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VAT splitting – what you need to know

One of our most popular articles last year was on a couple who beat the taxman at the First Tier Tribunal on VAT splitting. Given how many times the piece has been read, we thought it would be a good time to revisit the subject.

VAT and VAT splitting

As you know, once the turnover of a business has passed £85,000 in a year or there is the expectation that it will, a business must register for VAT. In nearly all sales of goods and services, an additional 20% must be added to the price paid by your customer.

This, and the additional paperwork, acts as a huge disincentive for many entrepreneurs to breach the threshold because they believe, with some justification, that they will be putting themselves at a competitive disadvantage of price.

While VAT-registered businesses you sell to can claim the VAT back, non-VAT registered business and consumers can’t so, to them, your prices have just gone up by a fifth.

In the case we reported on last November, the couple concerned (Mr and Mrs Belcher) ran two businesses – one a barber shop and the other a ladies hairdresser. They ran the businesses out of their marital home (Mr Belcher at the front of the house and Mrs Belcher out of their converted garage), shared the same utility bills, phone number, and music licence.

They only filled in one self-assessment form between them for both businesses and their accounts were under one name. They even made purchases from their suppliers using the same account and the money they received from clients was paid into the same bank account.

Taken separately, neither business turned over enough to get past the £85,000 point – together, they did. HMRC claimed that this was an artificial separation of the same business with the specific purpose of avoiding the VAT and they backdated a claim of £136,961.26 for VAT owed.

To the surprise of many, the judge sided with the couple saying that it was normal for spouses to pool their money as household income and that each business received its own business rates bill.

What are the rules with VAT splitting?

In order to have the best chance of proving that two businesses are separate for VAT purposes, it is important for you to show that:

  • Both businesses are viable and, without the presence of the other business, each business could trade profitably
  • Both businesses should supply different customers
  • The activities of one business should not provide financial or organisational benefits to the other
  • Each business should have separate management, employees, equipment, and premises.

If you fail to prove that, HMRC have the power to claw back the VAT it believes it is owed over the previous 20 years.

Every case is subjective and will be treated on its own merits so there are absolutely no hard and fast rules on whether two businesses are separate entities where there are close ties between them.

VAT splitting – playing it safe

One of the reasons that the tribunal judge’s verdict on the case of Mr and Mrs Belcher was a surprise is that their situation and the way they organised themselves went against the advice a normal accountant would give. Remember, as accountants, we’re going to err on the side of caution and be ultra-conservative about how we interpret things – that’s our job and it’s the way we protect you from unexpected tax bills and HMRC enquiries.

It’s best to show clear demarcation between the businesses and the best ways to do that would be:

  • Separate business bank accounts.
  • Separate tax returns.
  • Different suppliers would be great but if you have the same suppliers, each business has its own account.
  • If one business uses the assets, goods, or services of the other business, it would be advisable to issue an invoice for whatever is used and to pay that invoice.

Get the latest advice and guidance on VAT from TWP Accounting

Contact your TWP partner on 01932 704 700 or email us at service@twpaccounting.co.uk.

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