VAT for IT contractors:

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Limited Cost Trader:

From 1 April 2017 HMRC has introduced a new category of business called limited cost trader. A business will fall under this category, if their expenditure on relevant goods (see below) is either:

–    Less than 2% of gross turnover (turnover including VAT)

–    More than 2% of gross turnover but less than £1,000 per year or £250 per quarter

This is particularly relevant for IT contractors as their cost patterns likely to fall into this category.

VAT Rates:

Usually, IT contractors pay VAT @14.5%. However, the businesses categorised as Limited Cost Trader should pay VAT at 16.5% (first one year 15.5%).

Time to reconsider:

Flat rated businesses who fall into this category should rethink about their VAT scheme. Falling under this category may result in paying more VAT than a standard rated business because, unlike standard rated business, VAT percentage on this scheme is applied on gross turnover rather than the net and they cannot claim any VAT. The following example explains this:

A business received £2,400 from a customer including VAT (Net £2,000). Under Limited Cost Trading scheme, the VAT payable to HMRC is £396 (£2,400 X 16.5%) while as a standard rated business they pay £400 (£2,000 X 20%).

However, under the standard rate scheme, the business can claim VAT they pay on their expenses. So, if they pay £30 VAT on their accountancy fees, the net VAT payable under this scheme is £370 (£400 – £30).

Relevant Goods:

 Relevant goods are anything you exclusively use for your business except:

–    Vehicle fuel unless you are in the transport business

–    Food or drinks

–    Any capital expenditure i.e. laptop, PC etc.

–    Any services like

  1. Accountancy fees
  2. Advertising costs
  3. Rent
  4. Item leased or hired
  5. Downloaded software
  6. Bespoke software
  7. Stamps and postage
  8. Gas electricity not used exclusively for the business (i.e. home office)

 

–    Goods purchased for leasing, letting, resale or hiring out unless the main activity of the business is to do so.

–    Goods purchased to give away (for business promotion or charity etc.)

What choice do you have:

So it is very difficult for an IT contractor not to be categorised as a limited cost trader. As a result, the best option for them is to become a standard rated business and claim VAT on the expenses they are not allowed to claim as a limited cost trader.