This is the fourth in the series of articles on the report issued by the Office of Tax Simplification (“OTS”). The OTS commented that the most significant issue identified in the report is that of the VAT registration threshold, currently set at £85,000 within the UK, costing the UK economy £2 billion a year. This is the highest threshold in both the EU and the OECD, with the global average being circa £15,000.
Once a business reaches the VAT registration threshold, it must register for VAT but businesses with turnover below the threshold may choose to voluntarily register.. Although 55% of UK small businesses are not registered for VAT or PAYE, 44% of VAT registrations are voluntary. This may be for a number of reasons, one of which might be to create an impression of substance and credibility to the business venture.
There is a significant “bunching” of businesses whose turnover is just below the VAT registration threshold, in labour-intensive businesses and businesses operated by sole proprietors. Where this happens, the OTS says there is a “cliff-edge”. Compare a non-VAT registered business with turnover of £84,000 supplying to consumers and a business with a taxable turnover of £85,000, The latter is required to register for VAT and account for £14,167 to HMRC leaving net turnover of £70,833 (assuming it cannot increase prices). Research evidence suggests that businesses (especially sole proprietors) manage their turnover to remain below the VAT registration threshold. This appears to be due to the comparatively high threshold where labour-intensive businesses can generate a profit, which the owners regard as sufficient. This therefore acts as a disincentive to economic growth.
The OTS identifies two potential approaches exist in dealing with the competitive distortions caused by the current VAT rules.
The first would be to raise or lower the threshold to exclude a larger number of smaller businesses or to include all but the very smallest businesses. The second option would be to smooth the financial / administration costs of crossing the threshold. However, there are certain constraints on what may be possible while the UK remains subject to EU law in this area.
A. Threshold – To reduce / To increase
The OTS said that reducing the threshold to £25,000, similar to the national average minimum wage (£26,000), could yield as much as £2 billion for HMRC, but would mean up to 1.5 million more businesses collecting the tax. Should this occur, some might opt to cease trading or to structure themselves differently. In addition, this would result in a significant rise in HMRC administrative overheads. However it would also make it harder for businesses to evade VAT.
Raising the threshold level significantly to Singaporean levels of about £500,000, could impact 800,000 businesses. Although approximately 50% of such businesses may choose to remain voluntarily VAT registered, this could be said to reduce revenue intake by £3 – £6 billion per annum. It is unlikely than any increase above inflation would be possible under current EU law.
A more moderate approach would be to make a smaller change to indicate a direction of travel but would have a limited impact.
Having identified that the threshold creates a “cliff-edge”, the OTS has considered a number of options which may smooth the impact of the registration threshold such as retention of a proportion of VAT collected in the first few years of registration as well as administrative simplification. At present, many such mechanisms are likely to be incompatible with EU law. However, should the UK no longer be constrained by EU legislation, these options could be considered in further detail.
While the OTS report contains some useful evidence, its recommendation is for a review of the level and design of the VAT registration threshold, with a view to setting out a future direction of travel and it falls short of making any concrete recommendation. It remains to be seen as to how the government might implement the recommendations made above and in what time frame these can be achieved. It is understood from the OTS, that it considers such recommendations may be progressed in the short (1 year) to medium (2 -5 years) term. However, while there seems to be compelling evidence for a significant reduction in the threshold, anything seen as a tax on the growing self employed population would be politically risky (as evidenced by the difficulties encountered in raising self employed national insurance).
Follow this link to the OTS Report.