By Ruth Corkin, VAT and indirect Tax Principal
I awoke this morning to some chatter on the radio about the possibility of VAT provisions in the Autumn Statement. Being a VAT nerd, I immediately zoned into what the political commentator was saying. Nothing about rates but a quick one-liner about the “cliff-edge” for businesses being required to register for VAT.
This piqued my interest even more, as I was part of the team at the Office of Tax Simplification (“OTS”) that looked at this very problem in 2017. So, 6 years later, I thought I would revisit the issue and try and dispel some myths.
Myth number one- Being VAT registered is a disadvantage for small businesses.
The research conducted by the OTS team revealed that nearly 45% of the VAT registered businesses had registered voluntarily, pointing to the fact that being VAT registered was not a major issue. This figure may have reduced since the introduction of Making Tax Digital (“MTD”) for VAT, as a number of smaller businesses didn’t want the hassle of MTD reporting. However, the fact remains that the reasons for small businesses being VAT registered are many and varied.
Myth number two- Increasing the VAT threshold would encourage growth in small businesses.
There is a Government petition doing the rounds to double the VAT registration threshold to help smaller businesses grow and avoid the cliff edge. However, research has shown that the higher the VAT threshold, the steeper the “cliff edge” once registration becomes necessary.
Academic research (“VAT Notches, Voluntary registration and Bunching” Liu and Lockwood), showed that there was a tendency for bunching just below the threshold to avoid registering for VAT. This meant that practices such as closing the business for a period, particularly amongst sole traders was prevalent.
The OTS report commented on the raising of the threshold to £500,000 and it was estimated that this would potentially impact 800,000 businesses. Of those between 400,000 and 600,000 may choose to deregister. However this would reduce the income to The Treasury by £3bn-£6bn, further reducing the UK’s VAT efficiency ratio further and necessitating the raising of other taxes (or the standard rate of VAT) to cover the deficit.
Lowering the threshold would catch more businesses in the VAT net, potentially increasing the cost of living, but having a high threshold that encourages VAT avoidance is not the answer. It would also reduce competitive distortions. During the research many VAT registered businesses commented that the unregistered businesses were able to under cut them because of the VAT issue.
So what is the answer? Increasing the threshold could assist businesses, but they would inevitably reach the threshold at some point and the cliff edge would remain. It would also increase the tax burden on everyone to recoup the lost revenue if businesses deregister for VAT because the threshold is so wide.
Reducing the threshold would lead to more businesses being subject to VAT and a potential increase in the amount of VAT being paid by the public. It would, however provide headroom to give assistance to small businesses and those hardest hit by paying VAT.
The OTS also considered the type of assistance that could be given to mitigate the impact of a reduction in the VAT threshold. Whatever assistance is given to businesses that are suddenly caught by a reduction in turnover would also have to be given to those businesses that are already voluntarily registered.
For businesses making supplies to other businesses there is unlikely to be an impact as the customer would recover the VAT. However, those businesses making supplies to consumers or other persons not VAT registered would bear the brunt of the VAT cost as it is a cost component of their supply.
Whilst the UK was part of the EU, the UK could not provide assistance to sectors of businesses, but this has now largely gone away post Brexit (although State Aid could still be an issue). In other jurisdictions, newly registered businesses are able to keep some or all of the VAT on their supplies for a period of time to mitigate the cliff edge. This is then tapered until they are paying across the VAT charged to the Tax Authority, thus giving time for businesses to adjust and manage cashflow.
This would, however increase the administration by HMRC to monitor the taper however that is introduced. However, there is taper relief for other taxes in the UK, so not an entirely new concept.
Other options considered included a 6-month first VAT return to allow businesses to have longer to collect and pay the VAT due or to apply the turnover test to two years instead of one.
Overall, from a Government economic point of view, the reduction in the threshold would be preferable, but there does have to be some assistance for those that find themselves caught in the VAT net, either as a business or as a cash strapped consumer.
