Understanding VAT and disaggregation of a business
If your annual taxable turnover exceeds the VAT threshold during a rolling 12-month period, or you believe it will do so within the next 30 days, you need to register your business for VAT.
Although registering can offer benefits for some businesses, the requirement to keep records and file VAT returns digitally also results in a heavy administrative burden. Additionally, it means you need to charge more to your customers, and these are two reasons why some companies and sole traders decide to disaggregate their business.
What is disaggregation of a business?
Disaggregation means separating a business to avoid registering for VAT. The VAT threshold is £85,000 for the 2021/22 tax year, so if it looks likely that your business will exceed that amount, you may believe it’s a good idea to split it up.
The smaller ‘parts’ of the business can then operate with lower taxable turnovers, and you avoid having to register for VAT. But is business splitting lawful, and if not, what are the potential ramifications?
Is disaggregation legal?
HMRC views disaggregation as tax avoidance and you could incur heavy penalties, including fines and prosecution, if they believe you’ve disaggregated your business to avoid paying tax.
The tax body takes the view that businesses deliberately disaggregating gain a competitive and a tax advantage, and that the public purse is also depleted. If you’re concerned about allegations of business splitting, therefore, it’s important to consult your accountant.
HMRC’s opinion on each case is subjective, and they scrutinise each business on a case-by-case basis. This is why the professional insight of a qualified accountant is extremely valuable. But how does HMRC determine that a business is avoiding tax in this way, and what are the penalties for artificially splitting a business?
How does HMRC determine disaggregation?
HMRC looks at various aspects of a business to establish whether the businesses are linked, and that disaggregation has taken place simply to avoid VAT registration. They examine financial, organisational, and economic links between the businesses, and are required to prove that disaggregation has resulted in VAT avoidance.
These are just some scenarios that could cause HMRC to investigate further:
- A single bank account being used for both businesses
- A spouse or member of the family running one of the businesses
- The businesses being financially dependent on each other
- Operating from the same office or building
- Using the same business equipment
- The same employees working across both businesses
So what action can HMRC take regarding disaggregation?
VAT disaggregation penalties
HMRC can aggregate businesses they believe have been deliberately split with a view to avoiding VAT registration. A business’ total taxable turnover will then exceed the VAT threshold, and registration becomes mandatory.
Disaggregation notices, or Notices of Direction, are used by HMRC to inform business owners that they must treat their businesses as a single business for VAT registration purposes. If HMRC conclude that the businesses have been a single entity for some time, they may also issue a demand for backdated VAT.
There are various scenarios where disaggregation is legitimate – where regulatory obligations require it, for example – so if you receive a Notice of Direction it doesn’t necessarily mean you’ll face penalties.
If you are subject to an investigation by HMRC, however, it’s advisable to seek professional guidance to fully understand your obligations, the process, and potential ramifications. Handpicked Accountants can put you in touch with a qualified accountant, basing our referrals on long-established working relationships with accountants throughout the country. Please contact one of our expert team to find out more.