Andrew Needham looks at the problems encountered by sole proprietors who also own buy-to-let properties - and ways to avoid them.
The flat rate scheme (FRS) is designed as an administrative simplification for businesses with a turnover of less than £150,000 per annum. Depending on the business sector, the business applies a fixed VAT percentage to all of its turnover and pays this to HMRC. The FRS can be useful for some businesses, but it does have some problems to watch out for.
The rules for the FRS can be complicated, so businesses need to be aware of them when joining and leaving the scheme to make sure they maximise the benefits and don’t fall into any traps!
What is included in turnover?
When calculating the amount due to HMRC under the FRS, all of the business’s income has to be included in the turnover to which the flat rate scheme percentage applies. This includes zero-rated, lower rated and exempt income, not just standard rated taxable income. The only income that can be left out is non-business income such as bank interest or outside the scope income such as supplies of services to customers outside the UK.
Buy-to-let income
Let’s take the example of a sole proprietor running a consultancy business, but who also owns a buy-to-let property. He may consider the two businesses to be separate. However, HMRC will consider it to be one business as all a sole proprietor’s business activities are covered by the one VAT registration and the exempt rents for the ‘property business’ should be included in the turnover when calculating the flat rate percentage. This could result in a nasty bill plus penalties and interest.
Ways around the problem
The simplest way around this problem is for the two separate business activities to be run in different legal entities. For example, he could form a limited company to run his consultancy business through or, if he was married, run the buy to let business through a partnership with his wife.
Alternatively, he could ask HMRC to retrospectively leave the FRS. Tribunals have considered whether a business can retrospectively leave the FRS when it has been found that the business is paying more VAT than under ‘normal’ accounting but, although sympathetic to the taxpayer, has not allowed the business to leave the scheme retrospectively. HMRC policy not to normally allow retrospection was upheld as ‘rational’. The tribunals’ view was that the FRS offers simplified VAT accounting and if it costs a bit more this should have been considered by the business before applying to use the scheme.
However, HMRC have agreed in principle that they will apply proportionality to cases where unexpected amounts of VAT become payable under the FRS, and will allow businesses to retrospectively leave the scheme. If this came to light on a VAT inspection HMRC would probably allow a retrospective application as it would not be ‘proportionate’ to collect VAT on the rentals when the business genuinely did not realise that it had to be included in the flat rate turnover.
Practical Tip:
If you are on the FRS and operate buy-to-let properties as well, make sure they are run through a different legal entity. If it is too late to do this and you have been doing this for some time through the same legal entity then you should apply to retrospectively leave the FRS, but it will be at HMRC’s discretion if they allow it.
