The Flat Rate VAT Scheme (FRS) is a popular choice for small businesses as it helps to simplify VAT reporting.
However, if your business spends a minimal amount on goods, you might fall under the Limited Cost Trader category, which affects the VAT rate you pay.
Let’s dive into what it means to be a Limited Cost Trader and how it impacts your VAT responsibilities.
Psst! What to know exactly how to operate the flat rate scheme all the way to submitting VAT? Read this guide.
Don’t have time? Here’s the wrap-up of this article in less time it takes to eat a taco 🌮
▪ Limited Cost Trader is a business spending less than 2% of VAT-inclusive turnover or under £1,000 a year on goods.
▪ The VAT Rate for a Limited Cost Traders pay a higher flat rate of 16.5% (compared to other sectors in the flat rate scheme).
▪ ‘What’s Included?‘ Only goods used exclusively for the business count, but not services, capital expenditure, or items like food, fuel, and devices.
▪ Remember the Flat Rate VAT Scheme is designed for simplicity, but Limited Cost Traders may end up paying more VAT compared to normal VAT accounting.
▪ Operating under FRS means that special rules apply to the completion of VAT returns, specifically for boxes 1, 4, 6, and 7 (see step 10)
▪ n.b. Stay Sharp, Stay Savvy and Keep Winning.
Skip right to…
- Limited Cost Trader! Tell me more, Tell me more…
- 1- What Is a Limited Cost Trader?
- 2- Calculating Your VAT Liability as a Limited Cost Trader
- 3- What Counts as ‘Goods’ for Limited Cost Traders?
- 4- How Do You Determine Your Flat Rate Turnover?
- 5- Record Keeping as a Limited Cost Trader
- 6- Special Cases: Bartering and Non-Cash Payments
- 7- Limited Cost Trader and the 1% Discount
- 8- Is the Flat Rate Scheme Right for You as a Limited Cost Trader?
- Conclusion
Limited Cost Trader! Tell me more, Tell me more…
1- What Is a Limited Cost Trader?
Introduced in 2017, a Limited Cost Trader is a business that spends a small proportion of its VAT-inclusive turnover on goods. If your business meets one of the following two criteria, it will be classified as a Limited Cost Trader:
▪ You spend less than 2% of your VAT-inclusive turnover on goods.
▪ You spend less than £1,000 annually on goods, even if that figure represents more than 2% of your turnover.
This classification affects your VAT rate under the Flat Rate Scheme, increasing the percentage you must apply to your gross turnover.
Specifically, Limited Cost Traders must pay a flat rate of 16.5%, regardless of their industry sector.
2- Calculating Your VAT Liability as a Limited Cost Trader
For businesses classified as Limited Cost Traders, the flat rate of 16.5% is applied to their VAT-inclusive turnover. This rate is higher than most sectors within the standard Flat Rate Scheme to account for the minimal input VAT that Limited Cost Traders would typically reclaim.
For example, if your VAT-inclusive turnover for the period is £100,000, you will multiply this figure by 16.5% to calculate your VAT liability. In this case, the VAT due to HMRC would be £16,500.
3- What Counts as ‘Goods’ for Limited Cost Traders?
The classification hinges on how much you spend on relevant goods for your business. However, it’s crucial to note that not everything you buy qualifies as relevant goods under HMRC’s rules.
For example, a consultancy business spending less than £1,000 annually on office supplies, fuel, or materials will likely be classified as a limited cost trader. Certain expenses—like fuel, food for employees, or capital purchases—are not considered ‘relevant goods’ for determining whether you’re a limited cost trader.
| Regarded as Relevant Goods | Not Regarded as Relevant Goods |
|---|---|
| Stationery and office supplies used exclusively for the business. | Services like accountancy fees, even though they may be essential for running your business. |
| Gas and electricity for business | Leased items for the business |
| Stock or inventory for businesses involved in retail. | Food and drink for staff or personal consumption. |
| Computer software provided on physical media (such as a disk) or other necessary items used solely for business. | Capital expenditure items, such as computers, furniture, or any electronic devices. |
| Hair products for a salon | Rent and utilities, such as electricity for both home and business use. |
| Fuel used for a business-owned vehicle, but only if your business operates in the transport sector. | Vehicles and fuel not used in the transport sector. |
4- How Do You Determine Your Flat Rate Turnover?
To accurately calculate your VAT liability, you need to determine your flat rate turnover, which is the total VAT-inclusive value of your supplies during the accounting period. HMRC provides three methods for this calculation, but the most common methods for Limited Cost Traders are:
1- The Basic Turnover Method: This method calculates turnover based on the value of supplies with a VAT ‘tax point’ in the accounting period.
2- The Cash-Based Turnover Method: This method calculates turnover based on the payments received during the accounting period.
If you’re unsure which method applies to your business, it’s advisable to consult with your accountant or VAT specialist to avoid any complications or errors.
5- Record Keeping as a Limited Cost Trader
Accurate and diligent record-keeping is essential for Limited Cost Traders, as HMRC may require proof that your business is operating within the scheme’s rules. Here are the key records you should maintain:
▪ VAT Account: Keep a record of your flat rate calculation within the VAT account. Ensure that you’re tracking both turnover and the VAT amount calculated under the flat rate scheme.
▪ Invoices and Receipts: Ensure all VAT invoices show the correct standard VAT rate (20% for most goods and services). Even though you’re operating under the flat rate scheme, you still need to issue VAT invoices to customers and keep them as part of your records.
▪ Evidence of Costs: Document all goods purchased that qualify as relevant goods and keep receipts for all business expenses, even if they don’t qualify under VAT.
6- Special Cases: Bartering and Non-Cash Payments
Sometimes, businesses receive payments in forms other than cash. For example, bartering, where goods or services are exchanged instead of cash, must also be included in the flat rate turnover.
In such cases, the value of the goods or services received as part of the barter must be included in your VAT turnover, and the tax point is the date you received them. Similarly, if a commission is deducted before payment, you must include the full amount before the deduction in your VAT turnover.
7- Limited Cost Trader and the 1% Discount
If your business is in its first year of VAT registration, you are eligible for a 1% reduction in the flat rate for the first 12 months. For Limited Cost Traders, this would reduce the rate from 16.5% to 15.5% for that initial year, providing a slight relief in your VAT obligations.
Be cautious, though—this reduction applies for 12 months from the date of VAT registration, not from when you joined the Flat Rate Scheme. After the first year, you must revert to the 16.5% rate if classified as a Limited Cost Trader.
8- Is the Flat Rate Scheme Right for You as a Limited Cost Trader?
The Flat Rate Scheme offers a simpler way to handle VAT, but if you’re a Limited Cost Trader, you might find the 16.5% rate to be disadvantageous compared to traditional VAT accounting. This is especially true for businesses that don’t spend a lot on goods and rely heavily on services.
In these cases, businesses should weigh the administrative simplicity of the scheme against potential financial losses, as using the Flat Rate Scheme may increase your VAT liability compared to standard VAT accounting.
Conclusion
Being classified as a Limited Cost Trader under the Flat Rate Scheme means your VAT situation is slightly more complex than other small businesses. While the scheme simplifies the paperwork, the higher VAT rate and strict rules around relevant goods mean that businesses with low cost bases might want to reconsider if it’s the right option.
Staying compliant with HMRC rules and keeping meticulous records of your turnover and purchases is key to successfully navigating the scheme.
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