V7.227 Potential problems of using the flat rate scheme
As with many aspects of tax, a situation that may be suitable for one business may prove totally unsuitable for another. Example 2 illustrates one situation where the scheme produces a disastrous result for a taxpayer. Advisers should be aware of the important points in relation to the scheme that are mentioned in this section.
John trades as an accountant and tax adviser subcontracting a lot of work to three local practitioners, all of whom are VAT registered.
John's annual sales figure is £100,000 (excluding VAT) and his sole expense is the subcontractor fees of £40,000 (excluding VAT). Should he use the flat rate scheme?
Solution – John should avoid the flat rate scheme. Under normal accounting, with a VAT rate of 20%, his annual VAT bill would be £12,000 (output tax of £20,000 less input tax of £8,000). However, the flat rate scheme (14.5% flat rate for accountants) gives him a tax bill of £17,400 (£100,000 x 1.2 x 14.5%). He is worse off by £5,400. This is because the nature of his trading produces exceptionally high input tax – far greater than is recognised by the 14.5% flat
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