vat for contractors1 in 4 workers are now self-employed and the government doesn’t like it. They have been trying to introduce measures to discourage self-employed people over the last couple of years. Some of these, like the national insurance rise announced in the budget, they have had to U-turn on. Other measures, such as Making Tax Digital and dividend changes have been delayed until after the election. One of the changes that they have managed to get through is to change the rules on VAT for contractors.


Flat Rate VAT

For many years contractors have had the option of going on the flat rate VAT scheme. This meant that they charged VAT at the full 20% but only paid VAT to the government at between 4% and 14% and kept the difference. The conditions for this deal were that people on the flat rate scheme couldn’t claim back any VAT they had paid out on expenses. This made the flat rate scheme ideal for contractors who typically have low expenses (so not much to claim back) but who needed to be VAT registered.

As part of the government’s attempts to attempts to discourage self-employed people a new standard flat rate of VAT for contractors is being introduced at 16.5%. Previously the amount of VAT people on the flat rate had to pay depended on their industry. So food retailers paid the lowest at 4% while architects, lawyers and IT consultants paid the highest at 14.5%. Anyone now deemed to be a ‘limited cost business’, otherwise known as a contractor, will be put straight onto the 16.5% rate.

So, if you were a contractor working in financial services you would previously have charged 20% VAT on any invoices but only paid out 13.5% to the government. Under the new scheme you will pay out 16.5% to the government. The table below shows how this works with a £10,000 invoice:


£10,000 invoice Old Flat Rate Scheme New Flat Rate Scheme
Total Charged to Client £12,000 £12,000
Amount paid to government £1,350 £1,650
Amount you keep £10,650 £10,350


As you can see the result of the new flat rate scheme is that the contractor ends up with £300 less and the government ends up with £300 more.


Why this matters

The Flat Rate VAT scheme change is probably not going to stop a high paid financial services or IT contractor from working, but it probably will take several thousand pounds a year out of their pocket. Alongside the other tax changes and dividend changes for self-employed people it will help to discourage people from going self-employed and cause stress and confusion to those already working freelance.


With 1 in 4 workers now self-employed this change is going to mean a lot of people suddenly have a lot less money to play with and unsure about where their money might be cut next. If the government wants to create a vibrant entrepreneurial economy then this doesn’t seem a sensible way to go about it.


As an online accountancy company Zooconomics deal with a lot of contractors on the flat rate VAT scheme. If you are concerned about how the changes to the flat rate VAT scheme might impact on you just give us a call on 0800 0460 560