VAT – Business Splitting

Alan Pink

It can be fiddly and time consuming, and HMRC don’t like it. But the device known as “business splitting” is still a very popular method of legally escaping VAT.

George Osborne has even, we’re sure inadvertently, made things easier in the March 2011 Budget by increasing the VAT registration threshold from £70,000 to £73,000.

So how does business splitting work (or, in some cases, not work)?

The registration threshold in this country is extremely high in relation to other European member states, and this is because, incredible though it may sound, our government really does seem to be committed to imposing less red tape upon us than is the case in other countries. One of the ways they do this is to provide a rule that anyone in a small way of business need not register for VAT or account for tax on their turnover. The £73,000 threshold applies on an annual basis, and once your business goes over this, broadly speaking, you have to register.

This is a very difficult threshold, commercially speaking, to find yourself crossing over, if the following applies to you:-

  • Your sales comprise a resale of your or your employees’ labour, to a significant extent; and
  • Your customers are not VAT registered, either because they are private individuals or because they are VAT exempt businesses.

Put briefly, going over the threshold makes you 20% more expensive in these circumstances, because there’s no way you can decrease your net sales turnover without decreasing your profit as well.

If you have two different business activities, though, and the turnover of those two parts are each below £73,000, you could consider putting the two business sections into separate entities. There’s nothing stopping one entity being yourself, and the other being yourself and your other half in partnership, for example, or one entity could be a limited company you set up, and so on and so on.

One inventive idea that a chain of laundrettes came up with unfortunately can’t be recommended, because it doesn’t work, however it illustrates the lengths that some people will go to to secure the advantages of splitting. They set up a separate company for each day of the week, so that Monday Limited had the turnover of coins pushed into the washing machines on that day, Tuesday Limited got Tuesday’s turnover and so on.

A more common, and arguably more firmly based, form of business splitting is the pub where, typically, the husband does the wet sales and the wife does the food. Because the food is probably turning over less than £73,000, this escapes VAT – or should do.

And that brings me on to consider the HMRC counter-attack.

The Counter-Attack

Obviously HMRC are not going to stand by and let businesses run a coach and horses through their tax collection system, and so the law gives them two weapons to counteract those situations that come to their attention.

It matters an awful lot identifying correctly which weapon HMRC are threatening to use, if you are in the unfortunate position of being identified by the VAT man as a possible business splitter.

The first, and far less damaging, weapon is the power they are given to direct that a number of businesses be treated as one for VAT purposes. A VAT man might visit a pub (they do, occasionally) and elicit the information that Mrs Landlord is running an apparently completely separate catering business from the same premises as her husband. He is then within his rights to write to them directing them to include both the wet and dry sales in the same VAT registration.

Collapse of the tax planning. However, this direction, which it is difficult in practice to fight against unless there is genuinely no link between the businesses, only applies from the date on which the direction is made. Therefore, you haven’t got a problem with having to find VAT on the food sales (to continue our example) for the last four years, plus interest.

So, although the party’s over, hopefully the hangover won’t be too bad.

The second weapon, though, is much more deadly. You will effectively be putting this weapon in the VAT man’s hands if all you do is “dress up” a single business as if it were two. If the VAT man can get a charge of “sham” to stick against your arrangements, he can and does go back and seek to claim arrears with interest and penalties.

So, what can you do to make things as hard as possible for the VAT Inspector, by showing that the businesses in which you are involved are genuinely separate?

Here’s a list of the features of genuinely separate businesses, the more of which are present, the more difficult it would be to claim that splitting them is a sham:-

  1. Open separate bank accounts for each business.
  2. Set up a separate set of accounting records for each business.
  3. Where practicable, give each business a separate image vis a vis the outside world, for example different names and different telephone numbers.
  4. Make sure there are genuinely different interests held in the separate businesses, for example an ideal situation is where one business is run, for example, by a partnership between two brothers, whereas another is just one of the individuals, and the two brothers genuinely each have an interest in the partnership one.
  5. Where possible, differentiate what the businesses actually do to the maximum extent possible.
  6. Where possible, base the different businesses in different locations.

We would stress that you don’t necessarily need to be in a position to have all of these “anti sham” protective features, and having all of them is probably something of a counsel of perfection. However, the more of these factors are present, the stronger your defence against any allegations of sham will be.

And with VAT now at 20%, we don’t see any lessening in the likely demand for this particular VAT avoidance device.

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