Contractors can optimise their VAT recovery when first starting their contracting careers. “Limited company contractors should time their VAT registration to take effect when they first start trading so they can enjoy a full year’s benefit of the FRS’s first year 1% discount,” explains James Abbott, founder and head of tax at contractor accountant Abbott Moore.
“And when making those initial purchases of computers and office equipment, contractors should aim to make a single transaction on the same invoice of over £2,000 on capital items so the full amount of VAT can be recovered.”
Timing VAT and FRS registration
According to Abbott, although it is technically possible for a contractor to request that their VAT registration takes effect from, for example, 1 April and the FRS starts on 30 April, in practice HMRC likes everything to be rolled into the same quarter.
“Ideally, a contractor would want to have the first month of trading under normal VAT rules so they can claim the full amount of VAT for all of their start-up expenses,” says Abbott. “Then they would want to join the FRS to benefit from the VAT savings they make under the scheme.
“Unfortunately, although a contractor can specify the date when the VAT registration takes effect and when they wish to join the FRS, HMRC will roll them into one, meaning that the FRS will take effect as soon as the contractor is VAT registered or delayed until the next VAT quarter starts.”
Although the rules can be complicated, it is possible for contractors to reclaim the VAT on goods purchased and still held at registration for company use going back three years, and to claim some services going back six months.
Benefitting from HMRC’s first year 1% FRS discount
The 1% discount on the FRS that start-up companies enjoy takes effect from the day the company becomes VAT registered. This means that a trader registering for VAT on day one but delaying registering for the FRS for three months, would only receive 9 months of the 1% discount.
New companies benefit from a 1% discount on their FRS rate for the first 12 months of trading
James Abbott, Abbott Moore
“New companies benefit from a 1% discount on their FRS rate for the first 12 months of trading,” says Abbott. “That means if the contractor’s FRS percentage would normally be 12%, they only have to pay 11% of turnover plus VAT to HMRC for the first 12 months.”
Abbott says the timing is important because it can often take a contractor several months to get the business up and running before they issue their first invoices: “I’ve had contractor clients who set up their contracting business but then took three months to leave their employer. But the clock started ticking on their 1% VAT discount from the day they first registered their new company for VAT, and so they lost several months of the discount.”
Choosing the correct classification
Abbott warns contractors to ensure they choose the correct category when registering for the FRS: “Deciding on the category may not always be straightforward. For example, a contractor who sells advertising on behalf of their clients doesn’t necessarily fall into the advertising category.
“Many choose to use the management consulting code, as this can apply to a wide range of contracting activities and HMRC stipulate “if you act as a consultant and you do not fit into another specific sector, you should choose management consultancy. This sector is not restricted to businesses that fit the traditional idea of management consultant” ”
Contractors can consult HMRC’s VAT notice 733 for a full description of the FRS rules and the different categories.
Abbott concludes: “The FRS generally works in favour of contractors, and by paying attention to timings contractors can benefit from a further 1% discount for a full 12 months of trading.”