Why now is the worst time to force small businesses into VAT registration

The VAT registration threshold has been tweaked, nudged and prodded, yet still manages to trip up thousands of small business owners and sole traders. 

But despite all its flaws, raising the threshold – again – is still the best option we’ve got. Not because it solves any problems with the current system, but because every other alternative is worse.

Anyone who’s spent time in the self-employed world knows about “bunching.” It’s what happens when businesses deliberately hold back growth to avoid crossing the VAT threshold. The result is a cluster of businesses earning just under the limit, reluctant to take on new work or expand because the moment they do, they’re hit with a tax and compliance burden that can wipe out their margins.

Whether the threshold is £90,000, £120,000 or £250,000, bunching will happen. The only way to prevent it would be to scrap the threshold altogether and make everyone register for VAT. But for several reasons, that would be a mistake.

Tax experts who have called for the threshold to be reduced or even scrapped aren’t wrong about the distortions it creates. But what these proposals fail to consider is the wider impact of such a change. And more importantly, why now is absolutely the wrong time.

In essence, what they’re really proposing is a tax hike on the smallest businesses – on the sole traders, the freelancers, the people just starting out. These are the folks already juggling the rising cost of doing business, the threat of late payments, and the looming rollout of Making Tax Digital for Income Tax. Piling VAT compliance on top of that would be a political choice to burden our smallest businesses with increased tax and compliance.

HMRC’s customer service troubles are well publicised. Just this year, the Public Accounts Committee reported that HMRC’s already poor service to taxpayers has become even worse.

Expanding the VAT net overnight would swamp their systems, leaving thousands of new registrants without the vital help they need and increasing the burden placed on HMRC’s support systems.

The current threshold is designed so that businesses crossing it can typically afford professional help with VAT compliance. Lowering or removing the threshold would pull in thousands of micro-businesses that simply can’t afford that advice. This would place a heavier admin and time burden on those least equipped to handle it and, unsurprisingly, more pressure on HMRC to pick up the pieces.

Let’s not forget that the UK is a global leader when it comes to entrepreneurship. We have the largest number of micro businesses that have survived at least five years in all of Europe. But if the think tanks and policymakers have their way with tax reforms, we’re at real danger of discouraging business creation.

This is a just a friendly reminder that not everyone wants to be employed, and that 100% employment should never be the goal. We appear to have lost sight of this.

As part of IPSE’s campaigning ahead of the November Budget, we’ve written to the Treasury to call for the threshold to be increased to £120,000, from the current £90,000.

This, we believe, would account for rising inflation and the rising cost of doing business. Such a move would also unleash our small businesses to grow a little more before facing the compliance burden of dealing with VAT.

But most importantly, it would also act as a message from government to our smallest businesses that says: “We see you. We understand the pressures you’re under. And we’re not going to make it harder for you to grow.”

We’re not pretending that raising the VAT threshold to £120,000 will fix everything. It won’t. The bunching problem will still exist. But in a world of imperfect options, this is the one that does the least harm and the most good.

Over the next few weeks, we’ll be breaking down the key measures we included in our Budget submission and our rationale behind them. Stay tuned for further updates.