VAT matters for small business
Written by Ray Coman
Every twelve months the cumulative taxable turnover of a business is tested against the VAT registration threshold. Once gross income has gone over the threshold a business has 30 days to register for VAT. However, businesses below this threshold can register voluntarily. Businesses that benefit from voluntary registration should seek to register at the earliest chance. Where this is not the case, it could be possible to at least delay registration by re-arranging working arrangements. This report explores the options in commonly encountered scenarios by the self-employed.
Drawbacks of voluntary VAT registration
Separating a distinct business activity into a company
Loss making businesses, hobbies and anti-avoidance
VAT caused by subletting surplus commercial space
Drawbacks of voluntary VAT registration
Traders beneath the VAT threshold typically consider two main risks about a voluntary VAT registration. B2C business can operate on better margins through staying unregistered. This is because the end consumer bears the brunt of VAT. A VAT registered business would be indifferent to being charged VAT since VAT payable to its supplier reduces VAT otherwise payable to HMRC.
The hassle factor can be off-putting. The lower the VAT paid to supplier, the less the pay-off from a VAT registration. VAT brings with it a quarterly filing requirement through MTD software. HMRC penalties apply for late payment and other non-compliance. The size of any VAT reclaim might not warrant the time and aggravation required from a VAT registration.
Separating a distinct business activity into a company
A person is assessed to VAT on all income regardless of its nature. However, as a company is a separate ‘person’ for VAT, a trader can separate two income streams by incorporating one part of the business.
As an anti-avoidance provision, HMRC require that the business activities are sufficiently distinct. An artificial separation of the business through a company would occur where the sole or main purpose is tax avoidance. An example of artificial separation occurs where a second branch is opened in a new location. The business offering is identical to the old branch, and separate assessment of the new branch would confer an unfair advantage. So, a high street chain would charge VAT in a new branch even though that branch, regarded independently, had not yet exceeded the VAT threshold.
Loss making businesses, hobbies and anti-avoidance
A commercial intention should be demonstrable for the separation for VAT purposes to stand up to HMRC scrutiny. A hobby type of business might not have sufficient profit motive, and this a particular risk for activities that give rise to VAT refunds.
A common and well established fraud involves registering for VAT with the sole aim of recovering VAT on purchases of a non-business nature. HMRC are alert to this practice and VAT refunds on the first Return of a newly registered entity are routinely subject to HMRC inspection. Some businesses will take longer to establish a profit, especially in the field of research and development. A profit motive is harder to prove while the business is in loss, and more so if it has no track record.
Pre-registration input VAT can be recovered on services six months prior to registration and on assets four years prior to registration. Postponement of VAT registration until income streams are more established will make profit motive easier to demonstrate. Loss of VAT recovery would be reduced where capital outlay comprises the bulk of the reclaim: Shop fit, catering, gym, van, dentist and other professions requiring specialist equipment are examples.
VAT caused by subletting surplus commercial space
Increase in income does not necessarily bring corresponding increase in profits. A trader can take on more space than required to improve control over business premises: Counsellor, masseuse, physiotherapist, fitness instructor, dance school, and other types of activity that bring a collective of the professionals under one roof often face VAT challenges. The combined activity of being self-employed in a chosen field and a commercial landlord of surplus workspace could bring income over the VAT threshold.
Subletting of commercial space is normally VAT exempt. The landlord would need to notify HMRC of an option to tax to bring that activity into VAT. However, if the rental is not separated from other business activity by bringing it into a separate company, recovery of VAT could be impeded by the rules on partially exempt activity.
In practice, if the sub-lessor would only recover any VAT on rent paid to the extent that this relates to a VAT registered business . A letting business is usually exempt, unless the landlord has commercial space and explicitly requested an option to tax from HMRC. Usually therefore, VAT would not be recoverable (for instance on rent paid) to the extent that it relates to space which is sublet. Floor area and/or time spent would be a reasonable basis of apportionment.
In another scenario, if tenants are VAT registered, opting to tax the property business would allow the sub-lessor to enjoy better margins. Other business activities that the sub-lessor does not need and does not want to charge VAT should be conducted via a separate company. This is subject to the other activity being sufficiently distinct.
VAT caused by subcontracting
Subcontracting work can bring a trader over the VAT registration threshold. Turnover for determining if a trader has exceeded the VAT threshold will depend on the extent to which the trader is operating as agent (rather than as principal.) Agency is determined by who the client regards as his or her supplier. A further key factor hinges on the degree to which the trader carries out the work: Estate agents, casting agents and recruiters are all types of business in which the services of the trader are assessed separately. An estate agent could charge VAT even though the property is exempt from VAT.
A builder could seek to add value by offering a team to cover greater scope of the project. A firm of builders will price on the combined fee of all tradesmen and therefore likely to breach the VAT threshold. Therefore, a homeowner can seek to obtain a price advantage by hiring individuals who are not VAT registered. While a keener price point can be achieved through each tradesmen contracting direct with the homeowner, the builder compromises control and likely margin by facilitating such an arrangement.
Comments
This would result in an exposure to VAT equal to whatever has been invoiced divided by 1.2. For instance, £166.67 would be payable on an invoice for £1,000. Any VAT paid since the date that the business should have been registered for VAT will be deducted from the above to determine VAT payable.
In some cases, especially where the clients is a VAT registered business (as opposed to a private individual) it is practical to credit note the original invoice and re-issue an invoice including VAT. This will ensure that you are not out of pocket.