VAT threshold

The VAT threshold has now been frozen at £85,000 a year since 2017 and is to be kept at that level until at least 2022.

There had been talk of even reducing the threshold, perhaps even halving it to around £43,000. This would have created a huge amount of extra work for both HMRC and smaller businesses with little extra revenue to show for it. About three quarters of all VAT charged by a supplier is recovered as input tax by the customer. As Making Tax Digital is now compulsory for all traders with turnover above the threshold, this would have imposed even more burden on them.

VAT is an EU tax. The UK has the highest threshold of all EU states, most of which are around £25,000. Germany’s threshold is below £20,000.

The 2018 Spring Statement said that reducing the UK threshold would bring in another £2 billion a year and require another 1.5 million businesses to register.

To businesses whose customers are VAT-registered or where its supplies are zero-rated, the threshold is of little relevance. But for many small businesses, including sole traders, the threshold is a real problem. It is charged on turnover and not profit. Consider a freelance electrician. He may charge £100 to fit a £100 appliance. His bill is £200 if he provides the appliance, which the customer may wish, but £100 if the customer buys the appliance directly. In such a case, the threshold is really £42,500.

It leads to some sole traders stopping work for perhaps two or three months a year to avoid crossing the threshold. Unlike income tax where extra income simply means a little extra tax, the VAT threshold means that the trader must increase his or her prices by 20% putting them at a competitive disadvantage.

There is always the risk that such a trader, seeking to avoid the threshold, may accidentally cross it. That is exactly what happened in the case Mr Timothy Hughes [2018] TC 6609. (Details can be found on the Tax Training Ltd website here.)

It is sad that in the discussion that there has been no consideration as to why the UK has a higher threshold and whether those reasons still apply.

VAT was introduced when the UK joined what was then the EEC (now EU) in 1973. The threshold was then £5,000, ten times the threshold for purchase tax which VAT replaced. Denmark, which joined at the same time, had a threshold of about £300.

The reason was that the change in tax meant that the number of taxpayers mushroomed from 50,000 to more than a million. Customs and Excise (as that part of HMRC then was) did not want to have to process millions of pieces of paper from every piano teacher and dog walker in the country.

In the 1990s, the government was keen to reduce compliance costs on small businesses. This included abolishing statutory audit for small companies as well as sharply increasing the VAT threshold twice. Chancellor Norman Lamont reported that the EU agreed readily to these large increases.

Leaving any threshold unchanged has the effect of increasing taxation through what is known as fiscal drag or withering on the vine. So this freeze represents a reduction in real times. And that is a reversal of VAT policy since 1973.

Obviously any threshold will be arbitrary to some group of traders, but the UK has had a policy of having a relatively high threshold which has been roughly indexed each year. At a time when the government is talking about providing help to businesses in the wake of Brexit, it seems a strange policy to abandon previous help to business.

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