Andrew Needham looks at retrospectively joining or leaving the VAT flat rate scheme for small businesses.
The flat rate scheme (FRS) is designed primarily as a means of simplifying VAT accounting for small businesses.
However, some businesses can achieve VAT savings from being on the FRS and, in some cases, may want to backdate their applications for membership. Similarly, some businesses find that they are disadvantaged and want to leave retrospectively. What is HMRC’s view on retrospective applications?
Retrospectively joining the FRS
HMRC will allow businesses to retrospectively join the FRS, but only in ‘exceptional’ circumstances.
Most often a business that has not registered for VAT at the correct time and has its VAT registration backdated by HMRC will be allowed to join the FRS with effect from the date of registration. This can often simplify matters by meaning that the business can take advantage of the automatic allowance for input tax built into the system without having to find and list purchase invoices for periods of what can be several years.
In other cases, HMRC will want to see that there are exceptional circumstances before allowing a retrospective application. If a business finds that by joining the FRS it can save, for example, £1,000 per annum and wants to backdate its application to take advantage of the saving, HMRC will almost certainly reject the application. If a business did this, it would need to recalculate and resubmit its VAT returns and HMRC would not see this as simplifying VAT accounting, but rather adding complication.
In some cases, if a business has not submitted returns and applies to backdate the application to cover the missing periods, giving the reason for backdating the application as administrative savings, the backdating will often be allowed on the grounds that the returns do not have to be recalculated as they had not yet been submitted.
Retrospectively leaving the FRS
HMRC take a similar view to retrospectively leaving the FRS as they do to joining it – there must be exceptional circumstances.
However, HMRC have agreed in principle that they will apply proportionality to cases where unexpected amounts of VAT become payable under the scheme and will allow businesses to retrospectively leave.
For example, if a sole proprietor runs a consultancy business but 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 and the exempt rents for the ‘property business’ should be included in the turnover when calculating the flat rate percentage. 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.
The tribunals have considered cases concerning retrospectively leaving the FRS when it has been found that a 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. See B Reynolds v HMRC [2010] ULFTT 40 (TC) and Northern Renovations Ltd v HMRC TC/2011/05795, where the HMRC policy on retrospection was upheld as ‘rational’. The tribunal’s view is 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.
Practical Tip:
If you want to either join or leave the FRS retrospectively, HMRC will let you, but only in exceptional circumstances. Saving or costing VAT is not considered to be an exceptional circumstance unless it causes a situation that is not proportionate.
