The VAT threshold and the issues it causes

The Chancellor Philip Hammond confirmed that the VAT threshold would remain frozen at £85,000 for at least the next two years in his Autumn Budget. Mr. Hammond’s reasoning was that the current threshold was well balanced to keep smaller businesses out of the VAT system.

However, a recent report from the Office of Tax Simplification (OTS) suggests that some small business owners are going to extraordinary lengths to ensure their business remains under the £85,000 threshold in order to avoid paying VAT on all of their sales. OTS tax director Paul Morton offered examples such as shops shutting for an entire month, and business owners strategically going on holiday. Mr. Morton described the current situation as an “impediment to growth”, with businesses taking steps to keep their sales down to avoid being charged VAT at 20% or £17,000, once they crossed the threshold amount.

The OTS sees three options open to the UK tax office to resolve the situation. The first is to increase the VAT threshold significantly to enable small businesses to grow without worry of significant loss of revenue to tax. However, if the threshold was increased to £500,000 – the same level as that set in Singapore, which has the highest VAT threshold in the world – this could mean a loss of up to £6 billion in tax revenues.

The second option is to cut the threshold significantly to a level similar to that of other European nations. However, a reduction to £26,000 would increase the administrative burden on the one million businesses that would subsequently be brought into the VAT system. A third option would be to introduce a smoothing mechanism, which would mean that businesses crossing the threshold for the first time would be allowed to claim back some of the collected revenues. The worry over this third option is that it may end up introducing further complication rather than making matters simpler.

Mr. Morton also highlighted how the UK VAT system “has not kept pace with the world”, as it has not been properly reviewed since 1973 despite VAT becoming more complex in the intervening years. One example relates to the sale of gingerbread men with different amounts of chocolate on them. A gingerbread man with just chocolate ‘eyes’ would have VAT charged at zero-rate, but one with a significant coating of chocolate (such as chocolate ‘trousers’) would be subject to the 20% standard rate. This is linked to the idea that a local baker should be able to sell their products at zero-rate, and that they wouldn’t have the technology to add more than simple decoration. This of course is no longer always the case, and arguably highlights the need for the VAT system to undergo a considerable review in the future.