27 Jun 2024
How are VAT Thresholds impacting businesses?
The current VAT threshold for 2024/25 increased to £90,000 in April this year. Usually, the VAT threshold rises in line with inflation, but until recently it had been frozen since 2017, at £85,000. This tax is significant because once the threshold is reached, suppliers must pay 20% VAT. For small businesses and sole traders who already trying to cope with the impact of increased business costs and high inflation, all whilst remaining competitive, this presents a huge chunk of income. As a result, many are taking active steps to avoid going over the threshold, which for many, will ultimately limit their growth.
In fact, according to research by Tax Policy Associates, approximately 26,000 businesses are stalling their growth for fear of hitting the VAT threshold.
So why is it proving such an issue, and what long term impact could it have on the UK economy? We spoke with Clare Bowen, Partner about the lengths that clients are going to avoid going over the threshold.
So why are certain businesses/sole traders trying to avoid going over VAT threshold
Some businesses, particularly small sole traders and tradespeople, try to avoid going over the VAT threshold due to the financial implications it brings. When a business surpasses this threshold and becomes VAT registered, it must pay VAT on its goods or services.
This additional tax burden can reduce profitability, especially for businesses operating in competitive markets where raising prices isn't feasible. As a result, many businesses prefer to stay below the threshold to avoid the VAT obligation.
What are the barriers?
The main barrier is the financial impact of VAT registration. Once a business crosses the threshold, it must charge VAT on its sales, which can reduce profits by around 20%. Additionally, VAT registration brings administrative burdens, such as maintaining VAT records, submitting regular VAT returns, and potentially investing in digital compliance software. The VAT threshold also disproportionately affects small customer-facing businesses, such as tradespeople who can’t easily pass on increased costs to customers.
Although it is positive to have these strong processes in place, it can also put small businesses off, because it is something extra to add to a business owner’s already very full plate, and costs money to set them up.
What are businesses doing to ensure they don’t go over the VAT threshold?
To avoid crossing the VAT threshold, some businesses actively manage their turnover. This might involve limiting sales during certain periods or avoiding expansion that could push them over the threshold. For example, some tradespeople might take time off work at certain times in the year to keep their turnover below the VAT registration limit. There are also instances of businesses working shorter weeks or being selective of the work that they take on.
In the longer term, what impact could this have on the economy?
If a significant number of small businesses avoid crossing the VAT threshold, it could hinder economic growth and productivity. By staying below the threshold, these businesses may forego opportunities for expansion and investment in their operations. This could limit job creation and dampen overall economic activity, particularly in sectors dominated by small businesses, such as trades and services.
Additionally, the practice of avoiding VAT registration may encourage cash-in-hand transactions, leading to tax evasion and undermining government revenue.
We may see future legislation brought in to solve this problem, such as freezing thresholds over time or bringing in a phased threshold. But in the meantime, Monahans will be continuing to support SMEs and sole traders, helping them to effectively plan ahead and ensure that they are taking advantage of all of the tax reliefs available to them. Our job is to help our clients to get the most out of the businesses they’ve worked so hard to build.
If you need help managing your finances and your tax liabilities, please get in touch with the team today, they are here to help and would love to hear from you.