Time for a VAT overhaul?

Last week the Federation of Small Businesses (FSB) shared its findings on how VAT rules are holding back growth for many small businesses. It called on the government to support these small firms by increasing the turnover threshold to ￡100,000 – up from the current level of ￡85,000, which was set in April 2017. Inflation to December 2023 would put this figure at ￡108,750.

Barrier to growth

According to the FSB’s ‘VAT for small businesses’ paper, 38 percent of businesses with a turnover between ￡75,000 and ￡100,000 said the ￡85,000 VAT threshold was a barrier to growth, while one in five small firms would look to expand their business if there was a discount payable after reaching the threshold.

It is undeniable that VAT is a significant challenge for both small- and medium-sized businesses.

For example, consider a business with a turnover of ￡80,000. It could push profit and exceed ￡85,000. It would then need to register for VAT and increase charges to customers to reflect the extra 20 percent cost to them.

Or should they rest on their laurels at ￡80,000, knowing their net income is likely to be hit if it exceeds the VAT threshold?

Where’s the incentive to grow?

Businesses might be able to recover some VAT if registered but it won’t be the full 20 percent.

This can be a significant disincentive for a business selling directly to customers. Bearing in mind their competitors with a slightly lower turnover could charge 20 percent less. ??

Perhaps tapered rates could help

Increasing the threshold might help some, but it does not address the fundamental issue – that the threshold approach is too ‘cliff edge’. Perhaps the real longer-term solution involves a tapering of rates executed through the VAT return, such as a reduced rate between ￡85,000 and ￡100,000, rather than just moving the cliff edge. HM Revenue & Customs already operates systems with a reduction in VAT rate for the first year via the Flat Rate Scheme, so this could be achieved relatively easily through quarterly VAT returns.

It is also worth noting that raising the threshold would not necessarily mean a reduction in tax take. ?Like the changes brought by the Addington Act in 1803 (yes, a very long time ago, we know). They cut the tax rate in half, ensuring revenue to the exchequer rose by 50 percent and the number of taxpayers doubled.

A higher VAT threshold may lead to extra profits and therefore increased revenues from sources such as corporation tax and income tax.