April 2017 will see many small companies with low annual costs faced with a higher VAT liability if they currently use the Flat Rate scheme (FRS). What will the change mean for contractors?

First, there is a change to the way ‘labour intensive’ companies will calculate their VAT liabilities for each quarter. The standard VAT scheme requires companies to calculate their VAT liabilities by adding up all VAT charged over that quarter, minus the qualifying VATable expenditure. The FRS was designed to make this simpler for smaller businesses using it.

Under the FRS, businesses calculate their VAT liability by applying a fixed percentage to their turnover, which includes VAT. The percentage is different for different trades. For most contractors, it is currently 14.5 percent.

This would mean, for example, that for a £1,000 invoice plus 20 percent, the small business would pay HMRC £174, rather than £200 under the standard VAT system.

Those paying the standard rate of VAT are able to reclaim VAT on all types of expenditure, while those using FRS are more limited.

The Government believes that some companies have benefited unfairly from the FRS, especially small businesses with low costs, such as contractors. Changing the way FRS works will maintain the simplification, but make it fairer.

Under the changes, limited cost traders must use a new 16.5 percentage rate. Other companies will use the percentages used by HMRC, which, for some contractors, could mean they could be paying hundreds or thousands more per year in extra VAT payments.