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HM Revenue and Customs's (HMRC's) new measure to crackdown on abuse of a VAT simplification scheme for small businesses may be ineffective and have unwelcome consequences for tax-compliant businesses, the Chartered Institute of Taxation (CIOT) has said.
The change concerns the VAT Flat Rate Scheme (FRS), a simplification measure for small businesses, which enables them to pay to HMRC a fixed rate of VAT, that is determined by their type of business, rather than keep detailed records of input and output VAT. It removes the ability of firms to deduct input tax.
At the Autumn Statement, the Chancellor announced changes to the FRS which mean that a business that falls into a new definition of a "limited cost trader" during an accounting period will pay a higher 16.5 percent rate, as opposed to the headline 20 percent rate. HMRC's stated intention is to tackle "widespread abuse" of the scheme by some employment agencies and similar businesses.
The CIOT said that while the Government must tackle abuse of the scheme, changes to the proposed measure are needed to avoid excessive collateral damage to compliant small traders.
Peter Dylewski, Chairman of the CIOT's Indirect Taxes Sub-committee, said "Targeted action against abuse of the FRS, which is masterminded by a relatively small number of businesses, is preferable to such wholesale changes. We are concerned that HMRC has significantly underestimated the collateral impact of these changes, both in terms of the number of businesses affected, and the financial impact."
The CIOT said it believes that far more than the 4,000 businesses estimated by HMRC will move back into standard VAT accounting, so as not to be affected by the new 16.5 percent rate, and that the costs for businesses of doing this could be significantly higher than the GBP180 per year suggested by HMRC. The proposed changes are also complicated, and could negate the simplification aims of the FRS, it said.
"HMRC will face difficulties building in effective anti-tax avoidance measures, to prevent traders side-stepping the new measure, for instance by buying and selling small amounts of goods to take them over the limited cost trader thresholds. We strongly suspect gaps will remain in the legislation and will be exploited, and we are also concerned that some users might simply ignore the changes, and just liquidate any businesses subsequently assessed by HMRC," Dylewski said.
He added: "The proposed changes add a significant level of complexity on small business owners who will need considerable guidance from HMRC. Many will have to pay for additional accounting advice. One of the main challenges will be for businesses to understand whether they have acquired goods or services, which is often unclear for expenses such as computer software, electricity and gas and professional subscriptions."
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