Andrew Needham looks at whether business splitting is a good idea and considers what needs to be done to make it effective.
As a business that deals with the public (e.g. a plumber or hairdresser) approaches the VAT registration threshold they realise that when they register for VAT they will either take a 20% pay cut in order to remain competitive, or increase their prices by 20% and lose customers.
In such circumstances, they might consider business splitting to avoid VAT registration.
Business splitting
HMRC are aware of this and have a term for it – disaggregation; this is where one business artificially splits itself into two or more entities to avoid VAT registration.
For example, a plumber does work for the public and also for commercial customers. They decide to split their business into a limited company working for the commercial customers and to trade as a sole proprietor with private customers. They do not mind if they have to register the limited company for VAT as their customers can recover the VAT they charge them, so they are not commercially disadvantaged. In fact, they can recover the VAT on the materials they use, so may be a bit better off if the limited company is VAT registered.
If HMRC find out what they have done they will look at the structure they have set up to see if the business has been artificially split and how separate the two businesses really are.
The areas pointing at an artificial split are that the two businesses were originally one business and they both have the same trading activity but to different customer bases.
The plumber could argue that they split their commercial side off and put it into a limited company to avoid personal liability for any action taken against him by his larger customers and so the action was taken for commercial reasons.
It is likely that HMRC would issue a ‘notice of direction’ directing that the two businesses be treated as one from a current date. HMRC cannot backdate a notice of direction so any VAT registration requirement and VAT due will only be from a current date.
Were there ever two businesses?
In our above example, let us assume that the limited company has become VAT registered and during a VAT inspection HMRC have questioned why the private customers have not been included in the limited companies VAT returns.
The plumber decides that if they buy all their materials from the same supplier they can get a better price and claim all the VAT back through the limited company even though the sole proprietor uses some of the materials. HMRC would say that there were never two businesses and assess them for the VAT on what they would view as undeclared sales to private customers.
Two businesses
Sometimes a businessman will have legitimate reasons for having two or more businesses; HMRC accept that this can be the case. For example, a person can have a limited company running an engineering company but also operate as a design consultant for other engineering companies.
The two businesses are related but sufficiently separate that they could not be classified as one business and there would be sound commercial reasons for having them trade separately.
Is it a good idea?
There can be good commercial reasons for having two or more business because they are genuinely different businesses. However, if you have one business and then decide to split it to avoid VAT registration, HMRC will almost certainly issue a notice of direction.
On the plus side, if the businesses have been separated properly, useful savings can be achieved while VAT registration has been postponed. If you decide to split your business make sure the two businesses are kept completely separate.
Practical tip:
If you decide to split your business to avoid VAT registration expect HMRC to direct that they be treated as one at some point, and make sure you separate them properly.
