2000. And most commentators believe they will keep going further, taking small steps towards that parity between the self-employed and those in regular employment.
Then They Went For VAT
The Autumn Statement of 2016 brought a completely new change by Philip Hammond, a new category of flat rate VAT, which threatened to raise the VAT bill for a regular contractor limited company up to 16.5% (from 14.5%). How does this work? Below we will look at the figures and how they will affect most contractors.
The Limited Cost Contractor
The changes to the VAT system have brought the idea of a new, all-inclusive category – the ‘limited cost trader.’ The definition of a limited cost trader is someone whose (VAT inclusive) expenditure on any goods will be either (a) less than 2% of their (VAT inclusive) turnover or (b) less than £1000 per annum in total.
The problem here though, and what is annoying for anyone who runs a service-oriented business, is that the concept of ‘goods’ does not include capital expenditure (such as the purchase of assets), drink or food, fuel or vehicles. But worst of all, the purchase of services is also excluded. So, even if you run a minor consultancy firm and have no chance of being caught in the IR35 net, you will still be penalised unfairly. Anyone who runs a service based company will know that there are all kinds of significant outgoings. These might include legal fees, accountancy fees, phone and email, website hosting, journal subscriptions and industry memberships and insurances for example. Yet with all of these (and many more) outgoings, it would still not be possible to escape being categorised as the aforementioned ‘limited cost trader.’
So What Happens Next?
From April 2017, as small service limited company owners, service-oriented contractors will have the simple FRS VAT system (Flat Rate Scheme) like other business owners, but they will be required to pay more for that same privilege. This is crazy when you think that approximately 78% of the UK’s GDP comes from service-oriented businesses!
Wow! What Will It End Up Costing Me If I’m A ‘Limited Cost Trader?’
It will be a significant change, that’s for sure. If you have a service business and you charge your clients £350 per day then after the Flat Rate Scheme changes you will end up more than £2000 per annum worse off if you are on the scheme. If your day rate is £150 you would be £864 worse off, if you charge £250 you would be £1440 worse off and so on. Consequently, if you would be classed as a limited cost trader and know that being on the FRS would raise your VAT bill, then you should give some thought to changing to the regular VAT scheme.
FRS or Standard Scheme?
Whilst the FRS will simplify your VAT and you will only pay a percentage of gross turnover, the standard scheme sees you needing to both add the VAT charged to clients as well as deducting the VAT paid on both the goods and services you have paid for. That difference is then owed to HMRC. That might sound overly complicated but with most companies and individuals having access to online accounting apps which can do this in a second, there really is no complication. So it is just as easy to be on the standard scheme as on the FRS.
Ok, So Should I Quit the FRS?
It’s actually quite an easy calculation to decide if you should remain in the Flat Rate Scheme or quit it. Ask yourself one simple question – do you spend in excess of 1% of your yearly turnover on goods and services that are subject to VAT? If you do, then you would likely be better off changing over to the standard VAT scheme.
In reality, it will probably all depend on the kind of business you operate. Should you be the type of contractor who skirts the edges of IR35 and who has very few outgoings except for travel and subsistence then you are exactly the kind of contractor that the Chancellor is after. You will take a big hit on the FRS rate rise and similarly would not be any better off changing to the standard VAT scheme.
However, should you be the type of contractor who operates a service business in the form of a consultancy style company then you will actually probably do better if you change over to the standard VAT option.
How Do I Leave the Flat Rate Scheme?
That part is actually quite simple. All you need to do is talk to your accountant and ask them to write to HMRC on your behalf, requesting the change. That’s it!
Once again, all this seems to be deeply unfair to contractors and the contracting sector has more reason to grumble about their treatment at the hands of Chancellor Hammond. He might have done it all because of what he saw as ‘aggressive abuse of the VAT Flat Rate Scheme’, but in reality, this, like many recent measures seems overly punitive and will likely affect the competitiveness of service businesses, particularly with the timing placing it alongside everything going on with Brexit. Throw in the ever tightening of IR35 and the changes to national insurance and it is becoming clear that contractors should give serious thought to becoming consultants, especially if they don’t wish to continually be the target of HMRC come budget time!