6 March 2018
The Office of Tax Simplification has made proposals that could impact small businesses.
In 1973 Value Added Tax was introduced to coincide the UK’s accession to the Common Market, replacing Purchase Tax which had by that time become rather complex. It was hailed by the then Chancellor of the Exchequer, Anthony Barber, as a simple tax which ‘will avoid some of the ridiculous anomalies that were part of the purchase tax system.’ With hindsight this statement is laughable. VAT legislation is found in 42 Acts of Parliament and 132 Statutory Instruments, and there are currently over one hundred VAT Notices issued by HMRC giving guidance on aspects of the tax. Some complexities have been a source of public entertainment and newspaper headlines – many will remember the furore over the charging of VAT on hot takeaway food known as the Pasty Tax. The OTS itself quotes a curious anomaly whereby a gingerbread man with chocolate eyes is zero-rated while one with chocolate trousers is standard rated!
Whilst surmising that the country’s departure from the EU may present opportunities to change VAT rules, OTS has made recommendations to Government concerning several areas of VAT that it regards as over-complicated. These include multiple rates, partial exemption, the capital goods scheme, the option to tax land and buildings, and various special accounting schemes. The area that its report devotes most space to, however, is the threshold for compulsory registration (registration threshold), currently £85,000.
A simple concept
To put VAT into context, it is now the Exchequer’s third largest source of revenue after income tax and national insurance, raising £120 billion in 2016/17. Its concept is simple: at each stage in the supply chain a manufacturer, producer or supplier charges his customer with VAT – output tax. If the customer is a registered trader he reclaims the tax (his input tax). The tax thus cumulates at every stage that value is added and finally becomes the liability of the end user, consumer, or unregistered trader at the end of the chain.
A brake on the economy
It is this unregistered trader at the end of the chain that is the focus of a large section of the OTS’s report. There is compelling statistical evidence that many small businesses, fearing that they might be overwhelmed by administration or become uncompetitive if they have to charge VAT on their supplies, are deliberately keeping their turnover below the £85,000 registration limit. This applies particularly to tradesmen whose supplies are mostly to consumers (as opposed to other businesses) and consist largely of labour, therefore not having many taxable inputs on which to reclaim VAT.
In order to remain under the threshold these businesses use tactics such as deferring contracts to the next accounting year, avoiding expansion by not recruiting additional staff, or ceasing to trade for a period. Some, of course, demand cash payments from their customers and fail to account for a proportion of their sales. 55% of small businesses have a turnover below the threshold and the Office of Tax Simplification thinks that for them this is a disincentive to business growth that ultimately has a negative impact on the economy.
One very simple solution would be to reduce the threshold. The UK has the highest VAT registration threshold in Europe; in the EU the average threshold is £20,000. There would be beneficial consequences for the public purse. It is calculated that if the threshold were reduced to £25,000 between 1 and 1.5 million businesses would be required to register and the additional tax-take would be between £1.5 and £2 billion annually. Those traders that are avoiding registration so as not to have to raise their prices would see most of their competitors also being obliged to register, thus levelling the playing field.
It is recognised that such a change would impose a sudden administrative burden on small businesses. In these circumstances the OTS envisages a transitional period or smoothing process which could involve allowing these traders to retain a percentage of the VAT they collect, this percentage being gradually reduced to zero over a three year period. The administrative burden could be reduced by using or extending the flat rate scheme.
It does lead to the question as to how would the already overstretched HMRC cope with another 1.5 million quarterly returns, and what are the implications for Making Tax Digital, which, when introduced next year, will require all traders with a turnover exceeding the VAT threshold to submit quarterly accounting information?
Cloud Accounting packages have a role to play. The software available is easy to use and is relatively inexpensive. Whilst giving traders and HMRC the information they need, these systems also give small business owners the type of information that previously lay at the hands of their larger counterparts. This brings all sort of added benefits – giving more accurate financial information and, not least of all, helping them to become more effective at debt collection.
The Government has yet to respond formally to these recommendations but I think we can expect to see measures introduced in due course, probably in 2019 or 2020. Most likely is a reduction in the threshold. It is possible that over a million small businesses will find that their lives become a little more complicated. One man’s tax simplification is another man’s business complexity!
Value Added Tax is one of the most complex issues that businesses have to deal with on a day-to-day basis. If you would like one of our experts to review your VAT affairs, and to consider the Cloud Accounting tools to help you manage your obligations and to drive your business forward, don’t hesitate to contact me or one of your local UHY advisers to discuss your options.
Alternatively, fill out our contact form here to get in touch.