Changes to VAT Notice 733: Flat Rate Scheme for small businesses.

HMRC have recently updated their Flat Rate Scheme Notice 733, changes have been made to the guidance on selecting the appropriate sector rate. Previously HMRC had a whole paragraph (4.4) dedicated to ‘business activities that are the source of common enquiry’ with advice on which trade sector to choose. Noting that if you act as a consultant and don’t fit into another specific sector, you should choose ‘management consultancy’ (14%) even if you didn’t fit the traditional idea of a management consultant. This pre-empted the alternative choice of ‘any other activity that is not listed elsewhere’ at the lower 12% rate.

The guidance listed the trade sector ‘architect, civil and structural engineers’ to include engineering consultants and designers; this was the area of dispute in the two First tier Tribunal cases, of IDESS Ltd (TC03638) and SLL Subsea Engineering Ltd (TC04256).

HMRC’s changes to Notice 733 follows on the footsteps of the ATT urging that HMRC guidance was misrepresentative and did not reflect the courts findings.

In the cases of IDESS Ltd (TC03638) and SLL Subsea Engineering Ltd (TC04256) both companies provided mechanical engineering services and chose ‘any other activity not listed elsewhere’ with a flat rate percentage of 12%. In both cases HMRC decided that the companies should apply the higher 14.5% for the ‘architect, civil and structural engineer or surveyor’ category.

IDESS Ltd was engaged in mechanical engineering, working in the nuclear industry. Following an inspection of the company’s records, HMRC decided that the company ought to have been applying 14.5% using the category ‘architect, civil and structural engineer’ and assessed them with penalties. On appeal, the Tribunal found for the taxpayer for the very simple reason that the company was not an ‘architect, civil or structural engineer’. The company had been engaged in general maintenance and repair tasks involving machinery, but never buildings. Insofar as HMRC’s VAT Notice 733 ‘Flat rate scheme for small businesses’ included guidance that all engineers should use the 14.5% rate, the Notice was plainly wrong and in contravention of the law.

The Tribunal found in a similar case SLL Subsea Engineering Ltd, that HMRC was not reasonable to reverse the appellant’s choice of flat rate sector; primarily because HMRC had erred in looking to their own guidance as being authoritative when they should have looked at the legislation and given it its ordinary meaning. The case stated that ‘Paragraph 4.4 cannot extend the meaning of the 1995 Regulations … The fact that HMRC think that any engineering design or consultancy work falls into their chosen category does not change the ambit of that category at all.’

These cases highlight an area of law that may be of use; moreover they provide a practical example of HMRC attempting to contravene the law with their own guidance. This can be both confusing and intimidating to tax payers, who might assume that the two are always the same.

The starting point for any business adopting the VAT flat rate scheme for the first time is to refer to the list of categories in the 1995 VAT Regulations, SI1995/2518, Regulation 55K (for which there is a link in Notice 733 at paragraph 4.3), applying the ordinary meaning to each of the descriptions as they appear. In areas of doubt (e.g. where there is no specific category for the business description), HMRC offers assistance in the flat rate scheme manual at paragraphs FRS7200 and FRS7300 (paragraph 4.1 of the Notice), which now reflect the recent court cases.

In choosing your sector rate, it is advisable to make a note of your selection criteria; provided that you are able to demonstrate that your choice was reasonable, HMRC will not be able to make a robust challenge retrospectively.

This was demonstrated in the case of Vintage Tea House Ltd (TC03160) where the appellant was partially successful in their appeal against HMRC back dating an assessment based on reversing the taxpayers decision to choose the lower rate choice for ‘retailing that is not listed elsewhere’ as opposed to the higher rate sector for ‘catering services including restaurants and takeaways’.

The shop sold teapots, mugs, novelty signs and the like as well as providing about 10 seats for customers to enjoy light refreshments. The tax payers original choice was found to be reasonable based on the fact that there was no ventilation for an oven and the terms of the lease prescribed that use of the premises was for ‘the sale of home and garden accessories, with ancillary sale of cakes, sandwiches, pastries, etc…’

They were not totally successful, as they should have reviewed the split between sectors on the anniversary of joining the scheme and changed to the catering sector at the point when the teashop side of the business increased seating availability to accommodate 28 and thereby represented the predominant part of the turnover.