What is Limited Cost Trader and how do you know if you're a Limited Cost Trader?

As per the HMRC i.e. Her Majesty’s Revenue and Customs, a limited cost trader is defined as one that spends less than 2% of its sales on goods, not services for a given accounting period. In other words, HMRC classifies you as a limited cost trader if you buy only a few goods and you know if you are a limited cost trader if your expenditure on goods including VAT is either:

  • Less than 2% of its VAT inclusive sales for a quarter, or
  • More than 2% of its VAT inclusive sales for a quarter but less than $250.
  • Also the sales should not include the cost of following items such as:
    • Capital expenditure
    • Food and drink for the business or its staff
    • Vehicles, vehicle parts and fuel, unless vehicles are owned by your business, for example if you own and run a taxi hire company.
    • Payment for services including rent, accountancy fees, advertising costs, internet bills, phone bills etc.
    • Gifts, promotional items and donations.
    • Any services which is anything that isn’t goods.
    • Training and memberships.
    • Capital items for example office equipment, laptops, mobile phones and tablets.
    • Goods you resell or hire out unless that’s your main business activity.
    • Any software you download
    • Bespoke software designed specifically for you

For Example

  • If your business quarterly turnover is of £10,000 and expenditure on relevant goods excluding those as listed above is £260, then it accounts for more than 2% of the flat rate turnover. So it doesn’t qualify as limited cost trader.
  • If your business quarterly turnover is £20,000 and expenditure on relevant goods is £325, then in this case although the expenditure is more than the set amount but less than 2% of the quarterly turn over and thus classifies as limited cost trader and applicable rules of limited cost trader will be applicable on your business.
  • If your business quarterly turnover is £10,000 and expenditure on relevant goods is £225, then in this case although the expenditure is less than the set amount but more than 2% of the quarterly turn over and thus classifies as limited cost trader and applicable rules of limited cost trader will be applicable on your business.

HMRC Criteria for Limited Cost Traders in Flat Rate Scheme

If your firm is VAT registered then they have to charge VAT on their sales and can claim it on the purchases made by them and thus involves a meticulous task of record keeping of all the transactions as well as the VAT rate applicable on them and in order to reduce the burden of record-keeping on smaller firms, HRMC came up with a Flat Rate Scheme, which relieves small firms don’t have to track VAT on purchases.

Read Also: VAT Registration Numbers: Search for Company VAT Numbers in UK

Flat Rate Scheme was first introduced on 1st April 2002 and has been quite a favourite scheme amongst small businesses. The principle on which the scheme works is that while the businesses continue to charge output tax on its sales, a specific flat-rate percentage is applied to the gross business income, which is inclusive of VTA i.e. rather than instead of including the output tax on its VAT return and claiming input tax on its expenses i.e. normal VAT accounting, a fixed rate percentage is applicable to the gross income as per the trade sector you are dealing in. And before you opt for the scheme, you must remember that under the scheme, a fixed rate percentage VAT is applicable on the net gross sales as compared to the standard VAT charged on net sales and thus check if it will be a prudent call to join the scheme.

The Flat Rate VAT scheme works on simple principle as mentioned below:

  • You have to pay a flat percentage of VAT on gross sales on gross sales.
  • It can be used both on a cash basis or accrual basis as per the applicable case i.e. you can opt for cash when your customers pay you and accrual basis if you have raised an invoice to your customers.

Flat Rate Scheme, when introduced became an instant hit amongst the small business and traders mostly because it helped them to save both time and money because firstly the requirement to calculate and record output tax and input tax was no longer applicable. The VAT in the accounting period is calculated by applying the flat rate percentage to the tax inclusive turnover for the period. Also, it helps you to save money by paying a fixed rate percentage in the flat rate scheme.

In simple words, HMRC introduced Flat Rate Scheme under which a business pay a fixed percentage of VAT to HMRC and keep the difference between what you pay and what you charge your customers and in order to be eligible for the Flat Rate Scheme, your business must have an annual turnover of £150,000 or less, excluding VAT and percentage of VAT you pay for depends and varies according to the business you own, for example:

  • If your firm is in catering services will pay 12.5%,
  • If you own management consultancy firm, then you will pay 14%.
  • Computer repair services will pay 10.5%,
  • Hairdressing or beauty services will pay 13%.
  • Hotels and accommodation will pay 10.5%.
  • Legal services will pay 14.5%.
  • Estate agency will pay 12%.
  • Photography will pay 11%.

The flat rate you can use depends on the business or the sector you are dealing in and if your business deals in two or more sectors, the percentage or the flat rate applicable will be as per your main business which in turn is measured by the expected turnover.

It was on 1st April 2017 when the HMRC made a remarkable change in the Flat Rate Scheme by introducing a new category for a limited cost business i.e. for the business that spend either 2% of their gross sales on goods or £250 in a VAT quarter and the new rate introduced was 16.5% and although most traders with qualifying turnover are eligible to join the scheme in case they don’t fall under the exclusion list as prescribed by the HMRC in order to avoid any abuse of the mentioned scheme as well as to avoid any complex interactions with other schemes. And while the Flat Rate Scheme increase the VAT paid by the labor-intensive businesses, it will also affect construction workers who although supply their labour, the raw material for the business comes from the main contractor.

Flat Rate Scheme also allows owners to apply a fixed rate percentage to their annual turnover ahead of the VAT bill which apart from simplifying the administrative burden of sales and purchases records into one calculation, also supports small businesses that intend to spend less on goods, especially those who are in the services sector and don’t rely on the raw materials. As per the mentioned guidelines of HMRC, you can join the Flat Rate Scheme if:

  • You are a VAT registered business and
  • Your taxable turnover is either £150,000 or less and in order to join, you can do so by: a. Online, or b. By filling up the form VAT600FRS and send it by post to the address as mentioned in the form in order to apply for the annual accounting schemes.
And you cannot join the scheme if you fall under one of the categories mentioned as below:
  • If you have joined the scheme earlier but left before 12 months.
  • If you have committed offense such as VAT evasion in the last 12 months.
  • If you were either eligible or have joined a VAT group in the previous 24 months.
  • If your business is closely associated with another business.
  • If you have joined a margin or capital goods VAT scheme.
  • If you have used one of the margin schemes for second-hand goods, art, antiques and collectibles, the Tour Operator’s Margin Scheme or the Capital Goods Scheme.

Also, you must leave the scheme if and when the annual turnover of your business reaches or cross £230,000, unless you have a written agreement from the HMRC, which can also be done if the total sales in the following 12 months are less than £191,500 or less and in order to do, you can write a letter to the HMRC and post it at the below mentioned address: HM Revenue and Customs Imperial House 77 Victoria Street Grimsby Lincolnshire DN311DB

And once they receive your letter, they will confirm a date on which you can leave the Flat Rate Scheme and must wait for 12 months before you can rejoin.

The main reason behind the introduction of Flat Rate Scheme was to ease down the admin burden on the business, especially the limited cost traders, however if not managed correctly, it might end up creating more admin issues and you need to be careful while choosing the most appropriate flat rate to your business otherwise to get or set it right is an expensive route which you might not like to travel.