Business VAT – Can I set up two businesses?

Because the VAT registration barrier has been frozen, there is a strong incentive to set up different legal organizations to trade below the limit.

Since 2017, the VAT registration barrier has been locked at £85,000, and it will remain so until at least 2024. Growing SME clients have an incentive to avoid registration by trading through two separate businesses, each with its threshold.

More clients and advisers are interested in the contentious topic of business splitting as a result of the yearly VAT registration threshold being locked at £85,000 since 2017. In other words, can we separate our business into two different legal entities so that each entity gets its VAT threshold? This potentially means annual VAT-free sales of £170,000-happy days! The incentive to keep out of the VAT club is enormous for a service firm that sells to the general public, or for a restaurant that has no connected inputs (food) but standard-rated sales (meals).

HMRC Powers 

If two different businesses have ‘financial, economic, and organisational linkages,’ HMRC has the authority to consider them as a single partnership/business entity.

However, there are three important facts:

• As long as the split was done appropriately, HMRC has the authority to correct the register at any time in the future. This implies that each entity has its bank accounts, trading identities, self-assessment tax reports, supplier accounts, and customer circle.
• HMRC must prove all three financial economics and organisational ties, not just one or two, according to the legislation.
• If the split was not done correctly, with record-keeping and trading issues jumbled up between the two firms, HMRC may try to register the combined businesses for VAT retrospectively, going back up to 20 years.

Family challenges

All inter-trading between two closely connected entities must be carried out on an arms’ length basis; i.e proper recharges are made for shared expenses and overheads. This outcome is harder to achieve when families are involved. There is not the same incentive to keep costs separate when money all belongs to the same family pot. The charging process can sometimes score a VAT own goal because will increase the taxable sales of the business making the charges.

The VAT issues are not clear out. Advisers and HMRC might reach different conclusions on the same case.

Practical tip – make sure your clients are focused in their mind about the commercial reality of the split. Always stand back and look at the important issue of customer perception. Do customers realise that they are dealing with separate entities when they part with their hard-earned cash? If the answer is ‘no’ there will almost certainly be a potential VAT problem lurking in the background.