In the Spring 2024 Budget, the previous government raised the VAT threshold from £85,000 to £90,000, having frozen it at £85,000 for six years. This means a business must register for VAT if its taxable sales have exceeded £90,000 in any rolling twelve-month period. Furthermore, you must register if the sales will exceed £90,000 in the next 30 days. But can you avoid VAT Registration by conducting business through two entities?
HM Revenue and Customs (HMRC) refers to this as business splitting, also otherwise known as disaggregation. It is the process of legally restructuring a business into two or more entities to take advantage of multiple VAT registration thresholds.
If you are successful in business splitting, it will allow one or more businesses to be exempt from VAT. That’s the whole point. If a small business does not have to register for VAT, it can keep its prices competitive, especially if the customer is a member of the public.
Using business splitting is completely legal, but it requires careful planning. HMRC has the authority to challenge business structures if it suspects that the split is not genuine or properly implemented.
What is business splitting?
Business splitting is a strategy often adopted by a business approaching the registration threshold that does not want to register if possible. This is because its sales are standard-rated, and its customers cannot claim input tax.
In order to be successful at business splitting you must show there are no links between the two businesses as follows:
- financial links, e.g. having the same bank account; and
- organisational links, e.g. having the same person running the businesses; and
- economic links, e.g. sharing the same office space.
The key word here is ‘and’; in other words, HMRC has to prove all three links to issue a direction.
An example
Meet Sheila, a dedicated yoga teacher who spreads her positive energy through classes in multiple locations in the county. She runs her business as a sole trader, bringing in about £70,000 yearly.
Sheila is excited about her plan to organise exclusive yoga and meditation retreats in the UK for women over 50 years of age.
Sheila anticipates having 10-12 people attend each retreat, costing roughly £3,000 per person per retreat. She’s optimistic that hosting three retreats yearly will make her business financially worthwhile.
At full capacity, Sheila’s business could bring in a turnover of £108,000, but she is hoping for a minimum of £90,000 annually. Combining both businesses will mean that Sheila will have to charge VAT to her clients who are attending the classes, and she doesn’t want to do this. Her clients are individuals, and a 20% increase in the price will be a lot for some of them.
Sheila’s Accountant has, therefore, advised her to keep both businesses separate and form a limited company for the retreat business.
So how can you avoid VAT registration by conducting business with two entities?
HMRC have strict rules to restrict business splitting so if you are going to split your business then it needs to be for a genuine reason. The two or more businesses must be able to operate as separate businesses.
It’s important to have legitimate business reasons for splitting the business. In Sheila’s case, the client base for each type of business will be different. Additionally, the services offered will provide a completely different experience and cater to different price point.
Here’s a short list of things you need to bear in mind. However, it is not an exhaustive list:
- Customers need to clearly understand the business they are engaging with.
- The activities of the two entities should be separately distinguishable from each other.
- All promotional materials, including websites and social media accounts, should be kept separate.
- Separate bank accounts, supplier accounts, and sales invoicing procedures should be established for each business.
- Completely separate records should be kept when it comes to bookkeeping.
- There should always be two types of business entities. For example, a sole trader and limited company, a husband and wife as partnership in one business, with only the wife as sole trader in the other, etc.
- There should be commercial recharging of any shared costs, e.g. laptops, software, cars etc.
You can end up having big problems with HMRC if the processes and records of the separate entities are muddled, i.e., there is a lack of discipline and focus to ensure a proper separation.
For example, if Sheila were to use the same yoga mats for her classes (owned by the sole trader) in her retreat business. So, to keep it simple, she should ask the attendees of the retreats to bring their own mats. That way, things won’t get muddled.
If there is a mess and muddle, HMRC could conclude that there have never been two separate businesses and seek retrospective registration going back up to 20 years based on combined sales. That would be a disaster! Not at all the Zen life Sheila was hoping for.
In reality, Sheila needs to ensure that the two businesses are separate and have not been artificially split to avoid tax.
If you want to learn more, the full details from HMRC can be found in their manual.
If you have any specific questions on this topic, please contact your normal manager. If you are not yet working with us, here’s how we work.