VAT threshold under the microscope

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By Donald Drysdale for ICAS

23 March 2018

When an increase or decrease in the VAT registration threshold was mooted last year, a sharp reduction in the limit seemed the most likely outcome, as Donald Drysdale explains.

A call for evidence

Chancellor Philip Hammond’s Spring Statement of 13 March didn’t say much of immediate interest to the man on the Clapham omnibus. However, a call for evidence from HM Treasury on the design of the VAT registration threshold may pave the way for changes for the majority of Britain’s small businesses.

For some businesses supplying particular types or mixes of goods and services, VAT compliance can be fraught with difficulty.  However, for many businesses with straightforward affairs, the process can be a relatively simple procedure.

All this is about to change with the imposition from April 2019 of mandatory online accounting and VAT reporting for all businesses registered for VAT. The UK’s smallest businesses fought fiercely to be excluded from the onerous administrative burdens about to be imposed by Making Tax Digital (MTD).

They were apparently successful. The Government bowed to pressure, restricting MTD to VAT alone in the first instance and exempting businesses not registered for VAT. Businesses with annual taxable turnover below the threshold (currently £85,000) were therefore let off the hook.

The existing registration threshold

In the words of Mel Stride, Financial Secretary to HM Treasury: “The UK has a high VAT threshold for a reason. It has the benefit of keeping the majority of small businesses out of VAT altogether, therefore helping our small businesses avoid the administrative burden of accounting for VAT.”

There are 5.7 million businesses in the UK. Of 4.5 million of these which have annual turnover below £85,000, 1 million are registered voluntarily for VAT.  This leaves 3.5 million small businesses that are unregistered.

By allowing small businesses to remain unregistered for VAT purposes, the current threshold effectively costs the Exchequer in revenues forgone every year.  For example, the Government estimates that this loss amounted to £2.1 billion in 2017/18.

Having a high threshold has the benefit of keeping the majority of small businesses out of VAT altogether, avoiding all the administrative requirements of VAT compliance. However, the Treasury contends that business opinions on the threshold are divided, and that some would prefer a lower threshold to reduce distortions of competition.

OTS observations

In its November 2017 report 'Value added tax: routes to simplification’, the Office of Tax Simplification considered the potential implications if the threshold were to be raised significantly so that fewer businesses would have to register for VAT or make returns.

For example, if the threshold was increased from £85,000 to (say) £500,000, which could be done once Brexit took us beyond the strictures of EU VAT law:

• between 400,000 and 600,000 businesses might choose to de-register and thus simplify their tax compliance obligations;
• the Exchequer would lose further revenues of £3 to £6 billion annually;
• the UK’s ‘VAT efficiency ratio’, as measured by the OECD, would reduce even further from its existing low level; and
• removing the disciplines of VAT from a significant sector of the economy could encourage the hidden economy in the UK.

At the opposite extreme, if the threshold was slashed to (say) the level of the national average wage (i.e. £26,000):

• some 1.5 million more businesses would become VAT registered, bringing the Exchequer additional revenues of £1.5 to £2 billion a year;
• those businesses would face increased tax compliance costs, especially as a result of being drawn into MTD;
• HMRC’s administrative overheads would increase as a result of the near-doubling of the number of VAT registered businesses; and
• the plunge in the unregistered business population would arguably reduce competitive distortions and make it harder for VAT evasion to remain undiscovered.

The OTS recommended that the Government should examine the current approach to the level and design of the VAT registration threshold, with a view to setting out a future direction of travel for the threshold, including consideration of the potential benefits of a ‘smoothing mechanism’.

The call for evidence considers a number of ways in which the costs or administrative implications of VAT might be smoothed at the point a business first becomes obliged to register. A variety of possibilities are put forward for discussion – but attempts to encourage business growth by applying VAT on a more gradual or progressive basis seem as likely as not to add significant additional complexity.

Likely outcomes

At £85,000, the UK’s VAT registration threshold is the highest in the EU (where the average is £20,000) and the highest general threshold of all 35 OECD countries. Against that background, a lower threshold would not be hard for the Chancellor to justify.

Imagine that you were the occupant of Number 11, trying to balance the nation’s books. Given the choice between gaining extra revenues of up to £2 billion a year, or losing existing revenues of up to £6 billion, which would you find the more attractive option?

Hammond may well see a sharp reduction in the threshold as very tempting. While this might not take it as low as £26,000, the OTS report also examined the impact of an arbitrary threshold of £43,000, which (at the time) was equal to the higher rate income tax threshold.

Practitioners and small businesses will doubtless argue that the extra compliance burdens falling on them and HMRC as a result of any significant cut would be undesirable. However, the Treasury might see these as an acceptable price for the extra tax take.

Request for views

The call for evidence contains three chapters. The first explores how the current threshold may be affecting business growth. The second looks at the burdens created by the VAT regime at the point of registration, and why businesses might manage their turnover to avoid registering. The third considers possible policy solutions, based on international and domestic examples.

The document sets out questions within these broad areas. It also provides an online questionnaire for small businesses who want a quicker way to respond.

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