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Dilemma: Register for VAT or split the business

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16th Aug 2016
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The VAT registration limit can be a real deterrent to business growth, because a business owner may have to increase income by up to 20% just to pay the VAT.

Split option

In principle, one way to stay below the VAT registration limit is to split up - or disaggregate the business - by hiving one or more parts of it into separate ownership where one or both parts trade below the VAT registration limit.

But these arrangements often don't work in practice, and the business owners end up with a lot more hassle, worry and cost - in addition to their VAT bills - than any potential VAT saving. So where do so many business owners go wrong? Is it possible to make such split business arrangements work?

Key issues

The key to disaggregation is that there are two distinct VAT technical issues: separate ownership and separate business activities.  

Separate business owners

This is where two (or more) distinct business activities are owned by different people, and where one or more of the owners aren't registered for VAT. If HMRC believes that all of the various activities are owned by and under the control of one "owner", the "owner" has to pay VAT on all business income from the date on which the combined turnover exceeded the VAT registration limit.

Separate business activities

In this situation, HMRC may accept that certain activities have been performed by separate people, but there is only one business. HMRC must prove that the owners are "financially, economically and organisationally" linked. HMRC doesn't have to demonstrate that the motive for separating business activities was avoiding VAT registration.

A good example is where a VAT registered husband runs a pub and the non-registered wife sells the food in the pub. In this case, HMRC can direct that there is one business activity, which means that the VAT registered owner has to pay VAT on all the business income; pub wet sales and the food.

Real example

A partnership owned an unregistered business for several years that traded below the VAT registration limit. The same partnership recently bought a pub as a going concern and are now registered for VAT. However, the partners haven't paid VAT on income from the original business, on the basis that it is a separate business activity.

The partners discussed the situation with a HMRC officer, who agreed that the businesses were separate activities. The partners believe this means that they don't have to pay VAT on income from their old non-registered business.

In this case, the issue isn't whether there are two separate businesses; the point is that both businesses are owned by the same partnership. This means that the partnership is liable to pay VAT on income from both business activities from the date on which it registered for VAT for the pub business.

How to disaggregate successfully

The main problem is that business owners often try to re-arrange their affairs for VAT purposes without following through the other commercial, tax and legal issues. Any business re-organisation must be done properly so that the new owners trade with each other on a normal, commercial basis.

For example, the pub owner could charge his wife for the use of the pub's facilities, perhaps based on a percentage of her sales. They should also retain separate bank accounts, insurance policies, charging for the use of premises, telephone etc. with separate accounting records and annual accounts.

There is no point setting up such separate business arrangements if they aren't put into practice. Many such arrangements fail because the business owners forget to issue invoices, or collect payment from each other. I've even seen situations where income from proposedly separate businesses was paid into a joint bank account. Sometimes I wonder whether the time and effort involved in creating and maintaining separate businesses is worth any potential VAT saving.

Bite the VAT bullet

If your client’s long term aim is to grow their business, it is probably simpler to bite the bullet and register for VAT. That way, the business owner can focus on finding more business rather than trying to avoid dealing with VAT.

Also, remember the 20% VAT cost doesn't take account of VAT which can be reclaimed on purchases and expenses. This could reduce the 20% additional cost significantly. The VAT Flat Rate Scheme for small businesses and the VAT retail schemes can also help to reduce the overall VAT bill for the business.

But if your client is determined to remain outside the VAT net, make sure that the business arrangements are set up properly and are commercially viable. Also those arrangements must be properly implemented.

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Replies (19)

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By [email protected]
17th Aug 2016 07:40

Great article Marie

Whats your opinion on a limited company (sole trader sole director and shareholder) setting up a seperate business to the existing sole trader business, would this pass the financially, economically and organisationally argumnet

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Replying to [email protected]:
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By johnjenkins
17th Aug 2016 12:04

The same rules would apply, so just by having a Limited Company (even though it is a separate entity) would not exempt vat registration.

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Replying to johnjenkins:
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By robobhoy
17th Aug 2016 12:50

Are you sure jj?
Are you saying that 2 separate ltd coy's under common control can't have separate vat registrations?

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Replying to robobhoy:
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By johnjenkins
17th Aug 2016 15:18

No that isn't what I'm saying robobhoy.

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By robobhoy
17th Aug 2016 15:31

OK jj............well what are you saying?

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Replying to robobhoy:
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By johnjenkins
17th Aug 2016 16:04

I thought my post was quite clear. Please tell me what you don't understand about it?

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By robobhoy
17th Aug 2016 18:14

Pffft........so, J Bloggs (Building) Ltd and J Bloggs (Repairs) Ltd. Both owned and run by same person.
(Building) Ltd turnover is £200k and is vat registered.
(Repairs) Ltd turnover is £50k and is not vat registered.

The above structure is ignored and HMRC would aggregate turnover for vat purposes.

IS THAT WHAT YOU ARE SAYING JJ?

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Replying to robobhoy:
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By johnjenkins
18th Aug 2016 10:08

The question was:- If a sole trader traded as a sole trader and a ltd company, would the fact that the sole trader was trading as a limited company make any difference. I pointed out that the fact that just because there is a limited company involved, that mere essence of having a limited company would not make any difference to the rules.
Let's look at your scenario. J Bloggs building Ltd charges J Bloggs repairs Ltd for whatever. J Bloggs repairs has to pay the vat:- sounds good business sense to me.
Where ownership is one person customs will always seek to amalgamate, although if two ltd companies are both owned by the same person and both vat registered any transaction between to two are vat exempt.

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Replying to johnjenkins:
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By robobhoy
18th Aug 2016 10:57

Sorry jj..i really don't understand your latest post.
I'm not talking about the vat status of any inter-company trading (??)
Anyway, i think i'll leave it. Wish i hadn't bothered with the original comment.

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Replying to robobhoy:
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By johnjenkins
18th Aug 2016 12:02

My point about the Blogg's was a bit of banter.
A normal person cannot split their income into bits for vat purposes (Unless vat exempt trades). Nor can Limited Companies. However if you are a 50% shareholder (not with your wife) in a vat reg Ltd co. you can have a ltd co under your own name 100% shareholder (say turnover £50K) without registering. You could still get a challenge from Customs though. In Blogg's scenario customs would look to VAT reg both companies.

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By leon0001
17th Aug 2016 15:37

I am afraid that Mr Harra is really gullible if he believes what he has been told about small self employed traders and landlords by advisers who have absolutely no knowledge or experience of these people.

Apart from the unnecessary and onerous burden being imposed, I am horrified by the assumption that the whole system will be operational in 18 and a half months from now.

The consultation isn't closed until late November and systems have to be specified, designed and tested.

Us agents have to review every case, advise our clients of their new responsibilities and then agree who will (or will not) be dealing with various aspects. There will be a change to our workload, the timing thereof and staffing requirements.

In addition, we, and/or clients will have to acquire the necessary software. As at today, no software has been approved by HMRC and we don't know when it will.

And all this will be in place by April 6 2018? I doubt it.

I would get on my hands and knees and beg Mr Harra to think again and particularly:

Delay by another year
Start with VAT registered businesses
Leave the smallest cases until last.

If this is left to happen on the proposed timescale, I predict that Mr Harra will have to carry the can for an unmitigated disaster.

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Replying to leon0001:
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By johnjenkins
17th Aug 2016 16:03

You really want to make sure people see your post don't you Leon. Have you put this on every thread?

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7om
By Tom 7000
17th Aug 2016 15:56

The Grand Folkestone v HMRC is what you need 27 pages of which 21 argues whether it is or not business splitting .

Its also on page 21 of ICAEW taxline June edition

FTT said it was one entity was the result

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7om
By Tom 7000
17th Aug 2016 16:59

read the Grand Folkestone Hotel v HMRC case
27 pages of which 21 is on business splitting

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7om
By Tom 7000
17th Aug 2016 16:59

read the Grand Folkestone Hotel v HMRC case
27 pages of which 21 is on business splitting

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Replying to Tom 7000:
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By johnjenkins
17th Aug 2016 17:19

Tom have you got hiccup[s

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By carmenfer
18th Aug 2016 12:30

good article Marie,

i also think you can separate the company from the shareholder to have the most benefits

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By miketombs
18th Aug 2016 14:04

One really simple tweak would be to automatically turn on agent authorisation when an agent applies to register the client for taxes. With a new limited company for example we will typically register them for PAYE, VAT and notify HMRC that they have started trading for CT in one go, but still we have to separately register for OAA.

Also, we are part of the Beta testing for PAYE and for a handful of clients we only have limited access (including for our own company!) although we have always applied for OAA in the same way, never with a FBI2. Another gripe with that trial is that CIS isn't automatically included with PAYE although they are so integrated.

It does need some sort of client approval but if we could register for full access to all the taxes using the UTR and the client gets a code to BLOCK access if they so wish to be used within say 7 days before access is activated, the whole process would go more smoothly.

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By miketombs
18th Aug 2016 14:09

I had one client (who we subsequently fired!) who had a second-hand goods business. He wanted to split the ground floor and first floor of his premises into separate businesses to keep them below the VAT threshold.

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