HMRC – Martin Rosenbaum

The VAT cliff edge: How the threshold impedes small businesses

Data analysis, FOI / 9 October 2024 / HMRC, tax, VAT

As Rachel Reeves ponders her forthcoming budget and how to balance raising money against economic growth, one of her self-imposed constraints is her pledge not to raise the rate of VAT. However the impact of taxes also depends greatly on the thresholds from which they apply, even though this tends to get a lot less attention in public debate (as is certainly the case for income tax).

So what about the annual turnover level at which businesses have to register for VAT?

Data I have recently obtained from HMRC under the freedom of information law shows the dramatic impact of the VAT threshold in restricting the growth of some of the UK’s small businesses.

In 2021/22 the UK had 21,752 businesses with annual turnover in the range £84,000-£85,000, just below the then threshold. But there were only 10,096 businesses just over the limit, in the range £85,000-£86,000.

In other words the number of businesses clustered just under the VAT threshold was more than double the number just above, as businesses curtail their activities to remain outside the VAT registration system.

The graph above clearly shows the cliff edge in the data.

Many small businesses are desperate to keep their annual turnover under the VAT level, so that they avoid the bureaucracy and costs of registration and they don’t have to charge VAT to customers, which would make them less competitive. However the consequence is that they then won’t grow further into larger, more successful operations.

For some businesses the VAT threshold functions as a ceiling constraining their growth.

Research by Warwick University in 2022 concluded that earlier data of this kind reflected genuine curtailment of business activity rather than false reporting to HMRC.

This is the latest data available from HMRC, which says that more recent information is still being processed. The current VAT threshold is now £90,000, as the figure was increased by the Conservative government before the general election.

The UK’s VAT threshold is high compared to other European countries which tend to impose VAT registration on businesses at a much lower level. While the UK policy saves many small businesspeople from the compliance burden of VAT, the significantly lower thresholds elsewhere make it less likely that enterprises will be found bunched and held back just under the relevant level of turnover.

I also wanted to get a breakdown of the data by sector of the economy, to see which kinds of businesses were most affected. HMRC said it could provide this for 2019/20, as it had previously extracted the information involved, but that more recent breakdowns would probably exceed the FOI cost limit.

According to these 2019/20 figures, the most dramatic effect is in the construction sector.

This data shows 4,445 construction businesses with an annual turnover of £84,000-£85,000, but only 1,425 in the range £85,000-£86,000. So the number of construction businesses appearing to have kept themselves just below the limit is over three times the number who grew a little more and just exceeded it.

The chart shows the impact for construction and some other economic sectors with large numbers of small enterprises.

These FOI releases from HMRC constitute the latest and most thorough official evidence of what the tax expert Dan Neidle of Tax Policy Associates has called ‘the VAT growth brake’.

The full HMRC spreadsheets can be downloaded here:

1) Summary data for 2019/20, 2020/21, 2021/22

2) 2019/20 sectoral breakdown

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The art not seen

Suppose you are the lucky owner of a very valuable object which is ‘pre-eminent’ for its historic or artistic interest.

When you die, that might result in a substantial inheritance tax payment. Except that this can be completely avoided, if HMRC agrees that the item constitutes a national heritage asset, and the inheritor is willing to let the British public come and look at it.

And if you are not already the owner of such an artefact, but you can afford it, you could buy one – as a handy method of reducing the tax liability of your estate. Naturally there are legal and financial advisors who will help you do this.

The objects exempted from tax under this law range from a Rembrandt self-portrait to a ‘pair of Chelsea Derby candlestick figures, each of a scantily draped winged cupid kneeling with arm around a floral encrusted bough, rococo scroll base with gilt enrichment, 6 3/4in. high (both with sconces missing, some damages)’.

A full list is published by the government, in a database currently containing over 36,000 entries. Some are on public display – HMRC has told me that about 8,000 are on loan to museums or galleries. But for the others, which is the large majority, how often does anybody actually make use of their legal right to go and see them?

No overall statistics are available to answer this question. However, according to information I have just obtained from HMRC under FOI, there were just 5,521 searches of the database in the last financial year (2023/24).

Obviously the number of actual visits will doubtless be much fewer than the number of database searches, many of which will not lead to any further action. Even though it is possible visitors might see more than one item at a time, it seems very likely indeed that most of these ‘national assets’ – saved for the nation at public expense – are never appreciated by any member of the general public, and certainly not by significant numbers of them.

You can find out what is available, and when and how it can be viewed, by searching the database. In many cases public access must be allowed without a prior appointment for at least a few days each year. Outside these open days, an appointment may be required.

That’s the theory. The practice might be somewhat trickier. As the tax consultancy Ross Martin states: “It seems that few people try and see some of the objects. On a practical level, it is very difficult to gain access to some of the assets. Access in most cases is handled by private client law firms and the links given to open days can be uninformative. Be prepared to be ruthlessly persistent if you wish to see an object or a collection.”

HMRC also informed me that ‘we do from time to time get contacted by members of the public directly to make us aware of any access issues that they have experienced’. But it does not have a central record of receiving any formal complaints about this.

In the 1990s the campaigning comedian Mark Thomas organised coachloads of visitors to attempt to see various artworks involved for a television programme. The law has since been changed, and access should have become easier.

HMRC estimates that this inheritance tax exemption/loophole (according to your personal preference), together with a similar rule for land and buildings, reduces government tax receipts by about £60 million annually.