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Falling Flat

The recent VAT tribunal case of Morgan (The Harrow Inn) highlights quite how rough and ready is the flat rate scheme for small traders. This is the (voluntary) arrangement under which most traders with taxable turnover below £150,000 can avoid the need to bother with input and output tax and instead calculate their VAT payment as a percentage of their turnover. The percentage varies, of course, with the category of business. If your business straddles two categories, you must use the percentage that applies to the business that you expect (as at the start of the accounting period) to account for the majority of your turnover for the accounting period.

Mr and Mrs Morgan got it wrong. They ran a pub at which they also sold meals. The food sales marginally exceeded the drink sales though following a refurbishment of the bar they expected that to reverse. But it didn't. And the tribunal upheld HMRC's view that VAT should have been paid at the restaurant rate of 12% instead of the pub rate of 5.5%.

There are a number of points to bear in mind here.

The first is that HMRC do not accept that a pub is a pub is a pub. In the Morgan case there appears to have been no separate restaurant area; the sale of food was ancillary to that of bar sales; for planning and rating purposes the premises were classed as a public house; they had an on-licence; and the lease of the premises described them as a public house. The Morgans understandably but erroneously thought that that made the business a pub and that 5.5% was the applicable rate.

Second, a flat rate trader needs to be alert to the possibility that the category of trade (and hence the VAT rate) may change with time.

Third, even where it is obvious that a business straddles two categories there is no scope for apportioning turnover between them. For a "gastro-pub", if the turnover is expected to be split 50.1% drink 49.9% food, the applicable rate is 5.5%. If it is expected to be 49.9% drink and 50.1% food it is 12%. The logical and sensible option of using an average rate of 8.75% is not available.

Nor are these the only problems that lie beneath the surface of the flat-rate scheme. For example, the flat rate percentage may give a distorted result if the business would otherwise have any substantial zero-rated sales, perhaps through doing business with non-UK customers. Generally, the scheme works well only for simple fully-taxable cash businesses; and (as the Morgan case shows) even they can fall foul of it.