When business owners seek to avoid VAT by splitting their business into two or more businesses to ensure each part is below the VAT threshold and so not have to pay VAT, this is known as Artificial Disaggregation. And as you’d expect HMRC don’t like it.
What is disaggregation?
By setting up two businesses, each with a turnover below £85,000 (the VAT registration threshold), rather than one with a turnover above £85,000, a business owner might think that they can avoid registering for VAT. If HMRC consider this to be a contrivance, then they will almosyt certainly declare this to be “Artificial Disaggregation.”
Why do it?
The obvious answer to this question is that it will save the business(es) from paying VAT. If you operate in a Business to Consumer (B2C) market, it's unlikely you can pass on the VAT to your customers so £16 in every £100 you sell is VAT. This can eat in to your margins and therefore being able to not pay this would prove helpful. Business owners believe they can either increase their profits or gain a competitive edge.
Attempts to avoid VAT by disaggregation is common in Retail, Health and Beauty, and Hospitality. Common ways businesses attempt to split are:
Geographical - if there is more than one location a natural split would be to operate each location as a separate entity.
Service - A salon owner might try to split the business into a hair salon and separate beauty business, or a pub hiving off the catering side.
Market - If a business has both a physical, and an online presence, the business owner might seek to divide the business along those lines.
Can I do it?
HMRC believes that this is tax avoidance and has come up with some rules to ensure only legitimate and genuine splitting occurs. Only if you can prove there is no ‘financial, economic or organisational’ link between your businesses, will HMRC accept that there is a genuine business split.
HMRC will consider these matters:
Financial
- Do the businesses have the separate bank account?
- Is there a common business profit or financial interest that benefits both businesses?
- Is there a financial dependency on one another?
Economic
- Do the businesses share equipment?
- Do the business use the same offices and share resources?
- Are there shared marketing and advertisements?
Organisational
- Do the businesses have employees that work across both businesses?
- Do customers and suppliers know that they are dealing with two different businesses?
Should I do it?
Maybe. Probably not. It is viewed as aggressive tax avoidance and the penalties are harsh if you get it wrong. If it's a genuine splitting of a business then that's a different matter. There can be positive indicators to HMRC that this is the case if your businesses operate with the following characteristics:
- Separation of bank accounts and business records
- Each business is separately registered with HMRC and submit their own tax returns
- Each business is owned and managed separately
- Customers should be convinced that they are dealing with two businesses
- Any charges for goods and services between the split businesses must be conducted at arm’s length.
What are the consequences of getting it wrong?
As anyone who has experienced it will testify, tangling with the VAT office can be both expensive and stressful.
If HMRC discover and artificially disaggregated business they will take action to get the multiple parts of the business registered as a single entity. If this happens, not only will the business have to account for VAT on its combined taxable supplies from the date it should have been registered, but it may also be liable to a Failure to Notify penalty of anything between 10% to 100% of the undeclared VAT.
If you've concerns about your own business and whether disaggregation rules could apply, it’s best to speak with an accountant or VAT expert for specific advice. Call our team on 03330 166559 or fill out the contact form.
