Small businesses could struggle to compete if VAT threshold drops

After reports surfaced that Chancellor Philip Hammond was considering lowering the VAT threshold in the last budget, one vital point that was arguably overlooked was the impact a lower VAT threshold would have on the UK’s small businesses.

As a small business accountants, it is our understanding that a number of small business owners go to considerable lengths to keep their turnover below the £85,000 threshold at which they have to charge 20 per cent VAT on all their sales.

For example, these lengths can include shutting shop for a month, deciding not to let an extra room in a bed and breakfast, changing the layout of a cafe or restaurant to accommodate fewer people, or simply going on holiday.

A study of tax audits in 2000-10 by the Institute for Fiscal Studies found that bed-and-breakfast owners typically failed to disclose more than half their income.

Overall, the threshold seems, from an outside perspective, as being counter-productive as it appears many small business owners have no intention or ambition to perform above a certain level in fear of having to pay VAT.

How does the UK VAT threshold compare to other countries?

The alternative argument would be to significantly increase the VAT threshold, thus stop it from being a barrier to the growth of small businesses, but the UK already has one of the highest VAT thresholds in the world, with the sole exception of Singapore.

If the UK were to increase its VAT threshold to Singaporean levels of about £500,000, the Office of Tax Simplification (OTS) estimates this would cost £3bn-£6bn in tax revenues.

Another option would be to slash the threshold to near that of other European countries - but a reduction to £26,000 would bring roughly one million businesses into the VAT system, increasing their administrative burden.

A third option would be to introduce a transition mechanism that would allow businesses that crossed the threshold to retain some of the revenues they collected.

Why do small business want to stay below the VAT threshold?

The answer to this question isn’t as cut and dry as the fact that the owners don’t want to pay VAT.

For one, the VAT threshold allows small business to be competitive against the bigger hitters in their industry. By not having to integrate the cost of VAT into their prices, small businesses can, to an extent, undercut the bigger business and ultimately be more competitive.

As mentioned above, operating beyond the VAT threshold comes with a great deal of administrative work which, overall, would impose a great strain on the productivity of small businesses.

In fact, a recent survey from the Federation of Small Business (FSB), VAT-registered small business owners spend an average of 44 hours, the equivalent of six working days, managing VAT administration every year.

Depending on how that owner values their time - let’s call it £100 per hour - VAT admin could chalk up a total cost of £4,400 in lost productivity per business.

According to the survey, correctly calculating the proportion of VAT owed is most frequently identified as the most time-consuming element, with four in ten firms flagging this as an issue (43%).

Additionally, filling out VAT returns (17%) and researching guidance (10%) are also commonly highlighted as time-consuming elements of the process.

What would this mean for Making Tax Digital (MTD)?

From April 1st, 2019, all businesses with turnover above the VAT threshold will have to keep digital records under the Making Tax Digital (MTD) reforms.

Any reduction in the VAT threshold would draw small businesses into MTD record keeping obligations earlier than they may have expected.

In addition to the time needed to get to grips with the new MTD requirements, those businesses may face extra costs for adviser fees and software.

The imminent introduction of MTD for VAT and the current uncertainty surrounding Brexit mean that we do not believe this is the appropriate time to increase compliance burdens and costs for small businesses in this way.

Instead, we would recommend that the Government consider the alternative approaches suggested by the OTS, including the potential to smooth the impact of the registration threshold.

Our team of tax accountants are experts in dealing with VAT-related issues - whether it's VAT returns, VAT registration or advising you on the different VAT schemes available to small businesses.

Get in touch today to discuss your VAT queries.