Q:
My daughter has Gents and Ladies hair salon,gross takings approx £85K over the past 12months.She has already had a letter from Inland Rev about VAT. Her ex-husband who works for an accountants, has set up up a Ltd company for the Ladies.(this is the 3rd one he has done for her, the previous 2 folded) I’m her father,and I do her present day to day accounts,but I am very concerned as to this arrangement, he has done this to save her paying VAT,
I’m sure the VAT man would not accept this arrangement, as in my view could be seen to be avoiding VAT deliberately, and she could get prosecuted etc.
My daughter is torn between me and her ex, he has named himself and my daughter as directors of the new company (he wanted me to be a director), he says would not be involved in the running of the business.
I am not prepared to be involved with the business in case I was seen to a part of it. I do all the financial accounts, including the wages at present.
There are four staff plus my daughter, all of whom cut both gents and ladies, her ex says’s he can split the business because the ladies is in an adjacent room, and has it’s own door. although the whole salon is one building, my daughter also lives above the shop. At present, she is self employed, and I pay all the taxes from her account.
Her ex has opened a new separate bank account, with another bank. I believe there is a figure, which hair salons can use as a fixed VAT calculation,( is it 15%). In would rather her register for VAT and put her prices up, either that, or cut her staff, and come below the VAT limit. rather than have the taxman after her.
Please let me know if additional information is required.
Any advise would be welcome.
A:
Hello
Thanks for your query. I understand your frustration and concern about your daughter’s situation. I know that all small retail businesses have a very difficult time dealing with VAT and it seems very unfair to me that a small business which keeps four people employed as well as the directors should have to pay 1/6 of its income to HMRC as VAT.
I’ve seen many such situations over the years and unfortunately there is no easy way of dealing with them. Obviously I can only provide some very general guidance here on the forum, not specific advice, but I do know from experience that trying to separate businesses to avoid VAT normally causes more hassle than is worth the money it saves.
First of all, it’s important to know that HMRC have built up a lot of experience and knowledge about practices of certain trade sectors and what they might do to avoid VAT. This includes hairdressers. They are VERY well aware of the things hairdressers and other small retailers/service businesses do to avoid paying VAT.
Plus your daugher’s business is already on HMRC’s radar and she should have been registered for VAT from the time her turnover exceeded the registration limit. So she could already have an outstanding VAT debt from the date she should have been registered.
And frankly, I doubt that they’d accept the ex’s proposed set up. This is because one of the effects of separating the business into two separate companies would be to avoid the need to register for VAT.
HMRC don’t have to prove that separation of the business is done just to avoid VAT, all that they have to do is show that the VAT saving is a consequence of separation of the business
HMRC Guidance
I’d suggest that you look at the guidance given by HMRC in fact notice 700/1: Should I be registered for VAT? Section 13 of the notice http://tinyurl.com/5ss6ofh sets out HMRC’s statement of practice about artificial separation of businesses. It confirms that the separation of business activities where one of the effects is to avoid the need to be registered for VAT or to reduce the VAT bill could be regarded as artificial. Even having separate entrances, rooms, bank accounts isn’t normally sufficient. There are several more aspects to consider. And I certainly wouldn’t recommend anything along the ex’s proposals if I was formally advising a client on the subject.
Alternatives?
Unfortunately I’m not aware of any ways of dealing with this other than the ones you’re already thought of – ie by downsizing the business so that the turnover falls below the VAT registration limit or seeing if the VAT bill can be reduced by using the fixed percentage calculation.
This is called the flat rate scheme. Basically the way it works is that instead of calculating the VAT liability by taking one sixth of the turnover (i.e. the output tax) and offsetting this by claiming a deduction for VAT incurred on purchases and expenses (i.e. the input tax), you simply apply a basic flat rate fixed percentage to the turnover, but don’t claim any input tax.
Information about the flat rate scheme is here http://www.hmrc.gov.uk/vat/start/schemes/flat-rate.htm and you will see that the fixed-rate percentage for hairdressers is currently 13%. What you need to do is to calculate whether your daughter/s business would be better off using this fixed-rate percentage or by calculating its VAT liability using the normal method.
Obviously, I don’t know the exact details of your daughters income and expenditure, but I thought it would be helpful to give you some indication how much the Flat Rate Scheme might save.
Comparison of VAT liability using FRS
Based on turnover of £85,000, the output tax under the normal method would be just over £14,000. I assume that the business does not incur very much input tax as most of its costs will be staff related, but there will be some VAT on the cost of utilities, telephone bills, equipment, towels etc. For the sake of this illustration, let’s assume that the annual input tax would be £1500. This means that the VAT liability under the normal method would be (£14,000 minus £1500) 12,500.
By comparison, the VAT liability under the flat rate scheme would be just over £11,000. This would mean an annual saving of £1500 per annum. Not a huge saving but at least if you look at the figures, you’ve got a better idea of how much VAT could be involved. One point is that HMRC don’t normally allow retrospective applications for teh flat rate scheme so if your daughter should have been registered in the past, she’d have to pay VAT under the normal method on any past income.
I hope these comments help you with your daughter’s situation. I appreciate that you are in a very difficult position here, given the family relationships involved and the fact that services such as hairdressing very price sensitive. Even increasing the cost of a hair cut by 50p or a pound to cover the cost of VAT could put customers off, or make them take their business elsewhere. Everybody knows some hairdresser who isn’t registered for VAT and can provide the same service as a lower price and it is a very price sensitive business. But since the merger between the VAT office and the Inland Revenue, the VAT office has full access to information about all businesses income and they do look into these things as a matter of course nowadays.
But it sounds as thought your daughter should already be registered for VAT and she will end up with penalties from HMRC if she doesn’t deal with the situation as soon as possible. I’d strongly recommend finding a good local accountant who can help her sort things out and decide what to do in the future.
Marie