The VAT registration threshold increased from £85,000 to £90,000 on 1 April 2024, following a six-year freeze.
This means businesses must register for VAT if their taxable sales exceed £90,000 over any rolling twelve-month period or are expected to exceed this amount within the next 30 days. Registration would then be effective from the start of that thirty-day period.
Business splitting is a strategy some businesses use to avoid registering for VAT, especially when their sales are standard-rated, and customers cannot reclaim input tax. For example, a business that sells ice creams and rents deckchairs might consider operating the ice cream sales as a sole trader venture and the deckchair rentals as a limited company, keeping each entity under the threshold, even if their combined turnover exceeds £90,000.
HMRC’s Powers and Legislation
HMRC has the authority to issue a written direction to treat two or more closely connected entities as a single taxable entity for VAT purposes. This is based on their assessment of the financial, organisational, and economic links between the entities. HMRC must prove the existence of all three types of links before they can issue a direction.
The relevant legislation is found in Schedule 1, paragraph 1A(1) of the Value Added Tax Act 1994. Its purpose is to prevent the artificial separation of business activities that would otherwise result in VAT avoidance. HMRC’s powers are designed to counter businesses deliberately splitting their operations to fall below the registration threshold.
A Case Study: Splitting in Practice
Consider a business owner who operates a garden maintenance service as a sole trader while running a limited company that provides fencing installation, paving, and irrigation services. While each business trades below the £90,000 threshold, their combined turnover exceeds this figure. The argument for separating the two entities is that one business maintains existing features while the other creates new installations.
HMRC can only issue a direction to combine businesses going forward and cannot enforce retrospective registration if the split is legitimate and well-structured. For the split to be properly executed, several factors must be in place:
1. Separate bank accounts, supplier accounts, and sales invoicing for each business.
2. Customers must clearly understand which business they are dealing with.
3. Separate marketing efforts, ideally with distinct websites and promotional materials.
4. Separate accounting records and systems for both businesses.
5. Different ownership structures, such as involving a spouse or other family member in one entity.
6. Clear distinction in activities, such as maintaining gardens versus installing new features.
7. Transactions between businesses must be conducted at arm’s length, with appropriate recharges for shared costs.
8. Financial independence between the businesses, with no loans or asset transfers between them.
If there is a lack of clear separation, such as shared equipment or muddled accounting between the businesses, HMRC may determine that no genuine separation exists. This could result in retrospective registration, potentially going back up to 20 years, which could have severe financial consequences for the business.
Guidance and Best Practices
Although HMRC does not provide a detailed checklist for identifying financial, organisational, or economic links, their decisions are typically based on common business practices. HMRC’s Statement of Practice 4, issued in 1983, outlines factors that could indicate a connection between entities. Despite the considerable case law that has emerged since, this guidance remains relevant.
Conclusion
In the case of the garden maintenance and fencing businesses, there may be a valid argument for business separation due to the distinct nature of the services offered, the customer bases, and the materials used. However, each case must be considered individually, and the separation must be genuine to avoid issues with HMRC. Business owners considering splitting should ensure they have the proper procedures in place to maintain clear separation between their entities, mitigating the risk of VAT complications.
If you have any queries about how VAT splitting may affect your current or future trading activities please contact us.
Finally, we would like to wish Warrington Worldwide a Happy 25th Anniversary. As early contributors to the magazine we are proud to support Warrington Worldwide and look forward to continuing to do so in to the future.
WatkinsonBlack have considerable experience in all areas of taxation and business services. This includes providing a very cost-effective payroll bureau service, as well as assisting to ensure compliance with the latest Making Tax Digital legislation, including the Basis Period Changes. If you are employed or self-employed either as a sole trader, partnership or limited company, or are subject to self-assessment due to rental or other untaxed income, and want to arrange a no-obligation initial meeting on any taxation or accounting matter then please contact us by telephone on 01925 413210 or by e-mail to [email protected]
Please note that these ideas are intended to inform rather than advise and you should always obtain professional advice before taking any action.
