As accountants, we are often asked whether splitting a business into separate legal entities (eg sole trader and partnership) can help avoid VAT registration. While this may seem like a logical step for small business owners wanting to remain below the VAT threshold, HMRC has clear rules regarding VAT disaggregation, and artificial separation of businesses is not permitted.By Chris DaviesUnderstanding VAT Disaggregation
VAT disaggregation occurs when a single business is artificially split into two or more separate legal entities to keep turnover below the VAT registration threshold, currently set at £90,000 (from April 2024). HMRC actively investigates cases where businesses are structured in this way and can direct that they should be treated as a single taxable entity for VAT purposes.Case Example: Hair & Beauty Business
One of our clients, a self-employed individual, operates a Hair and Beauty business and has asked whether she can separate it into two separate businesses – one for Hair and one for Beauty – in order to keep both businesses below the VAT threshold.In assessing whether this would be considered artificial separation, we must examine the key indicators HMRC uses to determine whether two businesses are genuinely separate or whether they should be treated as one. In this case:- Same Premises – Both the Hair and Beauty businesses would operate from the same location, making it unlikely that HMRC would view them as separate.
- Common Control – The client would remain the sole owner and operator of both businesses, further indicating that they are, in substance, a single entity.
- Interdependence – The client would promote both services at the same time, often during consultations, demonstrating a significant overlap in operations.
- Shared Resources – There would be one telephone number for both businesses, and they would likely share other facilities such as marketing materials and administrative functions.
- Common Customers – Many customers would likely use both services, reinforcing the view that these businesses are closely linked and should not be treated separately for VAT purposes.
The Consequences of Artificial Separation
If HMRC determines that disaggregation has taken place, they can direct that the businesses should be treated as a single entity for VAT purposes. This would mean:- The combined turnover of the two businesses would be considered when assessing VAT registration.
- VAT would be payable on past sales if the combined turnover exceeded the threshold, potentially leading to significant backdated VAT liabilities and penalties.
- Additional scrutiny from HMRC, leading to further tax compliance risks.
