Insights

Data obtained by the Financial Times relating to small business revenues appears to show a trend for business owners to stall growth rates to avoid having to register (and therefore pay) VAT.

A freedom of information request by the publication to HMRC showed that the numbers of companies generating enough income to meet the £85,000 threshold was lower in 2018/19 than in earlier years and yet inflation has been steadily rising which should have resulted in the reverse trend. It is prompting calls for the VAT registration threshold to be increased, because some analysts believe business owners are deliberately letting their revenues remain low to avoid the tax. Experts say this behaviour is a big factor behind the country’s low productivity.

Which businesses are most affected by VAT?

VAT is a very important source of Treasury revenues and yet small business owners who are selling goods and services to the general public will be keenly aware of its impact in pushing up prices. In a market where price based competition is becoming more cut throat and yet greater scrutiny is being placed on business owner record keeping, with real-time accounting policy like Making Tax Digital, one way to control the impact of taxes like VAT is to stay outside of the threshold.

Tradespeople and those selling services to the public are most typically affected, with VAT registered businesses selling to other businesses being less affected. This is because VAT registered businesses can reclaim VAT suffered whilst for those dealing with end consumers having to charge VAT increases their prices, which can either impact them getting the work in the first place, or if they cannot raise prices, eats away at profit margins.

How is VAT impacting business productivity?

Tax policy lobby groups state that the £85,000 threshold is much lower in the UK compared to equivalent European economies, e.g. in France and Germany, where the level of domestic product generated per hour worked, a general measure of productivity, is much higher. It is estimated that over 25,000 of the UK’s smaller sole traders, companies and partnerships may have held back on business growth in the 2018-19 tax year (the most recent for which data is available), in order to avoid VAT registration and the complexity and cost this brings. These conclusions are being drawn because in 2014-15 when the VAT threshold was £81,000, there were more businesses reporting comparable revenue levels than there were 4 years later, when the threshold increased. In the earlier period when these businesses would have been outside the VAT regime, 7,000 reported c£80,000 revenues and the number almost halved for those within the threshold. The same trend was visible when the level increased to £85,000 and the number plummeted.

Economists suggest that the current threshold of £85,000 could be particularly damaging to UK productivity levels. This is because it is high enough for many to consider the income they can generate is high enough to sustain a reasonable standard of living without having to register for VAT and so artificially remain below the limit.  Given that the Treasury can ill afford to walk away from such a good source of revenue by increasing the threshold, experts at the CIOT (Chartered Institute of Taxation) are recommending a compromise, with a tiered rate. Smaller businesses that only marginally meet the registration criteria would pay a lower VAT rate, thereby reducing the impact on their prices. The FSB (Federation of Small Business) want a higher threshold and are lobbying for it to be set at £100,000. Whatever happens any increase is not expected in the very near future because the government has said VAT registration will remain at the current £85,000 level until the 2026-27 tax year.

How is corporation tax increasing in April 2023?

Although the VAT registration threshold is not expected to change, corporation tax is rising very soon. From 6 April 2023 the new higher rate of 25% will commence for all companies that make profits above £50,000. It will be interesting to see whether this has the same effect as VAT policy in stifling productivity.

If you are concerned about the forthcoming increases to corporation tax, or if you would like specialist VAT advice for your business, please contact us via partners@rjp.co.uk.