Worsening VAT registration cliff edge prompts calls for UK reform

An increasing number of small British businesses are holding back their growth to avoid meeting the value added tax threshold, new data show, adding pressure on the government to review its policy around the UK’s third most lucrative tax.

Thousands of businesses are keeping their annual revenues below £85,000 to avoid having to register for or charge VAT, according to data obtained from HM Revenue & Customs through a freedom of information request.

The data showed that the number of companies with revenue leading up to the threshold limit in 2018-19 was significantly higher than four years previously, and fell more dramatically after it had been breached.

Analysts have warned that smaller companies holding back their revenues risked exacerbating low productivity and highlighted the case for reform of Britain’s VAT threshold, which is higher than many of the UK’s peer countries.

Tax experts could not say definitively what was behind the worsening “bunching effect”, but warned the trend risked continuing to increase as high inflation drags businesses’ revenues over the £85,000 line.

“I think this could be one of the UK’s most critical tax policy problems,” said Dan Neidle, founder of think-tank Tax Policy Associates, which submitted the FOI request.

He added that it seemed “plausible” that the issue could feed into the UK’s long-term productivity problem, where domestic product per hour worked lags France and Germany.

The UK has a higher VAT registration threshold than any country in the EU, which has an average of about £30,000.

Neidle estimated that as many as 26,000 sole traders, companies and partnerships were deliberately holding back growth in 2018-19, the latest year for which data is available.

In 2014-15, when the VAT threshold was £81,000, there were around 7,000 sole traders with annual revenues of £80,000 to £81,000, falling to roughly 4,000 for revenues within £1,000 above the threshold, according to a chart published in 2017 by the Office of Tax Simplification, an independent adviser to the government on the tax system.

In 2018-19, the comparable number of sole traders below and above the £85,000 threshold plummeted from about 8,500 to 3,000.

Avoiding the VAT threshold is attractive to sole traders offering services, such as builders or plumbers, or those renting furnished holiday lettings.

When a business crosses the threshold it has to charge VAT up to 20 per cent to customers, which can eat into profits if customers are unwilling to pay extra. VAT registration and reporting can also be a significant compliance burden that small business want to avoid.

Ben Lockwood, professor of economics at the University of Warwick, said that the current threshold of £85,000 is “probably the worst of both worlds”, as it enables small businesses to operate quite effectively without paying VAT while disincentivising growth.

John Cullinane, director of public policy at the Chartered Institute of Taxation, said the “sacred cow” of the UK’s high VAT threshold had been “too much of a political nettle to grasp”.

He recommended that the government consider a “smoothing mechanism” where a reduced VAT charge is applied for businesses that only exceed the threshold by a fixed amount.

Anita Monteith, head of taxation policy at the Institute of Chartered Accountants in England and Wales, a professional body, said a lower threshold would help SMEs and entrepreneurs to cope with VAT registration.

The Federation of Small Businesses has called on the government to increase the threshold to £100,000, which its research said could help 1.4mn businesses to expand.

The Treasury said: “We keep all taxes under review, but . . . the current VAT registration threshold will be maintained at its current level of £85,000 until 31 March 2026.”