The VAT flat rate scheme is a simplification scheme for small businesses, with various fixed rate percentages for different business categories. HMRC reissued Notice 733 in May 2016, replacing the 2013 version, following a number of defeats at the First-tier Tribunal and widespread criticism. In the earlier notice, HMRC made a definitive decision about which businesses it considered belonged to certain categories; but this has now been replaced with its ‘interpretation’ only.
The previous prescriptive approach by HMRC affected in particular two FRS categories: management consultants and civil engineers. The rates for these two categories are 14% and 14.5% respectively, rather than 12% for any other activity that is not listed elsewhere. HMRC’s attempts to extend the boundaries of these higher rates suggest that its underlying purpose was to generate additional revenue rather than to improve business compliance or understanding.
HMRC decided arbitrarily to widen the definition of civil engineers to include mechanical engineers, issuing assessments accordingly. In the case of Idess Ltd [2014] UKFTT 511 (TC), this was overturned when the tribunal decided that there was a distinction between civil and structural engineers who provided services for land and buildings and mechanical engineers who provided services associated with plant and machinery. Although not confirmed, there was a suggestion that HMRC had created a task force to examine the VAT returns of engineers working in the Scottish oil industry using the FRS, to issue backdated VAT assessments if they had used the ‘other activity’ category.
HMRC lost a further tribunal on a similar issue. In SLL Subsea Engineering Ltd [2015] UKFTT 0043 (TC), a business which provided mechanical engineering services to the oil and gas industry was judged by HMRC to be within the civil and structural engineering category, rather than ‘business services not listed elsewhere’. This was despite the fact that the active director was a trained electrical engineer and could join the Institution of Mechanical Engineers after completion of further study.
HMRC also lost the tribunal case of Calibre TAS Ltd (VTD 20508), after arguing unsuccessfully that the business, which provided the services of a forensic employment consultant and expert witness, was a management consultancy.
In all three cases, HMRC inspectors issued an assessment after relying upon their own opinion and interpretation of the categories that are listed in the VAT Regulations, SI 1995/2518, reg 55K. HMRC’s opinion was contained in the 2013 version of Notice 733 para 4.4, with an introductory explanation that the purpose of the paragraph was to provide further guidance for ‘business categories that are the source of common enquiry’. This paragraph did not have the force of law. HMRC has removed this paragraph from the latest version of Notice 733 and acknowledges, after prompting from these tribunals, that the descriptions are written in plain English and that businesses should apply the ordinary, everyday meaning to each description contained in the regulations.
Although the notice has been rewritten, businesses should continue to record why they made the decision to select a particular FRS category, and be prepared to challenge HMRC assessments of additional tax issued to retrospectively amend a previous choice of category. Notice 733 notes that HMRC will not change categories retrospectively if it judges that the original decision was reasonable, although HMRC may have a different interpretation of reasonable.
KDT Management Ltd [2015] UKFTT 690 (TC) established the principle that businesses are able to change an earlier incorrect decision on a business category and, if the correct category is a lower rate, to claim a VAT repayment for the over-declared tax. The business was buying and selling advertising space, yet chose the management consultancy category (currently 14%) when it joined the FRS, rather than advertising (currently 11%). HMRC refused to allow the business to backdate the change but the tribunal ruled that this decision was unreasonable.
If a business discovers that its original choice of category was incorrect, and the correct category is a lower rate, it should submit an error correction to HMRC and seek a refund. It is advisable to submit an error correction even if the over-declared VAT is below the error correction monetary limit of £10,000 for most businesses, as this will provide certainty and prevent future disputes with HMRC.
Home >Articles > Favourable changes to VAT flat rate scheme
Favourable changes to VAT flat rate scheme
The VAT flat rate scheme is a simplification scheme for small businesses, with various fixed rate percentages for different business categories. HMRC reissued Notice 733 in May 2016, replacing the 2013 version, following a number of defeats at the First-tier Tribunal and widespread criticism. In the earlier notice, HMRC made a definitive decision about which businesses it considered belonged to certain categories; but this has now been replaced with its ‘interpretation’ only.
The previous prescriptive approach by HMRC affected in particular two FRS categories: management consultants and civil engineers. The rates for these two categories are 14% and 14.5% respectively, rather than 12% for any other activity that is not listed elsewhere. HMRC’s attempts to extend the boundaries of these higher rates suggest that its underlying purpose was to generate additional revenue rather than to improve business compliance or understanding.
HMRC decided arbitrarily to widen the definition of civil engineers to include mechanical engineers, issuing assessments accordingly. In the case of Idess Ltd [2014] UKFTT 511 (TC), this was overturned when the tribunal decided that there was a distinction between civil and structural engineers who provided services for land and buildings and mechanical engineers who provided services associated with plant and machinery. Although not confirmed, there was a suggestion that HMRC had created a task force to examine the VAT returns of engineers working in the Scottish oil industry using the FRS, to issue backdated VAT assessments if they had used the ‘other activity’ category.
HMRC lost a further tribunal on a similar issue. In SLL Subsea Engineering Ltd [2015] UKFTT 0043 (TC), a business which provided mechanical engineering services to the oil and gas industry was judged by HMRC to be within the civil and structural engineering category, rather than ‘business services not listed elsewhere’. This was despite the fact that the active director was a trained electrical engineer and could join the Institution of Mechanical Engineers after completion of further study.
HMRC also lost the tribunal case of Calibre TAS Ltd (VTD 20508), after arguing unsuccessfully that the business, which provided the services of a forensic employment consultant and expert witness, was a management consultancy.
In all three cases, HMRC inspectors issued an assessment after relying upon their own opinion and interpretation of the categories that are listed in the VAT Regulations, SI 1995/2518, reg 55K. HMRC’s opinion was contained in the 2013 version of Notice 733 para 4.4, with an introductory explanation that the purpose of the paragraph was to provide further guidance for ‘business categories that are the source of common enquiry’. This paragraph did not have the force of law. HMRC has removed this paragraph from the latest version of Notice 733 and acknowledges, after prompting from these tribunals, that the descriptions are written in plain English and that businesses should apply the ordinary, everyday meaning to each description contained in the regulations.
Although the notice has been rewritten, businesses should continue to record why they made the decision to select a particular FRS category, and be prepared to challenge HMRC assessments of additional tax issued to retrospectively amend a previous choice of category. Notice 733 notes that HMRC will not change categories retrospectively if it judges that the original decision was reasonable, although HMRC may have a different interpretation of reasonable.
KDT Management Ltd [2015] UKFTT 690 (TC) established the principle that businesses are able to change an earlier incorrect decision on a business category and, if the correct category is a lower rate, to claim a VAT repayment for the over-declared tax. The business was buying and selling advertising space, yet chose the management consultancy category (currently 14%) when it joined the FRS, rather than advertising (currently 11%). HMRC refused to allow the business to backdate the change but the tribunal ruled that this decision was unreasonable.
If a business discovers that its original choice of category was incorrect, and the correct category is a lower rate, it should submit an error correction to HMRC and seek a refund. It is advisable to submit an error correction even if the over-declared VAT is below the error correction monetary limit of £10,000 for most businesses, as this will provide certainty and prevent future disputes with HMRC.
