VAT - The"Cliff Edge"

If like us, you are a believer in the importance of entrepreneurial thinking; There is 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 system promotes.

The UK’s VAT registration threshold (currently £85,000) is the highest in the EU. The average in Europe is around £20,000 and in Germany is as low as £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 possible to run a substantial, viable business without every tipping over the line. Or, as some critics call it, the ‘cliff edge’. Fear of this has led to a phenomenon referred to 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 O.T.S. gave an 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 extra grand; Either by restricting their trading hours in the case of retail, or by limiting the number of jobs taken on.

On top of all that, VAT comes with an additional administrative burden. A study by PriceWaterhouseCoopers found that in 2017 British businesses spent an average 25 hours managing VAT – several full days work. And if you get it wrong, you risk a tax investigation and might end up facing a retrospective tax bill.

Now there’s Making Tax Digital for VAT to contend with too. If you’re under the threshold, you get a stay of execution; otherwise, you should have already subscribed to an MTD compliant software package or bridging software. No doubt you have been inundated with sales calls over the past months.

Those who can’t bring themselves to turn work away, may 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 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 ploy 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.

Is change on the horizon?

The Government is uneasy with the very idea of small businesses consciously avoiding growth and therefore never achieving their full potential because of bureaucracy, and has been reviewing VAT and the threshold system for the past few years. In Budget 2017 and Spring Statement 2018, Phillip Hammond expressed concern about the problem of the “cliff edge” and launched a consultation. There was a general expectation that in Budget 2018 the threshold would be reduced drastically – by £50,000, the rumours had it. But that didn’t happen. Instead, the current threshold was frozen and is not set to change until April 2022.

Decision time

Until the system or the threshold substantially change, we are where we are, and business owners/managers have to decide 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 ‘cottage industry’, staying under the VAT threshold could well be the best option. But if you find yourself feeling frustrated that you are having to 'pull at the reins' re growth – then it’s possibly time to consider pushing on through the pack, and hoping that where you end up is compensation for the temporary turbulence ahead.