Artificial business separation

[Anonymous]

My Mother and her partner own a business supplying and installing aerial and satellite equipment to people in North Wales. The business is registered as a self employed partnership, not a limited company. This business has never had (and probably will never have) a turnover anywhere near the VAT bracket.
In 1999 Sky Television made changes to their payment systems that meant that all self employed independent installers needed to be VAT registered in order to make any money whatsoever from the subsidised “free” installations (and even then it was a tiny amount!).
I came up with the idea of making a second business just to deal with the Sky installations and registering that for VAT so that they could remain competitive in the local market for their services (if they couldn’t supply Sky TV they would lose out on a lot of business).
They don’t have an accountant so they spent a lot of time discussing this with the HMRC VAT helpline. They were told that this was definitely ok to go ahead with and that there would be no problem. Unfortunately they cannot remember, and have no records of the names of the people they spoke to all that time ago.
On the advice from the helpline they went ahead and registered a new business, again as a self employed partnership and registered it for VAT. I should state at this point that they have never claimed anything more against VAT than was allocated to that part of the business, so no intentional fraud there.
Now, 10 years later, HMRC have suddenly informed them that they are NOT allowed to do things this way as the INDIVIDUAL is registered for VAT not the business. They now want nearly £13,000. Most of this is for VAT on invoices from their original company that hasn’t been paid to HMRC. This VAT was NOT charged on the invoices, so they were not being intentionally fraudulent here either.
I have read as much as I can through the relevant points of the VAT act 1994 and I can see the following arguments:

– The legislation that they are bringing about this action under was put into place to combat companies who deliberately split up their business to AVOID paying VAT by keeping them under the VAT bracket. As I have stated earlier, these businesses (even combined) are NOWHERE near the VAT bracket.

– There might be some way to argue that the business is the ‘legal entity’ here, not the partners individually.

Please can you give me your views on this situation and let me know if you can see any other possible arguments or legislation that I have missed that might help?
Obviously I feel very guilty and responsible for this problem as the idea was mine in the first place.

Thank you very much for your time.

[Marie Stein]

Yes this definately sounds like a bit of a mess and I’m sorry that you’ve found yourselves in this situation. There are a few technical points that are relevant which I’ve summarised below.

First, HMRC are correct in that the VAT registration belongs to the person, not the business. In the same way that you have to submit tax returns as a limited company or partnership or individual, it is the legal entity that applies for VAT purposes. The legislation clearly states that it is the “taxable person” who is liable for VAT, not the business.

The disaggregation rules only apply if separate legal entities (eg a partnership and a sole proprietor) carry on business activities and the total of their joint income exceeds the VAT registration limit. But in your case, it sounds as though both businesses are run by the same “partnership”, ie your mother and her partner, in which case HMRC are correct in requiring them to account for VAT on all of their business activities. The disaggregation rules would only apply would be if there were 2 separate partnerships – perhaps one consisting of your mother and her partner, one consisting of your mother and yourself, or even one consisting of your mother and her partner and yourself (or other legal entities, eg a limited company etc). One way of confirming this is whether or not the VAT registered partnership has included income from both activities in its accounts and tax return. If the income from the 2 activities has been treated as income of different entities – eg 2 different partnerships, then the VAT assessment may be wrong.

But assuming that only one legal entity – ie the partnership of your mother and her partner – was involved, the important factor is that the partnership was registered for VAT and was therefore liable to pay VAT on all of their business income. Unfortunately I don’t see any way of getting around this, but there are a few things that might help to reduce the size of the VAT assessment:

• Assessments can normally only go back for 4 years, so check the dates that the assessment covers.
• Make sure that the assessment takes account of any input tax relating to the “unregistered” business activity over the relevant period.
• It might be worth asking HMRC if they would consider allowing the partnership to use the VAT Flat Rate Scheme (“FRS”) retrospectively. The FRS allows small businesses to calculate their liability using a single (usually reduced) VAT flat rate rather than calculating the difference between output tax and input tax. See VAT Notice 733 for further details about the scheme – it’s on the HMRC website. They don’t normally allow the scheme to be used retrospectively but in your case, it seems that there has been a genuine misunderstanding and it’s always worth asking.

As with all replies that I give here on the forum, the comments are only for general information and shouldn’t be relied upon as formal advice about your situation. I have real sympathy with small businesses as I know that they are normally working on tiny margins and often can’t afford to take formal advice or employ an accountant. But in cases such as yours, I strongly recommend that you invest in some help from a good local accountant to be sure that the VAT assessment is correct and to help ensure that future problems like this are avoided.

Marie
25 January 2011

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