As if the prospect of on-streaming businesses in line with HMRC’s Making Tax Digital (MTD) initiative for VAT wasn’t enough, as if scenario planning for the UK’s exit from the EU weren’t also a consideration, HM Treasury has set the hares running on VAT by opening a consultation on lowering the VAT threshold. According to HM Treasury’s call for evidence on the current VAT regime, there is growing evidence that the cliff edge nature of the threshold – no liability for VAT for those businesses with turnovers under £85,000 but a 20% rate for those trading above – acts as a disincentive for small businesses that might otherwise expand.
Around 3.5 million of the UK’s businesses have turnovers under the current VAT threshold. Out of those, one million are registered voluntarily while not actually liable for VAT. Out of the 2.5 million businesses that are unregistered, it is believed that 20% artificially restrict their turnover, according to an Ipsos Mori study, cited in the Treasury’s call for evidence.
However, the actual number artificially limiting their turnover may be higher, the government reasons, since businesses are unlikely to willingly admit to illegally suppressing turnover. The VAT threshold and the desirability of lowering it to increase the VAT take has been discussed for years, says Neil Gaskell, tax manager at ICAEW.
“What the Treasury is looking for is examples,” he says. “Why has a business stayed below the threshold? Is it to avoid a higher rate or is the threshold as it currently stands a natural cutting off point for that business? There are numerous reasons why a business might not grow beyond a certain point.”
At more than double the average for the EU and OECD countries (£29,000), the UK’s threshold for VAT is generous compared to other nations. That does create a massive distortion in terms of competition, says John Forth, indirect tax partner with RSM. “HMRC has always quite liked the high threshold,” he says. “It allows them to limit red tape – and there is the simplification element for a lot of businesses.
The pressure to lower the threshold because it is out of kilter with other countries and therefore anticompetitive has historically come from the EU.” But the cliff edge nature of the current regime is anti-competitive within the domestic market. VAT-registered businesses operating just above the threshold are at a disadvantage compared to similar businesses operating just below it – a factor limiting growth for those larger businesses. Moreover, in the Treasury’s view, small business directors focused on restricting turnover instead of growing it are necessarily avoiding investing in skills or engaging in new markets.
Clearly, this is an issue with political ramifications – and a timing issue. In his last statement, the chancellor committed to leaving the threshold at £85,000 until 2020, Gaskell points out. Any change would come after the introduction of MTD for VAT in March next year and – as long as negotiations follow the planned timetable – after Brexit.
One outcome to probably rule out is that the threshold will rise, Gaskell argues. The exemption already represents a significant loss in tax to the government – £2.1bn for 2017-2018, by the Treasury’s reckoning. The argument that the threshold acts as an artificial brake on business growth is one that carries some weight within the profession. Businesses that limit their opening hours or turn away work to remain exempt are obvious examples.
This kind of adverse impact is particularly a factor in the business to consumer environment, says Forth. “Businesses like these don’t want to increase prices. Typically they will share the pain, passing on part of the cost.” The impact of a lower threshold will vary depending on your businesses sector. “If all your clients are VAT-registered, it would make very little difference to you,” says Mark Gold, tax partner at Silver Levene. “If you are gardener, the situation is very different. Who is going to absorb those costs?”
However, he is less convinced that entrepreneurial, growth businesses in general are holding themselves back due to the threshold. “People want to grow their businesses; they want to do well. Artificially staying under a limit – it’s not going to get them out of their responsibilities on income tax or other administrative areas.” As well as increasing the tax take, the government argues that lowering the VAT threshold would help tax authorities police the black economy. The Office for Tax Simplification has noted that having a high proportion of businesses under the threshold and therefore unregistered could encourage off-the-record activity. “Behaviourally, you can see people blurring the lines,” says Forth. “The threshold drives the wrong kind of behaviour, but there is a positive message that needs to be put across: trade more, earn more and you’ll do better in the long run.”
Whatever the drivers, changing the VAT regime will not be straightforward – politically or practically. The OTS has suggested extending the first period for which a business has to account and pay VAT from three months to six, with more conventional VAT reporting brought in gradually. There is also the model applied in Finland, whereby the VAT rate increases gradually in line with an increasing turnover, so that its introduction comes as less of a shock to the business. A third option would be an extension of the UK’s current flat rate scheme, whereby once a business reaches the VAT threshold it can agree a flat rate of tax on its income.
The flat rate scheme is at present very sector-specific. “I suspect HMRC would look to an option like that. It’s a model that works for businesses – you wouldn’t go on it unless there was a benefit,” says Forth. What the government shouldn’t look to do is introduce a sudden and dramatic decrease in the threshold to, say, £60,000. While that is likely to capture those businesses engaging in off-therecord activity and failing to record all their sales – sudden falls in reported income can be difficult to explain away – this kind of move would come with a cost. “Politically, it would be hugely damaging to impose a 20% rate at that point, and bad for businesses,” says Forth.
Making VAT digital
In the meantime, barring a complete failure of the VAT pilot, MTD looks increasingly likely to come on stream as planned in March 2019, Gaskell says. For a business to make the transition successfully, it will need to ensure accounting software is compatible with the HMRC VAT portal, so the relevant data is transferred. Concerns remain that not all VAT registered businesses are aware of the changes and that many others will still be working in the realm of manual records.
“A significant amount will have agents who will assist them and many will be making a transition to a secure online access for the first time,” says Gaskell. The move to MTD may not be easy for larger businesses either, he says. “There may be difficulties linking numerous different systems. Some businesses have many accounting systems. All of them need to be digitally linked and that will present a practical difficulty for large businesses. Some may be overseas, some may be in different currencies.”
However, a new generation of VAT-registered businesses may be helped rather than hampered by the introduction of MTD, according to Ed Molyneux, founder of accountancy software business FreeAgent, who believes VAT registration and accounting is less burdensome and worrisome than a decade ago. “A lot of small businesses would have handed that over to accountants at some expense,” he says. “Nowadays, pretty much any package of accounting software will do that for you – if you’re doing it right as a software vendor.” Whatever the outcome of the consultation exercise, concerns remain that lowering the threshold increases red tape for smaller businesses and may act as a deterrent for some. “We are a nation of SMEs,” says Gold. “A lot of people when they go into business are testing the water and VAT is a huge administrative burden.”
Brexit and VAT
VAT rates and governing law: VAT as well as customs duties are in the frame for change in a post-Brexit world, as both are based in EU law. Once Brexit has taken place, EU VAT law and rulings of the European Court of Justice will no longer have direct effect in the UK, giving the UK government scope to bring in changes to VAT – and this could include changes to VAT rates – something that the current EU VAT regimes rules out.
VAT on imports: Another key potential change hinges on whether the UK will remain in the single market or not. If it leaves, it seems likely that formal procedures around bringing goods into the UK from suppliers in the EU27 will be reintroduced. These procedures are likely to be in line with procedures that govern the imports of goods from outside the EU. According to ICAEW, it seems likely that this will bring about an increase in duty deferment guarantees to cover VAT and customs duty imposed. Another possibility is that the UK reintroduces postponed accounting for import VAT, which would operate in a similar way to acquisition VAT or the reverse charge for services.
VAT refunds: Following Brexit, UK businesses are unlikely to be able to make use of an electronic facility enabling them to recover VAT incurred in EU countries. Claims will need to be submitted to the tax authority of the country in question, complying with the EU 13th Directive refund scheme.
Place of supply rules: Changes introduced in the EU in 2015, making the place of supply the country where the customer belongs rather than where the supplier belongs, will not be affected by Brexit. These rules affect all business-to-consumer supplies of broadcasting, telecoms and electronic services. VAT will still need to be charged and accounted for in relation to these kinds of supplies to customers in the EU27. It is not yet certain whether HMRC will be able to continue operating the UK Mini One Stop Shop scheme to facilitate this, or whether UK businesses will need to register for an alternative scheme in an EU27 country. For more details, see the ICAEW Tax Faculty guide to tax implications of Brexit.