Does the VAT registration limit deter small business growth?
As far as the government is concerned, in an ideal world, everyone would declare all of their income and pay all of their taxes at the right time. Every business that should be registered for VAT would be registered and there would be no need for VAT inspections or assessments because there would be no underdeclarations of income or mistakes on VAT returns.
And as someone who tries to do my bit and feels that we should all contribute, when we can, to the cost of our society and keeping the country running, I agree with that sentiment.
The problem is that while large businesses and wealthy individuals can afford to pay for expensive advice to help them reduce their tax bills, whether VAT, corporate tax and income tax, I’d guess that around 95%, if not more, of the population can’t afford to pay for such advice and don’t get the benefit of legal tax planning
One of the effects of this is that the most profitable businesses and most wealthy individuals pay a significantly smaller proportion of their income/profits as tax than the rest of us. With HMRC’s ongoing campaign against tax avoiders and evaders, it does seem as though the focus is on the 95% plus of the population who can’t afford to buy expensive planning advice. And I get so frustrated when I see HMRC come down on small businesses who are struggling to stay afloat.
We all know that there are some business owners who regularly avoid paying taxes in a systematic way. Understating income; splitting businesses up to stay under the registration limit – we’ve all heard clients say that competitors are making more money because of not being VAT registered, or not declaring certain income. And I know it’s wrong. But I can understand why people do it and until there is a better way of dealing with VAT for small businesses, it will continue.
But I also believe that the VAT registration limit doesn’t only cause avoidance in small businesses, but also acts as a real barrier for most small businesses growing
Let’s think about this. Suppose you run a small hair salon with 2 or 3 part time staff. To cover the cost of the rent, running costs, other business expenses such as accountants fees, staff salaries, NIC and other costs, you need to generate minimum income of say £60,000 each year. You only get a salary if your income exceeds this amount so if your income is say £80k each year, your gross salary is £20,000. Not a particularly large amount. But it keeps you under the current VAT registration limit of £81,000.
But business is booming and you want to take on a full time stylist and expand the salon. So let’s say that you need income of £100,000 a year to meet your costs. You’re pretty sure you can generate the business, but you’ll have to register for VAT. However, £100,000 turnover means that you have to pay an £16,667 VAT to HMRC each year.. Your net income, from which you have to pay your existing costs of £60,000, pay yourself a salary and find money to pay a full time stylist is reduced to £83,333. You might be able to claw a little bit of that back by claiming VAT on your costs, but most small businesses are labour intensive, so your income after VAT would still not be enough to pay the salary of a full time, or maybe even a part time stylist. So why bother?
HMRC point out that there are schemes to help small businesses reduce their VAT liability. In particular, the Flat Rate Scheme allows hairdressers to calculate their VAT liability at 13% of their gross income, which means that you’d only have to pay £13,000 VAT and you’d keep £87,000 of your income. But this is still nothing like enough to pay for the additional costs of expanding the business, so you don’t bother.
If the government is serious about helping small businesses to grow, then it has to do something about the way that the VAT registration limit prevents small businesses from growing.
The government would probably say that EU regulations make it difficult to change the way that the rules work and I understand that they have to work within the framework of the EU VAT system. But they need to spend some more time considering various options – what about a much lower rate of VAT for labour intensive businesses – say 5% for the first £100,000 of income, with tapering rates on the next £100,000 so that businesses only pay the full VAT rate of 20% (or the appropriate flat scheme rate) on income above £200,000. And I’m sure that there are other workable ways of reducing the burden on small businesses while staying within the EU framework.
Either way, if HMRC wants to prevent avoidance and REMOVE A SERIOUS OBSTACLE TO SMALL BUSINESS GROWTH, they will have to reform the VAT registration limit.
What do you think about this issue? I’m always interested to hear of specific situations where the VAT registration limit has prevented a businesses from expanding.
Marie
September, 2014