In conjunction with last week’s Spring Statement the Treasury has launched the consultation document, ‘VAT registration threshold – call for evidence’
The consultation follows the Office of Tax Simplification’s (OTS) 2017 report on VAT simplification which recommended that the ‘government should examine the current approach to the level and design of the VAT registration threshold, with a view to setting out a future direction of travel for the threshold, including consideration of the potential benefits of a smoothing mechanism.’
People may recall that shortly before the Autumn Budget of last year, there was much media speculation that the Chancellor would radically reduce the VAT registration limit but in the end Mr Hammond committed to holding the threshold at its current rate of £85,000 for the next two years from April 2018.
Why tinker with the threshold?
Since 1980 the threshold has increased almost every year in line with RPI inflation but, according to the government, business views on the subject are divided. Some argue that having a high threshold has the benefit of keeping the majority of small businesses out of VAT altogether, thereby avoiding all the administrative burdens associated with the indirect tax. Others consider that a lower threshold would reduce distortions of competition.
The OTS report found that the relatively high threshold has a distortionary impact on business growth caused by the practice of ‘bunching’, where small businesses deliberately limit their turnover to keep below the threshold and not have to register for VAT. The government suggest that it is also possible that by not investing, upskilling or innovating so as to remain below the threshold, small businesses may be limiting their productivity.
The lows and the highs
Once a business exceeds the registration limit, then they have to start accounting for and paying VAT. This requires businesses to spend time and money in ensuring they meet their VAT obligations, and charging VAT on their sales means they either have to pass this cost on to their customers or absorb it themselves.
Compliance costs of VAT should not be under-estimated. One survey found that for SMEs, over 40% of all financial costs of tax compliance and 50% of time costs are due to VAT.
Another research conducted by the Federation of Small Businesses suggest that their members find VAT to be the most time-consuming tax to deal with. One of the contributing factors here could be the different rates of VAT, i.e. zero, reduced and standard, as well as certain activities that are exempt.
Maintaining a higher VAT registration threshold would encourage growth because it keeps small businesses free from these burdens for longer. However, once annual turnover starts to get close to the threshold, some businesses employ a number of tactics, some legal and some illegal, to avoid the clutches of VAT, either by temporary cessation of trade, turning down work, splitting the business or non-declaration of cash-in-hand. Research suggests that around 20% of unregistered businesses take this type of action.
The OTS has suggested that having a higher proportion of non-VAT registered businesses could encourage others to operate in the hidden economy, reducing their compliance with other taxes. Government research indicates that increasing the perception of monitoring and auditing can have a positive impact on tax compliance, so by increasing the population of VAT-registered businesses might improve tax compliance generally. Furthermore, by reducing the threshold, this would make it harder for VAT-evading businesses to remain undiscovered.
Those businesses just above the threshold may be unable to compete with unregistered businesses which are similar in nature but have to charge their customers VAT, thereby hindering their growth.
Approximately one million businesses that operate below the VAT threshold are nevertheless voluntarily registered and therefore choose to incur the administrative costs of VAT because they believe the benefits of registrations outweigh that cost.
At the moment, the registration threshold is a simple cliff-edge, i.e. once the limit is breached then a business is compelled to register for VAT. There are ways however to make the transition for business more comfortable and smoother.
The OTS suggested two options for easing the business journey from not having to do any VAT accounting, to full VAT accounting
1.Extend the first period for which a business has to account for and pay their VAT obligations to 6 months, which is similar to the New Zealand system.
2.Apply the threshold test over two years rather than one. The test would be whether the taxable turnover of a business increased over £170,000 over two years rather than £85,000 in one year.
Another OTS suggestion would be to allow businesses a form of relief on their first VAT bills, decreasing over time. They also suggested a reduction in the Flat Rate scheme (FRS) rate that small businesses have to pay in the first years after registration.
The consultation document also sets out some international examples that could be considered for adoption into the UK VAT system.