As an independent VAT consultant, I deal with a wide range of businesses from those whose turnover is in the tens of millions to those whose turnover is in the tens of thousands. And based on that experience, it seems to me that one of the biggest barriers to growth is the VAT registration limit.
For larger businesses that are already registered for VAT, dealing with VAT is a routine function. The VAT reporting requirements are normally part of the businesses’ accounting systems. The addition of VAT to the net product/service cost is an accepted part of business pricing, even for their non-registered customers. Dealing with the tax is therefore part of their accounting and financial model.
But for very small businesses, dealing with the VAT registration barrier is not only a massive headache, but very often a real barrier to growth.
The maths is simple. If you register for VAT, you either have to add 20% VAT to your charges or you have to reduce your income by one-sixth by leaving your charges as they were and paying the VAT out of your existing income. And if your customers are private consumers who can’t recover VAT, they are often put off higher prices so you end up losing some or all of your customers.
Of course for some businesses registering for VAT can be beneficial as they will be able to recover VAT on purchases and expenses (input tax), so there can be some marginal reduction in costs. But the majority of small businesses tend to be labour intensive. This means that registering for VAT brings very little relief in the form of claiming VAT on purchases and expenses. For these businesses, often the VAT on their sales income (output tax) has to be mostly borne by the business because they can’t recover the VAT from their customers. And in the worst case scenarios, the business actually looses customers to cheaper businesses who aren’t registered and ends up with significantly less income than they had before registering.
And there’s another factor. For a business owner whose turnover is hovering just below or around the VAT registration limit – say between £70k and £80k – a lot of mental time and effort goes into trying to decide what to do about VAT.
An inordinate amount of time is spent thinking whether they can add VAT to their charges or whether they can afford to bear the cost of VAT from their gross income, so that their customers don’t have to pay any more.
So is a simple case of keeping out of the VAT club?
It’s not a simple issue and there are lots of different aspects to consider.
To begin with, the VAT registration has increased beyond the rate of inflation over recent years, from £70k to £77k in the past 2 years, so HMRC can correctly say that they are doing something to keep more small businesses out of the VAT net.
But it seems to me that the government could do more. Why not introduce a lower rate of VAT for small, labour intensive businesses. Many small businesses – such as builders or hairdressers – would be more likely to register and grow their businesses if they could pay VAT at 5% on say the first £100,000 of their sales income. Once they are registered and can focus their efforts on growing their business rather than keeping income below the registration limit, they are much more likely to be able to grow their businesses and pay more VAT to the Treasury. You’d think everyone would benefit from this sort of arrangement.
HMRC point out that there are some VAT schemes – particularly the VAT Flat Rate Scheme – designed for smaller businesses that can help to reduce the VAT cost for smaller businesses. But there’s no “ready reckoner” to help you here as the results depend entirely on each individual business. You need to do the sums to work out the numbers. And in some cases businesses can actually end up paying more VAT using a scheme than doing normal VAT accounting.
But whatever the facts, many small business owners believe that that registering for VAT will bankrupt them, so the easiest thing for them to do is to trade below the limit, even when they could otherwise expand their business. Such businesses owners are far more likely to try to come up with ways to avoid being registered legally, but then end up doing so “illegally”.
Most small business owners would like to trade legally but are stuck between a rock and a hard place.
So I’d pose two questions:
First to the government: Wouldn’t it be better for us as a nation to find a way for these hard-working and determined small business owners to grow their businesses without the VAT registration limit being a barrier?
And to the business owners: How much time and effort do you put into trying to trade below the registration limit where actually you’d be better off in the longer term by getting through the first year or two of registration when you know that you finances may be very stressed, but you can budget ahead and instead put that time and energy into finding more business?
If you do bite the bullet and become registered for VAT, you may find that the expansion in income will, in time, make up for any VAT that you loose.
I remember several years ago talking to a hairdresser, who had spent years working as a very small business and deliberately trading below the VAT registration limits. He ended up having to register and at the time it felt as though it was a major catastrophe and he’d end up going bankrupt.
But after the first 12 – 18 months, he started to see the benefits because not only was he no longer spending time and mental energy worrying about VAT, he realised that many of his customers were willing to pay a little extra for his services. And more importantly, it freed him up to expand his business, take on more staff and open up a couple of new branches over the next few years.
I appreciate that this won’t work for all or even most small business owners, but I’m just offering this as an alternative way of thinking about VAT registration.
So what should you do if you’re trading close to the registration limit?
First of all, make sure that you have to register. If your turnover is only going to exceed the registration for a short period of time or because of a single large value transaction or contract, then you may not have to register. See HMRC’s guidance on when you have to register VAT Notice 700/12: Should I be registered for VAT? http://tinyurl.com/dx6p52j
The most important thing is that if you do register, then make sure that you take every opportunity to minimise your VAT bills. These include the following:
• See if your business is eligible to use the VAT Flat Rate Scheme (see HMRC guidance here http://tinyurl.com/y8wstgk and VAT Notice 733 for further information http://tinyurl.com/cpj3aej ) as this may reduce your overall VAT liability. This scheme can be used by businesses whose turnover is less than £150,000. Newly registered VAT businesses also benefit from a reduction of 1% in their VAT flat rate for the first year.
• If you run a retail business, consider whether a retail scheme might save more money than the flat rate scheme or normal VAT accounting. There can be significant differences in VAT liability for even small businesses depending on your business type and trading pattern. See VAT Notice 727 Retail Schemes for more information http://tinyurl.com/3gkt6r8
• If you are doing normal VAT accounting, then make sure that you take advantage to recover VAT on pre-registration costs on your first return. See VAT Notice 700, The VAT Guide, section 11 for more information http://tinyurl.com/9ykqw .
• Smaller businesses with turnover up to £1.35m can also use the Cash Accounting Scheme, which gives automatic relief for bad debts – see HMRC’s guidance http://tinyurl.com/
• You can also reduce administration by using the Annual Accounting Scheme and have a look at the information given by HMRC for with information for newly registered businesses http://tinyurl.com/y8dqkrj
And finally, an oft repeated question: why can’t we just separate our business into 2 separate sections so that we don’t have to charge VAT for non-registered customers?
Everyone has heard of someone down the road/in the pub/through their accountant etc, etc who has set up separate companies or partnerships or separate husband and wife businesses and avoided registering for VAT by splitting up their business activities. And if I had a penny for every time someone has said to me “just make sure you keep your books and records separate, have separate bank accounts and use a separate room”…. Well I wouldn’t be rich but I’d have a good few pounds in the piggy bank by now.
There are very strict rules against this sort of “artificial separation” of business activities.
HMRC can and do pursue any such businesses rigorously, even if keeping the turnover below the registration limits is only a side effect. It is very difficult to find workable situations that fall within the rules. In some very limited circumstances it can work but these situations are rare and depend on a range of very unique situations.
THE ONLY WAY TO AVOID REGISTERING FOR VAT LEGALLY IS TO TRADE BELOW THE VAT REGISTRATION LIMITS.
So you may well be much better off biting the bullet and registering for VAT and trying to make up for any additional VAT costs by growing your business.
Of course if your customers are VAT registered and can recover any VAT you have to charge, that makes life very easy. However if your customers are private individuals, then of course things are more difficult. But if you have a loyal customer base and provide a good service, you may be able to increase your prices at least part way to cover the VAT. I’m not saying that this would be easy, but the point is that you might find customers are willing to pay a bit more.
I don’t agree with the rules and I think it’s quite clear that the VAT registration limit is a deterrent to small businesses growing. I think that the government should introduce a uniform low rate for small labour intensive businesses. But unfortunately, the rules are the rules and they apply to everyone who is in business. I’m not saying that it isn’t worth considering your options about VAT, but in reality your only practical and legal options are to trade below the registration limit or to register.