Vat--- artificial split?

Vat registration sole trader/ limited company

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A client has registered for vat for her limited company which distributes beauty products to nail salons etc. Turnover is below vat registration limit at the moment but is likely to increase in the future

She also has a beauty salon which is run as a sole trader business and is not vat registered

As both businesses are run from the same premises and by the same person do both need vat registration?  I am concerned that if output vat is not paid on the salon business sales then there may be problems in the future with HMRC. Would it be prudent to contact them to clarify sooner rather than later?

thanks for any advice

Replies (14)

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RLI
By lionofludesch
22nd Apr 2022 15:38

My initial thought was that these are different businesses.

But the proof of the pudding will be whether the businesses are kept separate.

Are there any shared expenses or mixing of bank accounts ? Where clients tend to fail in these things is in that they just become lazy and can't resist paying an expense of one business with funds from another.

I wouldn't waste my time asking HMRC. They can't possibly give a guarantee as they'll never have enough information, nor can they be certain that things won't change in the future.

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Replying to lionofludesch:
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By YDUNLOP
22nd Apr 2022 15:58

Direct expenses for each business will be paid from the relevant bank account.
There are shared overheads as both businesses operate from the same premises, which would affect amount of input vat claimable I would have thought?

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Replying to YDUNLOP:
RLI
By lionofludesch
22nd Apr 2022 16:10

YDUNLOP wrote:

Direct expenses for each business will be paid from the relevant bank account.
There are shared overheads as both businesses operate from the same premises, which would affect amount of input vat claimable I would have thought?

Of course. You and the business owner are best placed to see whether the businesses can be kept separate. It's hard work and the pits to fall into are numerous. The business owner needs to be aware of the risks. I don't necessarily agree with Les. I see where he's coming from but I wouldn't see "pay the VAT anyway, whether it's due or not" as being the best advice I could give.

Is there a possibility of running the two businesses from different premises ? If not, are they rented ? If so, can they be sub-let ? Premises costs might be the biggest problem. But you don't disclose enough information to say.

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Replying to YDUNLOP:
VAT
By Jason Croke
22nd Apr 2022 16:13

YDUNLOP wrote:

Direct expenses for each business will be paid from the relevant bank account.
There are shared overheads as both businesses operate from the same premises, which would affect amount of input vat claimable I would have thought?


This is one of the risks HMRC will have.

The VAT registered business can reclaim VAT, the salon cannot. So how do you guarantee that any VAT reclaimed only belongs to the VAT registered business?

Direct expenses paid by each business makes sense, shared expenses are in reality the expense of ONE of the trades and then that trade should recharge a portion to the other trade. Who pays the rent? Who pays the utilities? All of these are then recharged to the other on a fair apportionment basis.

If all the costs are in the salon (not VAT registered), then the recharging of the utilities and rent would count towards the VAT threshold, so if the salon is hovering around the VAT threshold, adding in another £5k-£8k of recharges to the retail business could trigger a VAT registration for the salon.

It would have made more sense to not register the new retail business for VAT, if selling B2C most traders would want to avoid VAT registration. If this business is wholesale/B2B then registration of course makes sense but then opens the wormy can of artificial separation.

There are two distinctly different trades here, the issue is one isn't registered for VAT but both are sharing the same resources and that creates links which HMRC can use to attack, so break those links.

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chips_at_mattersey
By Les Howard
22nd Apr 2022 15:51

I wouldn't ask HMRC. They are not going to provide 'advice,' just refer you to their website.
As a cautious adviser, I would just amalgamate the two businesses into one limited company.

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By Paul Crowley
22nd Apr 2022 16:02

I would never put my clients head over the parapet to see if it gets shot
You and client need to figure out whether they are genuinely separate businesses

Does salon buy from the distributor?
Does it pay for those products?

There needs to be a clear mind set confirmed by actions and evidence that the two activities are completely separated

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VAT
By Jason Croke
22nd Apr 2022 16:06

As Lionofludesch has posted, the biggest issue is the client gets lazy/sloppy.

They are clearly different trades (beauty salon vs retail beauty products) but to me, the issue is the goods are stored on the premises and presumably the admin/dispatch of those goods take place on the premises.....so the premises are shared....which makes creating an arms length between each business very difficult.

Where is the lease/license agreement for the retail goods business to occupy the premises of the salon? Who pays for the electricity? Presumably the salon, but then the retail product business cannot just get "free" electric as that removes the arms length.

The starting point is to assume the hair salon trade and the beauty products trade are arch rivals and enemies, so there is no problem with them sharing the office but both sides would want clear contracts in place, likewise, bank accounts would not be shared, any Director/company loans from one to the other would be clearly documented, market rate recharges for shared resources like gas/electric, business rates, rent, etc.

It takes effort and this is where it usually falls down.
HMRC guidance link below, HMRC have to prove there are financial economic and organisational links (all three have to be proven), organisational is already achieved as its the same owner, economic links would be sharing the premises and financial links could be where the retail business only sells product to the salon and so the retail business is entirely dependent upon the salon for customers, so you need to think about how to create space between the two trades, space at every level....Are they sharing the same telephone number?, Are they advertising the retail products on the salon website or vice versa?

Nothing is impossible (but some set-ups are more do-able than others), it is all about creating space/arms length at every turn, HMRC can still attack at anytime but if there is sufficient separation then it's harder for HMRC to get all three conditions met.

here https://www.gov.uk/government/publications/statement-of-practice-4-1983/...

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Replying to Jason Croke:
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By YDUNLOP
22nd Apr 2022 16:56

Thanks to you all for your replies. I can see that the issue is not that simple but your advice has clarified what I was intending to do re inter- business transactions eg charging the limited company for use of shop premises and charging shop for use of limited company stock. It would be simpler if the stock was held at a different location and I may suggest this to the client. There would be less input vat claimable on overheads but could avoid output vat being charged on the shop sales at some point should HMRC decide that the separation is artificial

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Replying to YDUNLOP:
VAT
By Jason Croke
22nd Apr 2022 17:24

You state that there would "be less input VAT claimable on overheads"......well if all the overheads are with the salon then there would be no input VAT reclaimable because the salon is not VAT registered.

As the retail business is the new trade, then I am assuming the salon is the existing trade and so this is why I conclude that all the overheads are with the salon (the rent, the utilities, the telephone, etc).

The right to reclaim input tax is only ever on the basis the costs were incurred i) by the business and ii) for a taxable business purpose.

If all those overhead costs are incurred in the salon and presumably address to the salon, then none of these costs are recoverable as only the salon can reclaim that VAT (as the supply is to the salon, not the beauty products business) and the salon cannot reclaim that VAT because the salon activity isn't VAT registered.

....hence the only input tax the NewCo can reclaim will be on direct costs such as purchasing stock/shipping, etc. Any costs recharged to it by the salon would not be VATable as the salon isn't VAT registered.

Sorry if that sounds pedantic or me "picking up" on your language but this is the sort of precision that is required here. The salon business is not the beauty product business, you cannot just reclaim some VAT in the beauty business based on the utility bill incurred by an entirely separate business (the salon).

The VAT registered business can only reclaim VAT where invoices are directly addressed to it and only where those invoices relate directly to the activity of that business.

Most Accountants will steer clear from advising in this area because if you get involved, advise and get it wrong, then the penalties will be on you. Even as a VAT specialist I am very very careful in how I advise in these situations and for your average unregistered hair salon (already high on HMRC's risk radar due to rent a chair arrangements) the risks of advising on splitting the business properly don't reflect the fees needed to justify the exposure/risk to the practice.

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Replying to Jason Croke:
RLI
By lionofludesch
23rd Apr 2022 17:32

Jason Croke wrote:

You state that there would "be less input VAT claimable on overheads"......well if all the overheads are with the salon then there would be no input VAT reclaimable because the salon is not VAT registered.

Ah yes - Who is Supplying What to Whom ?

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By Winnie Wiggleroom
27th Apr 2022 10:16

All of the above is of course very accurate and detailed advice.

The very first thing I like to say to a client in this situation is - "how does this look from the customers viewpoint". In other words does Mrs Jones walk into Kool Kuts for her fortnightly blue rinse and Mrs Kuts says "by the way you can buy this super product from us as well now" or is there a clear separation. That could be a different address, a different phone number, different customers and suppliers, it does not have to be all of those things but the point is that there has to be clear independence from each other right the way through the operation.

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By petestar1969
27th Apr 2022 10:19

Hmm, are we sure the VAT-registered company selling the beauty products isn't just a vehicle to try and recover input tax incurred by the salon via "recharges"?

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Replying to petestar1969:
VAT
By Jason Croke
27th Apr 2022 11:14

We might think that, it may be true, it is certainly what HMRC will think.

But, there is nothing wrong with having two different or similar activities and companies/sole trader businesses, but they must be kept well apart on economic, financial and organisational levels to avoid HMRC attention.

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By Watson Associates
27th Apr 2022 10:47

I would also make sure there are other people/directors/shareholders involved in the Company.
Everything mentioned above re keeping things separate is ok until the client gets greedy! Trust me it will usually happen!

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