Abuse of FRS
The government believes small businesses have been abusing the FRS by using it as the law intended, so it is changing the terms of the scheme to make is less attractive to use, and to reduce the cash advantage enjoyed by service-related businesses.
From 1 April 2017 a business will be required to use a FRS percentage of 16.5% if it is a "low cost trader". 16.5% of the gross turnover is equivalent to 19.8% of the net leaving almost no credit for VAT incurred on purchases.
Low cost trader
This is a business whose expenditure on goods (not services) is less than 2% of its gross turnover, or if more than 2% of its turnover, the amount spent on goods is less than £1,000 per year. Any expenditure on; capital items, motor expenses, or food or drink for consumption by the business, is ignored when working out the 2% or £1,000 threshold.
This emphasis on 'goods' will discriminate against businesses who incur VAT on services such as: rent, software licences, IT support, digital journals, sub-contractors, telecoms etc. In VAT terms a service is anything which is intangible, or where the cost relates to a tangible asset it is the temporary use of that asset - such as hiring.