You’re either getting close to the VAT threshold, or you’re over it, but struggling to keep up with your VAT payments. So you’re wondering if you can split your business to stay under the VAT threshold.
This is a great question, because if you go over the VAT threshold (currently £85,000) in any 12 month period, you have to register for VAT within 30 days, and start charging VAT on your sales, usually at 20%.
This is likely to mean a 20% price increase for your customers, if they are not VAT registered themselves. Alternatively, if you don’t increase your prices, your revenue will drop by 20%, as you’ll have to pay this VAT over to the VAT office.
It will also mean additional work for you, or increased costs if you decide to use your bookkeeper or accountant to manage your VAT returns.
More on registering for VAT here.
We’ve seen business owners come up with all sorts of ways to stay under the VAT threshold, but most of them are not allowed by the VAT office, who view splitting your business to avoid paying VAT as artificial separation.
So why did the VAT office bring in this legislation?
There are 2 main reasons that the VAT office introduced the artificial separation rules to counter avoidance of VAT:
- Tax losses accumulate, as you’d have paid VAT on the whole business over to the VAT office, before artificially separating your business.
- Unfair competition results, as you’re likely to have lower prices than your competition if they are registered for VAT.
The previous measures didn’t address the primary reasons that business owners were separating their businesses, which was to avoid registering for VAT. It was also difficult to disprove the stated reasons that businesses were artificially split. We now have a new paragraph in the Value Added Tax Act 1994, which includes the following statement
“In determining whether or not any separation is artificial the extent to which the parties involved are closely bound to one another by financial, economic and organisational links must be taken into account”
How can the VAT office stop the artificial separation?
This means that HMRC can now challenge the artificial separation of your business, and make a direction to aggregate the businesses together. They can only do this when:
- the separation is artificial
- the separation results in an avoidance of VAT
- the parties involved are closely bound by financial, economic and organisational links
- the other legal requirements are satisfied
Examples of artificial separation that will be challenged
It’s not possible to provide an exhaustive list of all situations that may give rise to a direction to aggregate the businesses, but here are some examples:
1. My favourite example is a fish and chip restaurant and takeaway.
They were run from the same premises, with the wife running the takeaway, and the husband running the restaurant. So let’s look at their situation.
They had the same:
In addition to this the husband and wife supported each others’ businesses financially, and shared the profits of the business between them. HMRC challenged this separation, and serviced a direction to aggregate the 2 businesses together.
2. A plumber decides to split his business between his commercial and domestic customers.
He registers the limited company for VAT, looking after the commercial customers, as they can claim the VAT back.
The business with the domestic customers is a sole trade, and not registered for VAT.
HMRC challenge this and make him join the businesses together again.
3. A bed and breakfast establishment provides the accommodation from a separate business to the breakfast.
Both parts of the business are managed as sole trade businesses, under the VAT threshold. If the 2 businesses were combined their joint revenue would be above the VAT threshold.
HMRC make a direction to aggregate the businesses.
Situations where artificial separation doesn’t apply
Genuinely franchised businesses operate independently, so HMRC don’t expect artificial separation to apply.
There is an agreement between HMRC and the National Hairdressers Federation to decide whether a stylist is employed or self-employed. The artificial separation rules only apply to self-employed stylists where it can’t be proved that they’re financially and economically independent.
Self employed taxi drivers
Where taxi firms comply with the rules around artificial separation, the drivers won’t be caught by the artificial separation rules.
This is a complex area, with further HMRC guidance here.
Businesses already registered for VAT
It may sound obvious that if both separated businesses are already registered for VAT then the rules don’t apply. However, HMRC may combine the VAT registration into one, with a new VAT number, and cancel already existing registrations.
When will you be registered from?
If HMRC decide that your businesses should be aggregated (combined), then the VAT registration date will be the date of their notice, unless they give you a later date.
Penalties and Appeals
As long as the aggregation is performed as instructed, there wouldn’t be any penalties. If you carried on with the artificial separation, HMRC are likely to penalise you.
It’s a complex area, and we would always urge you to seek advice. It may be prudent in difficult cases to obtain HMRC approval of your plan to separate your business before going any further. This will avoid pain and additional costs in the future.
We are always here to support you, so please do get in touch if you’d benefit from our expert guidance.