Written by the AAT Comments – 15 May 2024

Accountants weigh in on the problems the VAT ‘cliff face’ is causing their clients – and the economy.

The VAT threshold is significant because, once it is reached, suppliers must pay 20% VAT. SMEs and sole traders nearing the VAT threshold face a difficult choice: reach the threshold and register for VAT – meaning they must increase prices to account for the rate, and risk losing customers – or actively limit business growth to avoid reaching the threshold. This is unsurprisingly having a chilling effect.

Many small businesses and sole traders are struggling with the threshold, not least due to high inflation, increased business costs and overheads and the need to remain competitive. Small businesses that are VAT registered are at a huge disadvantage compared to non-VAT registered competitors.

The current VAT threshold for 2024/25 increased to £90,000 in April this year. Usually, the VAT threshold rises in line with inflation, but until recently it had been frozen since 2017, at £85,000.

Measures some businesses are taking to avoid reaching the VAT threshold limit include:

  • Working a four-day week.
  • Temporarily closing the business if turnover is nearing the threshold limit.
  • Turning down work.
  • Being selective of the work that’s taken on.

There’s also anecdotal evidence that some are asking to be paid in cash to avoid declaring income to HMRC.

We spoke to accountants about the issues the VAT threshold poses for clients and what some businesses are doing to legally avoid reaching the threshold.

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This unfair system massively stunts growth

Ed Stittle, Chartered accountant, Founder, ESDG Accountancy

The VAT threshold mainly affects small customer-facing businesses. That’s largely tradespeople such as plumbers, beauticians and electricians for example, who can’t easily pass on increased costs to customers. It’s a cliff edge. Once a sole trader exceeds the £90,000 threshold, they’re suddenly 20% more expensive than their competitors.

It can also be a real barrier to hiring, particularly once you’ve added insurance, additional materials and so on. And many are instead deciding not to grow their businesses – therefore not taking on employees or apprentices. None of this is good for the UK economy: businesses having to avoid the threshold results in less tax revenue for the government and stunted business growth.

Clients often ask me about how to avoid reaching the VAT threshold. My answer is usually either to commit to growth and accept VAT as a business cost, or the other extreme: work less and restrict growth, which isn’t ideal.

One plumber client now skips work on Fridays to avoid having to register for VAT. The Flat Rate scheme is something I’d recommend. This offers partial relief and a simplified system, but still doesn’t go far enough and is still ultimately a cliff edge.

You also have to be significantly over the VAT threshold to get any benefit and be in a position to claim input VAT – which most small businesses aren’t.

A better solution would be to make everyone register for VAT at much lower thresholds so it’s fairer. It would prevent a business £1 over the VAT threshold faced with being 20% more expensive than their competitor who is £1 under. It would generate more VAT revenue for the government and that surplus revenue could be used to reduce the 20 per cent VAT rate.

Verdict: Many clients are having to avoid the VAT threshold but this massively stunts growth – there needs to be a fairer system.

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The difference between £89,000 and £90,001 can be £14k in VAT

Alan Broome, Director, Acumenica Group

The VAT registration threshold is a huge cliff edge. The difference between £89,000 in turnover and £90,001 can actually be as much as £14k in VAT. B2B business can largely defray this by passing the cost on to the consumer who can, of course, reclaim it. B2C business find it much harder to deal with and must either absorb it as a cost, or pass it on to the customer, making them less competitive.

It’s common for business butting up against the registration threshold to restrict activity so that their turnover remains below the £90k mark. We’ve seen businesses turn away work, or close down for a few weeks so as not to exceed the threshold.

Others will try to be a little creative and look at splitting their business into two so that both are below the threshold. This is doomed to failure as this is known as artificial disaggregation and HMRC don’t like it.

We’re also aware that less scrupulous businesses will insist on cash payments from customers so that this activity doesn’t go near any official books.

Verdict: VAT registration threshold is a cliff edge that causes financial issues for small businesses: the difference between £89,000 and £90,001 can be £14k in VAT.

The VAT threshold hugely disadvantages smaller businesses

Wendy Ross, Founder and Director, Tonbridge Accountants

There are two key barriers to VAT registration. One: prices need to increase by 20%. For businesses selling to non-VAT-registered customers, this has a significant impact. Where customers cannot reclaim any VAT, the cost to them is 20% more. If selling to VAT-registered customers, the impact isn’t significant, as they can reclaim the VAT. For smaller businesses that are in direct competition with non-VAT-registered peers, this can be a huge disadvantage.

Two: Businesses don’t always have the finance processes in place to handle the administrative burden. Since the introduction of Making Tax Digital for VAT, all VAT-registered businesses must keep digital records and file the returns using HMRC-compatible software. This can be an additional cost, if you are not already using software. Also, every transaction has to be captured and recorded using the appropriate VAT rate and supported by documentation, such as a VAT invoice. If suppliers make a mistake with the VAT on their invoicing, additional time is spent correcting the error.

There’s a real mix as to how businesses approach reaching the VAT threshold. Some are selective about what jobs they take on while other business owners take time off and take on less work. However, a lot of businesses just choose to deal with issues as they arise or pass the threshold without realising, which can cause big problems.

I believe that the current VAT threshold is suppressing the economy. Data shows there’s over £100m of lost revenue from businesses capping their turnover at the VAT threshold level. The way the system is designed, a lot of businesses are much worse off being just over the threshold than they are staying under it and this really is preventing growth.

Verdict: VAT threshold is suppressing the economy and putting smaller businesses at a huge disadvantage.

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Some businesses may be tempted to avoid VAT threshold by fraudulent means

Natalia Micu AATQB, Freelance Accountant and Management Accountant, Novenary

Even though the VAT threshold has increased from £85,000 to £90,000, the biggest barrier is the cash flow. When any of my customers express the desire to register for VAT, I sit down with them and explain the ‘two baskets variance’.

The ‘two baskets variance’ is where, when making sales, rather than putting all the money in one basket, you distribute 80% in one and 20% in another. This ensures you have enough to pay the taxman at the due date.

For those not wanting to hit the threshold, you can either work less or turn down work. It’s potentially possible to incorporate a new company so turnover can be split and does not reach the threshold. However, this is not something I’d recommend as it’s not a practice HMRC condones and can be seen as potentially fraudulent.

My biggest concern is that some business may be tempted to avoid the VAT threshold by fraudulent means such as receiving cash directly for services and then not declaring that as income.

Verdict: Some businesses may be tempted to avoid VAT threshold through fraudulent means.

Small businesses are having to turn down work

Mike Block, Director of VAT, HW Fisher

Small businesses that deal with B2C customers will be more wary of crossing the threshold than those who sell to B2B customers as they aren’t able to recover the VAT. Once they register, they have two options: increase their prices (typically by 20%) to cover the cost of the VAT, which can make their business less attractive to its customers, or keep their prices the same and absorb the cost of VAT themselves, which can affect their bottom line.

Small businesses find themselves at a cliff edge whereby a business with income of £84,500 pays no VAT, and one with a taxable income of £85,500 pays a minimum of £14,250 if it is unable to pass on the VAT to its customers. Given these figures, many small businesses in the UK actively ensure that they remain under the VAT threshold by turning down work.

Verdict: Many small businesses are having to turn down work to remain under VAT threshold.

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If you are a small business and would like more information and advice, Best Accountancy are always willing to help – 01752338600

You can also read on by visiting the AAT website – The VAT threshold limit is a big issue for small business – AAT Comment