Splitting Your Business Up To Avoid VAT – Does It Work? (UK)
Whilst it might sound like the perfect solution - splitting your business into 2 (or more) parts, so you don’t need to be VAT registered. Unfortunately, HMRC has put legislation in place against this very thing.
HMRC calls it “artificial separation” or “disaggregation”.
Splitting Your Business to Avoid Paying VAT? - Is it ok?
Many business owners think about splitting their businesses to avoid paying for VAT. This is understandable given that being VAT-registered means raising your products’ or services’ prices to compensate for the higher taxes.
However, splitting your business to avoid the VAT threshold, currently £85,000 revenue in a rolling 12-month period, is not allowed.
HMRC has set specific rules to ensure only legitimate “business separation” happens and is not something done to avoid paying VAT.
Some business owners register multiple companies to avoid reaching the VAT threshold legally and avoid registering for VAT.
However, if HMRC finds a strong link between various businesses, HMRC can impose penalties and prosecute business owners when they prove that they are, in reality, just one trade.
Artificial Separation Indicators
HMRC looks into three aspects in evaluating whether a business is legally separated: financial, economic, or organisational links.
What links does HMRC consider to say that a business is an artificially separated company?
The businesses only use the same bank account.
There is a common business profit or financial interest that benefits the companies.
The businesses are financially dependent on one another.
There are common employees or managers between the businesses.
The businesses are sharing equipment.
The businesses are operating from the same offices.
The businesses are sharing advertisements.
HMRC will challenge a business based on each link using a points system, with higher points strengthening the case of disaggregation - the artificial separation for VAT avoidance purposes.
Legal Separation Indicators
On the other hand, HMRC considers the following factors as positive indicators that the businesses are separate from each other.
- The businesses use separate bank accounts.
- The businesses have separate business records.
- The businesses are registered with HMRC separately.
- The businesses submit their tax returns.
For HMRC to say that businesses are legally separated, their clients should also be convinced that they are transacting and dealing with different companies.
Financial transactions between the businesses have to be done at arm’s length, ensuring that there are no overlaps in providing services and in the exchange of goods.
Because HMRC’s rules are apply on a case-to-case basis, it is always best to speak to your accountant to avoid falling foul of HMRC rules.
When can you split a business?
You can split businesses with a legitimate operational reason, and the businesses are different in nature and industries.
For example, if you run a coaching business and decide to start a bakery, these are different in nature and industry and could legitimately be separate businesses.
However, let's say you are running a coaching business with a 121 offering for high-level clients and decide to start a membership for startups. That cannot be split as there is no difference in nature and industry. Just by having a different client market, that does not mean you can separate.
What if I just split my business anyway?
Suppose HMRC proves that both businesses have organisational, financial, and economic links, and they have established that your businesses are, in fact, a single entity. In that case, you will have to register for VAT.
HMRC can also order your business to backdate registration and to pay for all the VAT that would have been due since your business started operations.