New data suggests that thousands of UK businesses are holding back growth to make sure they avoid hitting the VAT registration threshold. The data from 2018–19 shows a cliff-edge drop in the number of businesses by turnover band, as turnover approaches the VAT threshold, rather than a smooth curve as might be expected.
According to Dan Neidle's Tax Policy Associates (TPA) whose recent research highlighted the problem, this means that ‘companies are holding back their turnover – slowing and stopping growth – to avoid having to charge VAT’, with around 26,000 businesses having stalled their growth as a result, creating a potentially significant drag for UK productivity.
In its 2019 report Value Added Tax: Routes to Simplification, the Office of Tax Simplification noted that the threshold creates a ‘bunching’ of businesses whose turnover is just below the limit, reflecting ‘the significance to a business of crossing the threshold’.
In an October 2022 working paper, the University of Oxford and others found ‘robust evidence that annual growth in turnover slows by about 1 percentage point when firm turnover gets close to the threshold, with no evidence of higher growth when the threshold is passed’.
At £85,000, the UK’s VAT threshold is higher than the equivalent for almost all directly comparable jurisdictions but, as TPA reports, simply raising the threshold pushes the problem to a higher turnover level with the obvious cost in lost VAT revenues. Equally, reducing the threshold would require thousands of smaller businesses to start charging VAT overnight. Freezing the current threshold might be a longer-term solution, allowing the amount to be eroded by inflation, but would take many years to address the current problem.
With VAT returns becoming digital (MTD for VAT), TPA proposes that a staggered approach, phasing VAT in smoothly from zero to 20% would be possible:
‘For example, at £30,000 VAT would be applied at 1% (and input tax recoverable at 1%), with the rate increasing bit-by-bit until by £140,000 VAT would fully apply at 20% (with the intention that the overall effect is revenue-neutral).’
Alternatively, VAT could be charged at 20% alongside a rebate system for smaller businesses, with the rebate dropping as turnover increases.
As TPA concludes, the data exposes a problem for the UK economy. Any solutions will require political will, and a great deal of expertise.
New data suggests that thousands of UK businesses are holding back growth to make sure they avoid hitting the VAT registration threshold. The data from 2018–19 shows a cliff-edge drop in the number of businesses by turnover band, as turnover approaches the VAT threshold, rather than a smooth curve as might be expected.
According to Dan Neidle's Tax Policy Associates (TPA) whose recent research highlighted the problem, this means that ‘companies are holding back their turnover – slowing and stopping growth – to avoid having to charge VAT’, with around 26,000 businesses having stalled their growth as a result, creating a potentially significant drag for UK productivity.
In its 2019 report Value Added Tax: Routes to Simplification, the Office of Tax Simplification noted that the threshold creates a ‘bunching’ of businesses whose turnover is just below the limit, reflecting ‘the significance to a business of crossing the threshold’.
In an October 2022 working paper, the University of Oxford and others found ‘robust evidence that annual growth in turnover slows by about 1 percentage point when firm turnover gets close to the threshold, with no evidence of higher growth when the threshold is passed’.
At £85,000, the UK’s VAT threshold is higher than the equivalent for almost all directly comparable jurisdictions but, as TPA reports, simply raising the threshold pushes the problem to a higher turnover level with the obvious cost in lost VAT revenues. Equally, reducing the threshold would require thousands of smaller businesses to start charging VAT overnight. Freezing the current threshold might be a longer-term solution, allowing the amount to be eroded by inflation, but would take many years to address the current problem.
With VAT returns becoming digital (MTD for VAT), TPA proposes that a staggered approach, phasing VAT in smoothly from zero to 20% would be possible:
‘For example, at £30,000 VAT would be applied at 1% (and input tax recoverable at 1%), with the rate increasing bit-by-bit until by £140,000 VAT would fully apply at 20% (with the intention that the overall effect is revenue-neutral).’
Alternatively, VAT could be charged at 20% alongside a rebate system for smaller businesses, with the rebate dropping as turnover increases.
As TPA concludes, the data exposes a problem for the UK economy. Any solutions will require political will, and a great deal of expertise.
