Many businesses would like to avoid being VAT registered. Especially as the VAT registration threshold has been frozen for at least two years. This article discusses the circumstances where HMRC might consider business splitting and VAT avoidance has taken place.

 

Business splitting and VAT avoidance

When considering business splitting and VAT avoidance it’s important to determine what is taxable turnover for VAT. For example, some sales might be considered outside the scope of VAT.

 

WHAT IS BUSINESS SPLITTING?

When two businesses trade independently of each other under different legal entities this is regarded as a business splitting arrangement. For VAT purposes, a legal entity is either a sole trader, partnership, LLP, limited company, club or association.

For example, you might decide to form a partnership with your spouse selling computer components online and carry out your digital marketing consultancy as a sole trader.

Neither one of these businesses might exceed the VAT registration threshold in isolation. However could HMRC argue that business splitting and VAT avoidance has taken place and force registration?

Typically the answer to whether or not business splitting and VAT avoidance has taken place is not straight-forward.

BUSINESS SPLITTING AND VAT AVOIDANCE – HMRC’S VIEW

The VAT man has detailed the circumstances where they consider business splitting and VAT avoidance have taken place. For example, the splitting of what is usually considered a single VATable supply. A bed and breakfast business with one legal entity supplying the bed and another supplying the breakfast.

This split can be disregarded by HMRC, if they can prove the two businesses have separate financial, organisational and economic links.

However HMRC must show that all three links apply to successfully argue that business splitting and VAT avoidance have taken place. They must also prove that VAT avoidance was the motive behind the split, rather than a commercial decision by the business owners.

If HMRC can prove VAT avoidance has taken place then they have the powers to treat the two separate businesses as one and register it for VAT. However, VAT registration can only be applied with a current or future date not retrospectively.

BUSINESS SPLITTING AND VAT AVOIDANCE – PRACTICAL POINTS

Most independent businesses trading from the same premises where no friends or relatives are involved usually have the following arrangements in place:

  • They will have separate business bank accounts, independent records and different invoicing arrangements

  • You would expect to see shared overheads/expenses recharged at a normal commercial rate. For example one business might act as a tenant in a rental agreement with a landlord, though sublet premises to the  second business

  • Each business will have separate suppliers to their activities with no overlap of costs 

  • They will have different trading names and will be responsible for different tax returns(!)

HMRC are far more likely to challenge business arrangements involving family members. A common example is where a husband (or wife) runs a pub as a sole trader and a husband (or wife) owns the catering activities separately. The latter activity happens to trade just below the VAT registration threshold.

BUSINESS SPLITTING AND VAT AVOIDANCE – A TAX CASE

Probably the most well-known case of business splitting is G & C Belcher v HMRC. This resulted in an unlikely victory for the taxpayer. This involved a husband and wife who were hairdressers operating as sole traders. However, HMRC considered they had always operated as a partnership. They were pursuing a six figure sum of VAT plus penalties.

The Belchers cause was not helped by a number of inconsistencies. For example their accountant produced one set of accounts and completed a partnership tax return(!). Additionally they only had one business bank account and a joint insurance policy.

However, despite all of this the tax tribunal was persuaded by the following facts and allowed their appeal:

  • The businesses paid for cash expenses separately from their own tills

  • Staff hiring and firing was done independently

  • There had been ‘no conscious intention to run a single business in partnership’. Mrs Belcher had also stated that either part of the business was sold this would not be a joint partnership decision. It would be the sole decision of the business owner concerned.

  • At the start of the enquiry Mrs Belcher had told HMRC that there were two separate businesses. This was unprompted and without HMRC asking the Belchers about their trading intentions.  This worked in the Becher’s favour with the judge, especially as it is HMRC’s policy to raise this question from the onset of any enquiry.

BUSINESS SPLITTING AND VAT AVOIDANCE – PLANNING

A number of family businesses trade independently for commercial reasons without being caught by these provisions. However if there is any interaction between your businesses make sure those terms are at arm’s length. For example any loans to family members are drawn up on normal commercial terms.

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