The growing number of contractors was directly cited by the chancellor in the recent autumn statement as the cause for declining tax revenues. The chancellor obviously thinks that tax and especially VAT were too generous to contractors. So, on top of the dividend tax increase which kicked in in April 2016, the government will now include changes to VAT.

How will the Flat Rate VAT change?

From April 2017 the government are increasing Flat Rate across the board for all personal service companies to 16%. Usually the Flat Rate VAT for most IT contractors operating through a limited company is between 14% and 14.5%. Even though the Flat Rate VAT scheme will increase from 2% to 2.5%, it will still be more cost effective than not being in the scheme.

Who does this apply to?

A definition has been created of ‘personal service company’ who count as ‘labour-only’ businesses that will have to use the 16.5% rate if they want to use the Flat Rate scheme.

A limited cost trader is defined as one that spends less than 2% of its sales on goods (not services) in an accounting period.

When working out the amount spent on goods, it cannot include purchases of:

• capital goods (such as new equipment used in a business)
• food and drink (such as lunches for staff)
• vehicles or parts for vehicles (unless running a vehicle hiring business)

If a firm spends less than £1,000 in their accounting period (that’s HMRC speak for the period you produce your annual accounts for), they also count as ‘labour-only’ even if this is more than than the 2%. If your accounting period is longer / shorter than 12 months, the £1,000 threshold is pro-rated.