Compact by design: riding the VAT threshold

  1. A mechanic working with tools.
    Ray Newman

    Ray Newman UKBF Regular

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    If you’re a believer in the importance of entrepreneurism there’s something distinctly depressing about the idea of businesses deliberately limiting their growth to avoid breaching an arbitrary target. And yet that’s exactly the kind of behaviour the UK’s VAT regime promotes.

    As forum user STDFR33 once put it: “If you can't sell more, sell less, and remain under the threshold.”

    The UK’s VAT registration threshold, at £85,000, is the highest in the European Union. The average in Europe is around £20,000 and Germany’s, for example, is just €17,500 – about £15,000.

    In the latter case, almost the moment you start doing any serious business at all, you'll find yourself liable for VAT. In the UK, on the other hand, it’s quite possible to run a substantial, viable business without every tipping over the line. Or, as critics call it, the ‘cliff edge’.

    Fear of this precipice has led to a phenomenon referred to in tax policy circles as ‘bunching’, whereby businesses pile up behind the £85,000 line rather than smoothly flowing across it.

    But what exactly are they scared of?

    Prices up or profit down

    Once you hit that VAT-registration threshold, your business enters a new world.

    It usually means putting prices up by 20%, potentially scaring off customers, or giving an edge to competitors who have stayed below the threshold.

    Or, alternatively, you might charge the same but cover the VAT from your own pocket, making your business less profitable.

    In a 2017 paper on the subject of bunching, the Office for Tax Simplification (OTS) gave the example of a business with a turnover of £84,000, and one turning over £85,000: “If VAT applied to the whole of the turnover, the VAT-registered business would be liable for an additional £17,000.”

    It’s easy to see why some might hold back from taking that fatal extra grand, either by restricting their trading hours in the case of retail or hospitality, or by limiting the number of jobs they take on.

    On top of all that, administering VAT comes with an additional administrative burden.

    In the most recent edition of its annual study of global tax regimes, Paying Taxes 2019, PricewaterhouseCoopers found that in 2017 British businesses spent an average of 25 hours managing VAT – several full working days.

    And, of course, if you get it wrong, you risk a tax investigation (yet another time suck) and might end up facing a retrospective tax bill of destabilising proportions.

    From this year, too, there’s Making Tax Digital for VAT to contend with. If you’re under the threshold, you get a stay of execution; otherwise, you’d better brace yourself for a whole lot of accounting software sales pitches, bridging software conundrums, and head scratching.

    Gaming the system

    Those who can’t bring themselves to turn down work sometimes resort to another workaround: disaggregation.

    This is the practice of splitting a business into smaller discrete units, each of which is itself under the VAT-registration threshold.

    It’s a legitimate approach as long as the split is genuine which, of course, it often isn’t, and the artificial separation of businesses is a wheeze to which HMRC is wise.

    Two businesses sharing premises and equipment, the same management team, and with all the profits going into one bank account? Nice try but, no.

    In one famous legal case, ‘Salmon Tail’, from 1999, a couple argued that one of them was running a distinct businesses from the partnership, but couldn’t provide evidence of a commercial relationship.

    For example, there was no record of the solo operator being charged for the use of the premises by the partnership.

    Change in the air?

    The Government is uneasy with the very idea of businesses hanging back from achieving their full potential because of mere bureaucracy, and has been actively reviewing VAT and the threshold system for the past few years.

    In 2016, Philip Hammond asked the OTS to investigate what might happen if the VAT-registration threshold was raised or lowered. In Budget 2017 and Spring Statement 2018, he continued to express concern about the problem of the “cliff edge” and launched a consultation.

    There was a general expectation that in Budget 2018, last October, the threshold would be reduced drastically – by £50,000, the rumours had it. But for whatever reason, that didn’t happen.

    Instead, the current threshold was frozen and is not now set to change until April 2022 – perhaps the commencement of a plan to effectively reduce it, very gradually, through the magic of inflation.

    Real world decisions

    Until either the system or the threshold substantially change, we are where we are, and business owners have to make a decision based on their own circumstances.

    As long as you want to make a modest living rather than a fortune, or are operating your business as a ‘side hustle’, staying under the VAT threshold could well be the best option.

    But if you find yourself feeling frustrated – if your business is pulling at the reins – then it’s probably time to consider pushing on through the pack, and hoping that where you end up is compensation for the temporary turbulence ahead.

  2. Mark P Trotter

    Mark P Trotter Guest

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    Ahh! the joys of taxation.

    Britain has always struggled with tax, historically it has collapsed governments and reduced the Civil Service to a group that is viewed with suspicion.

    All tax is challenging. People want the best education, health, transport and defence systems available but don't want to pay the tax to meet the demand. The UK deficit would have been covered quickly by raising additional taxes but politicians fear the public backlash.

    As a business owner I don't care what the VAT threshold is! Limiting growth in business isn't a bad thing but do it for the right reasons. The VAT threshold would be better placed at a substanially lower rate. Get all business involved in the system and collect tax quarterly.

    You make some interesting points but self interest always seems to win
    Last edited by a moderator: May 3, 2019
    Posted: May 3, 2019 By: Mark P Trotter Member since: Jan 1, 1970
  3. EeeTea

    EeeTea UKBF Contributor

    17 12
    Yes pretty much agree with the OP - I'm another that isn't VAT registered at this stage and unless I could see that I can earn substantially more, I will aim to stay under the threshold just to avoid all the extra time and cost on admin (and it's not just the actual cost of admin, its the lost revenue whilst you're actually doing it - a double whammy)

    I'm not averse to paying tax, but the UK has some of the most complex tax laws on the entire planet spawning a whole industry that wouldn't actually want a simplified system - if it were simple they would be out of a job.

    Really tax sucks, but not because I resent paying it. I resent paying to administer it above and beyond what is reasonable because of the complexity.
    Posted: May 3, 2019 By: EeeTea Member since: Feb 8, 2019
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  4. The Byre

    The Byre Full Member

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    On a minor point of order, in Germany, the threshold is zero for any full-time commercial activity. €17,500 only applies to hobby businesses - after €17,500 it automatically ceases to be a hobby!

    One aspect of this debate is those businesses that are investment intensive. If you need a machine or a commercial building on day one that costs real money, say £500,000 and you are not VAT registered, that's an extra £100,000 you have to find. So even if your TO is going to be below £85,000, it pays to register.

    Bunching is a real problem and a nonsensical brake on the economy. I see many one-man businesses that would dearly like to expand and take on staff but dare not for fear of alienating their retail clients. This seems to be particularly true for trades such as auto-repair and plumbing. They have an advantage over larger companies, in that they do not have to charge VAT, but they also can never expand.

    The system is lop-sided and leads to yet another reason why UK businesses are far less productive than their counterparts in Germany, France and elsewhere in the EU.
    Posted: May 3, 2019 By: The Byre Member since: Aug 13, 2013
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  5. RobinBHM

    RobinBHM UKBF Ace

    423 128
    One man band tradesmen often keep below the threshold.

    One way to do it is to ask the customer to supply the materials -which works well for tilers and carpenters. The internet encourages this because these days customers can often buy at the same prices as the tradesman.

    The problem is that a one man band not registered will be cheaper than a 2 or 3 man business that does. In reality the increase in cost is the VAT on Labour and any margin on materials.

    VAT isnt the only thing that stops businesses growing though -If a business grows it usually needs staff -that brings a whole world of pain. Suppose a disgruntled employee takes you to a tribunal -if you havent done everything correctly the fine could close the business. Once you go over 5 employees you then need a full H&S plan (that apply whether you employ 5 people or 5000).

    I know of a few businesses in construction that stopped employing people when the pension rules came in -a good example of the government handling the pension crisis issue over to employers. The software cost and support along with the extra admin cost me £1000+ over the last year.
    Posted: May 7, 2019 By: RobinBHM Member since: Apr 14, 2012
  6. Justin Smith

    Justin Smith UKBF Legend

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    Arguably, with the advent of MTD, there`s even more reason to stay below the VAT threshold, because the trader has to either pay an accountant about a grand a year or learn to use all the software. I can`t imagine what the Tories were thinking when they decided that MTD would be compulsory for every business over the £85K VAT threshold, even those only just over it. Remember that for some businesses (e.g. retail) £85K would not necessarily be making the trader that much money !
    I`d have thought, at the very least, there should be a higher threshold for MTD, between £150 and £250K ? Arguably if such a threshold was in place it`d not actually affect that many businesses because nearly all turning over that amount would probably have an accountant anyway.
    Last edited: May 22, 2019
    Posted: May 22, 2019 By: Justin Smith Member since: Jun 6, 2012
  7. locutus

    locutus UKBF Newcomer

    184 4
    I personally think there should be stages to the VAT rate. My business just hovers over the VAT threshold, and I think it's a bit harsh to pay 20% VAT because I'm a penny over, that I would like to see is a VAT rate of 10% for those between £85k-£100k, then perhaps 15% for those between £100k-£120k, and then 20% for those above £120k. This gives a nice cushion for small businesses as they grow.
    Posted: Aug 11, 2019 By: locutus Member since: Jun 12, 2015
  8. manofs

    manofs UKBF Newcomer

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    It would make sense for a host of reason to lower the threshold to a much lower amount, say £10k. Then everyone is in the same boat, without penalising hobbyists
    Posted: Nov 4, 2019 By: manofs Member since: Nov 1, 2019
  9. GazNicki

    GazNicki UKBF Newcomer

    35 6
    Staggered VAT wouldn't work though in reality. The VAT you pay is charged to the customer anyway - which will just push a lot of customers to seek out the lower tax charging customers anyway - which stifles profitability at the higher end.

    The reality is, we should follow in the footsteps of places like Germany. If every business was to be registered for VAT, then the playing fields would be more even. Little companies would be in the same position as larger companies instead of smaller businesses bunching up to remain competitive.

    What needs to really stagger is corporation tax.
    Posted: Dec 29, 2019 By: GazNicki Member since: Jan 17, 2014
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  10. khu

    khu UKBF Newcomer

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    i have two things to say. the second is about dealing with the matter described

    the first is to note that VAT was introduced to aid the WWII effort. it was intended to be temporary and to be ended. the politicians either liked it too much or got too comfy with it to allow that, and so it has continued

    now back to the specifics. the rate is simply ridiculous. locutus meanwhile gives the perfect solution for managing the bunching situation. here's a history of the rates and for a random comparison to our current state, here's the usa's present rates
    Posted: Sep 4, 2020 By: khu Member since: Sep 4, 2020
  11. Gareth83

    Gareth83 UKBF Newcomer

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    Does anyone know the cutoff point for being VAT registered or being non-VAT registered?

    As in if turnover is £84,000 don't bother trying for more, or aim for say £110,000 (figure in question) to make more after VAT is factored in? There must a point when it becomes worthwhile?

    Business in question = Retail

    Buy from VAT registered suppliers, sell to non-registered customers...
    Posted: Oct 7, 2020 By: Gareth83 Member since: Dec 18, 2019
  12. jim_0525

    jim_0525 UKBF Newcomer

    9 0
    Strange that the Value added tax threshold is based on turnover rather than Value added !

    I wonder if it has anything to do with accountants not having any input costs :)
    Posted: Apr 29, 2021 By: jim_0525 Member since: May 7, 2020