Can I split my business to avoid the VAT threshold?

Business looking to split the company to avoid VAT threshold
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    Once your business reaches a certain threshold (£85,000 turnover for the 2023/24 tax year) you must become a VAT-registered business. Splitting a business into two separate ventures to stay under the VAT threshold may seem like a clever tactic, but HMRC take a dim view and consider it tax avoidance.

    Splitting a business to avoid VAT registration is called “VAT disaggregation” and can prompt a tax investigation. If HMRC isn’t satisfied that they are genuinely different businesses, the two businesses must combine for VAT purposes. The business owner may face backdated charges and penalties.

    Even if you decide to split your business for legitimate reasons, you may be subject to scrutiny. So it’s essential to understand what HMRC considers two genuinely different businesses.

    Read on for Jameco Group’s helpful guide on VAT disaggregation or ‘artificial separation’. Please get in touch to find out more and book a consultation with our VAT experts.

    What is VAT disaggregation, and is it illegal?

    VAT disaggregation refers to the practice of splitting a single business into two separate businesses to keep each below the threshold for VAT registration, thus avoiding the need to charge and pay VAT. It involves a limited company becoming two separate companies (or in the case of a sole trader, they may initiate distinct trades).

    While it’s not illegal to split your business structures as you wish, to do so for the purposes of VAT disaggregation is considered tax avoidance by HMRC, which certainly is illegal.

    Unless the business owner can conclusively demonstrate that the separate entities operate independently without significant financial, economic, or organisational connections, HMRC can enforce tax avoidance penalties. HMRC rules are stringent and aimed at preventing businesses from exploiting the VAT system to gain an unfair advantage.

    An example of VAT disaggregation

    Anna’s Art Studio & Design Consultancy generates a taxable annual turnover of £140,000, pushing her above the VAT registration threshold.

    To avoid registering for VAT, Anna divides her business into two separate entities; “Anna’s Art Studio” selling her artwork and “Anna’s Design Consultancy” providing design services. Both businesses are projected to earn £70,000 annually, so as separate ventures, they fall below the VAT registration threshold.

    Anna plans to operate Anna’s Art Studio as a sole trader business and establish a limited company for Anna’s Design Consultancy, splitting her business interests. The businesses share resources, including staff, equipment and studio space. The design consultancy often subsidises the art studio when art sales are low.

    If HMRC becomes alerted to Anna’s arrangement, they will almost certainly deem it a case of deliberate VAT disaggregation. The two businesses may be legally separate companies, but they are clearly economically and financially dependent.

    If Anna can’t prove they are genuinely different businesses, HMRC could force them to be combined for VAT purposes, a considerable bill (not to mention a dent in her professional reputation).

    Jameco Group can streamline your accounting processes to ensure your design agency keeps running at full efficiency.

    Will forming another limited company prevent my primary business from meeting the VAT registration threshold?

    While it’s true that splitting your business in two may keep them under the VAT threshold, it’s not a legitimate practice. HMRC is tough on VAT disaggregation and is actively on the lookout for any signs that a business is being split to dodge VAT.

    Deliberate VAT disaggregation is a complete no-no, subject to penalties and legal action. If you genuinely run two separate businesses for reasons other than VAT avoidance, it should be OK, as long as you fulfil HMRC’s criteria. They will look for evidence of financial, legal and operational independence (more on this below). But it is still risky.

    Cases often end up in court, where outcomes can be unpredictable. If HMRC thinks you’re playing the system and they win, they can force both companies to register for VAT, and it doesn’t stop there. They will likely backdate any lost VAT leaving you with a hefty bill.

    So, while it might seem like a clever workaround, the potential fallout is not worth the risk.

    Why do some businesses avoid VAT?

    Avoiding VAT is all about saving money, creating less work and being more profitable.

    Businesses that take the artificial separation risk usually do so to maintain lower prices and beat their VAT-registered competitors. This is particularly appealing for businesses operating in sectors sensitive to price changes, where customers might be discouraged by VAT-inclusive prices.

    Avoiding VAT also simplifies accounting and compliance, which can be an attractive prospect for many business owners, especially those who do their own accounts.

    What are the HMRC rules/ tests for business splitting?

    If you wish to separate your business for legitimate reasons, you must do so properly to avoid falling foul of HMRC.

    These are some of the factors they will scrutinise:

    Shared Bank Accounts: To properly split the business, they must have separate bank accounts. However, it’s important to realise that creating a separate bank account isn’t enough on its own to indicate a split business.

    Financial Interest: HMRC will assess whether the split businesses have a common business profit or other mutual benefit. They will also require evidence that both businesses can sustain operations without financial support from the other, especially concerning sharing capital or expenses.

    Common Staffing: Both companies having the same management and employees is a big red flag that a business is not legitimately separated.

    Same Offices: While shared working spaces are common, issues arise if one business bears the entire cost, effectively subsidising the other’s occupancy.

    Same Equipment and Tools: This is particularly relevant for mobile or site-based operations, where the use of identical equipment could indicate a lack of genuine separation.

    Common Marketing: The lack of separate websites and separate advertising will also alert HMRC that the two businesses are linked.

    No single factor determines whether your particular business split is acceptable, HMRC will look at them as a whole and make its decision.

    Can HMRC force VAT registration?

    Paying VAT is required by law, so yes, HMRC can force VAT registration if it concludes that two or more businesses are, in fact, one business trying to avoid becoming VAT-registered. They may invoke the “single entity rule” and insist that the divided entities be treated as one for VAT purposes.

    It is possible to contest HMRC’s decision; there are several cases where business owners have successfully argued for legitimate business separation in court. Demonstrating clear operational, financial, and organisational distinctions between the split businesses is crucial to countering claims of artificial separation.

    Penalties and fines

    In severe cases, businesses may face penalties as well as a backdated VAT bill, which could have severe consequences for a small business. Fines vary in severity based on the extent of the avoidance and the perceived intent.

    Get to grips with VAT with Jameco Group

    If you are trying to get your head around VAT, Jameco Group has you covered. We like to keep things simple and can help you understand your company’s VAT position. If you opt for our full bookkeeping and tax services, we can compile your quarterly VAT returns on your behalf to ensure you never miss a deadline.

    We don’t just stop at filing VAT returns; we also offer tax planning services to help reduce your overall tax liability. Our unique blend of experience, approachability and excellent customer service, along with our affordable and transparent pricing, makes us the ideal small business accounting partner.

    Do you have questions or concerns about VAT? Get in touch to see how Jameco Group can help your business overcome common financial challenges and thrive.

    James Wheeler, founder and managing directors of Jameco Group
    James Wheeler

    James has over 10 years of experience in accountancy and taxation. He has a real passion for business and truly believes SMEs are the heart of the UK economy. In 2017, he founded Jameco Group to provide first-class accountancy, taxation, and business advisory services to individuals and SMEs across the UK.

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