How do small businesses feel about the UK’s ‘cliff edge’ VAT threshold?

Greater Birmingham Chambers of Commerce

With small businesses accounting for almost half of all private sector jobs in the UK economy, and the Industrial Strategy having recently presented the government’s ambitions to boost the nation’s productivity, incentivising small business growth is at the forefront of agendas.

To this end, the government is currently consulting small businesses for their views on the current Value Added Tax (VAT) threshold in the UK, particularly whether the “cliff-edge” nature of the current threshold acts as a disincentive for small business owners considering expansion.

The UK’s current VAT threshold is intentionally high – the highest in both the EU and the OECD - so as to avoid placing additional administrative burdens on the majority of small businesses. However, once the taxable turnover of any businesses in a 12 month period exceeds the VAT registration threshold (which stands at £85,000 until March 2020), that business is legally obligated to register and account for VAT.

If a business can show that turnover in a 12 month period falls below the threshold, they can choose to deregister.

Only around 1.2 million businesses (out of about 5.7 million total businesses) in the UK are currently above the national VAT threshold.

Prior to reaching the VAT threshold, businesses may voluntarily register for VAT though – and it can sometimes be worthwhile, as once registered, businesses must charge VAT, but can also recover VAT on their costs. Businesses not registered are treated as final consumers for the purposes of VAT and so cannot do this.

Simply put, it can be worthwhile to voluntarily register a business for VAT, if the majority of the business’s customers are themselves registered. There are approximately 1 million voluntarily registered businesses in the UK.

Business views on the threshold are divided. Some argue that having a high threshold has the benefit of keeping the majority of small businesses out of VAT altogether, avoiding all the administrative requirements that accompany the tax.

The British Chambers of Commerce 2018 Business Taxation survey has recently shown that of the 133 West Midlands businesses surveyed, 66% identified VAT – over PAYE/National Insurance contributions, Corporation Tax, Year End returns and Business Rates - as having the biggest administration and compliance burden on their business, and 76% reported that the overall burden of tax admin and compliance had either slightly or significantly increased compared to five years ago.

In November last year, the Office of Tax Simplification (OTS) published a report arguing that the relatively high level of the threshold has a distortionary impact on business growth however, due to small businesses deliberately limiting turnover so as to remain below the threshold.

Ipsos MORI research (here) suggests that 20% of unregistered businesses that operate just under the threshold take steps to restrict their turnover. The percentage may in fact be higher.

The ‘bunching’ in front of the threshold and the very significant fall-off in business numbers immediately after it, reflects the significance to a business of crossing the threshold. Depending on circumstances, this can potentially increase all a businesses’ prices for customers by up to 20%.

This phenomenon raises concerns that by not investing, upskilling or innovating (so as to remain below the VAT threshold), small businesses might be limiting their productivity. Click here for the full OTS report.

At Autumn Budget 2017, the Rt Hon Philip Hammond announced that the government was not minded to reduce the threshold, but that it would consult on whether the design of the threshold could better incentivise growth, potentially through the implementation of a ‘smoothing mechanism,’ as suggested by the OTS.

This consultation arrived in March, and looks to gather more evidence on how the threshold may currently be affecting business growth, the specific burdens created by the VAT regime at the point of registration, and possible policy solutions.

I would strongly encourage any small business concerned about reaching the VAT threshold, any who have intentionally avoided reaching the turnover threshold, and any other interested readers to respond to the government’s call for evidence by the 5 June deadline.

Further detail on the consultation and where to respond can be found here.