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The Chartered Institute of Taxation (CIOT) has taken exception to (part of) the latest VAT Notice 733 ("Flat Rate Scheme for Small Businesses"): they have thrown their weight behind the issue of whether or not "Flat Rate VAT" should be applied to bank interest received

What is the VAT Flat Rate Scheme?

The VAT Flat Rate Scheme is supposed to simplify the operation of VAT for small businesses: it doesn't reduce the amount of VAT that a business charges to its customers, but instead of having to tot up all the Output VAT on sales, and identify and claim the Input VAT on every receipt, the Flat Rate Scheme simply allows the trader to apply a specific percentage to all of its 'sales' (but see later) to come to a figure for the VAT due for each period.

HM Revenue & Customs (HMRC) specifies different percentages, depending on the business category - the idea being that the percentage is a reasonable approximation of the amount of VAT that would be due for a business of that type, using the more traditional 'accurate' method.

Flat Rate Scheme Applies to ALL Supplies...?

The problem is that many businesses don't realise that the percentage is meant to be applied to almost every type of supply made by the business, and not just normal sales. This includes rental income, and the sale of some fixed assets. This can apply even if the supply itself is exempt - in theory, the relevant percentage includes an adjustment for exempt supplies - so even if (for instance) there's rental income, which is normally exempt, a business should apply its Flat Rate Scheme percentage to that income as well as its sales, and account for that VAT to HMRC.

Sole trader businesses need to be particularly careful: their VAT registration applies to them in any business capacity, and not just what they might think of as their business. (E.g., a self-employed professional who also receives rental income).

Bank Interest - VAT or no VAT?

Enter Mike Thexton and Neil Warren, both tax professionals, who started a dialogue with HMRC as to whether or not the Flat Rate Scheme percentage should be applied to bank interest received to a business account. HMRC decided it did. Mike and Neil disagreed.

In the end, the matter ended up at the First Tier Tax Tribunal, which agreed with Mike Thexton - bank interest 'was outside the scope of VAT' and the percentage should NOT be applied thereto.

But this hasn't stopped HMRC from continuing to assert that business bank interest received should be included in the calculation of Flat Rate VAT due, in their VAT Notice 733.

So, CIOT has now written to HMRC to ask them to change their guidance in section 6.2 of the Notice, in recognition of the Tribunal's findings. Ironically, CIOT wrote to HMRC to challenge the version of the Notice which HMRC issued in January of this year, whilst HMRC has actually issued another version since then, in April - which still contains the misleading guidance that bank interest received should be included in the Flat Rate Percentage calculation!

The CIOT letter to HMRC may be found at: Notice 733 - Bank Interest Wrongfully Included in FRS Turnover

[Update - The VAT Notice 733 has now been amended - see HMRC Finally Updates Flat Rate Scheme Guidance on Bank Interest - Ed]