Can I split my business into two to avoid VAT? | Is it legal?

Can I split my business into two to avoid VAT?

It sounds like the perfect solution, doesn’t it? Split your business into two or more entities, so that you don’t have to worry about being VAT-registered.

Splitting your business into multiple entities to dodge VAT registration might seem like an ideal strategy. However, this approach, known as disaggregation or artificial separation, is scrutinised by HMRC. While avoiding VAT can offer financial benefits, businesses must be cautious, as HMRC has strict regulations to identify and penalise such tactics.

This article explores why businesses might consider avoiding VAT, the risks involved with disaggregation, legitimate reasons for establishing separate entities, and the severe consequences of being caught.

For businesses contemplating such moves, professional advice is essential to navigate the complex regulations and avoid hefty penalties. Contact our VAT accountants at VW Taxation today.

Why would a business want to avoid VAT registration?

Why would a business want to avoid VAT registration? That’s a mighty fine question and a legitimate one.

Avoiding VAT means saving money. And, when you save money, you might potentially have less work to do and be more profitable at the same time. Whenever your sales approach £85,000 in a business period of 12 months, that means you are now approaching the threshold which requires you to register for VAT.

No wonder businesses that go down the artificial separation route can maintain lower prices and often beat their competitors on price alone. Naturally, this is going to sound very appealing to businesses that operate in sectors where prices fluctuate frequently or where customers are easily discouraged when they see the words “VAT-inclusive”.

Another reason businesses are compelled to avoid VAT registration is to simplify accounting and compliance – this may be a particularly attractive proposition for many businesses, especially those who prefer to do their accounts themselves.

With all of the above, we would strongly recommend getting professional advice before you start exploring disaggregation to avoid paying VAT.

Does business splitting allow you to avoid VAT?

While there may be some very compelling reasons to split up a business into two or more parts (not just for the sake of avoiding VAT registration alone), one must tread carefully as HMRC has set our rules against any kind of artificial separation or disaggregation.

The VAT registration threshold for 2023/24 is the same as it has been since 2018: £85,000 for an individual business. Now, if this threshold is not exceeded, you don’t need to register for VAT and actually might enjoy a competitive advantage.

However, HMRC believes that this practice is akin to tax avoidance and has set out rules in a way to ensure that businesses split for legitimate reasons only and not just to avoid VAT registration. So, if you can prove that there is, in fact, no economic, financial, or organisational link whatsoever between your businesses, then HMRC will stay off your radar.

But if you can’t produce concrete evidence regarding the absence of such links, HMRC will not only impose penalties and force you to pay VAT which has been due since your businesses became operational – but also prosecute you.

So, unless you have a genuine reason(s) to split up your companies into two or more parts – such as economic, financial, or organisational – you should not do so just to avoid paying VAT, because HMRC will ultimately catch on to you.

What is an example of VAT disaggregation?

Let’s say you own a digital design and marketing business that’s currently generating a taxable yearly income of £150,000, which means you’re well above the £85,000 VAT registration threshold.

To avoid VAT registration, you divide your business into two separate parts or entities – e.g. “Jim’s Digital Design”, selling the design aspect of the services, and “Jim’s Digital Marketing”, selling the marketing aspect of the services. Both your businesses are estimated to rake in £75,000 each year, so they both fall below the VAT registration threshold as separate ventures.

At this point, Jim (that’s you) plans to run the first business (digital design) as a sole trader business and establish the second business (digital marketing) as a limited company. Both businesses share resources, including equipment and assets, office floor space, and staff. The digital marketing business often subsidises the digital design business during low-sale periods.

Now, if HMRC detects that you have made such an arrangement, they will most certainly write it off as deliberate VAT disaggregation – while both your businesses are legally separate entities, they are very much dependent on each other economically and financially.

What are legitimate reasons to establish a separate business entity?

Aside from avoiding VAT registration, there may be genuine reasons to establish a separate business entity, especially when you’re planning to branch out to a different set of products and services.

Additionally, you may be planning to split into a second business where:

  • There is no financial interest or interdependence between the two businesses
  • There are no shared bank accounts
  • Both businesses have their own dedicated staff and office floor space
  • Both are using their own set of equipment, assets, and tools
  • Both have separate websites and marketing staff

How does HMRC determine separate businesses?

When establishing a case of disaggregation or artificial separation, HMRC will consider thing such as:

  • Are both businesses reliant on each other – e.g. do they shared staff, finances, or other resources?
  • Do both businesses operate from the same premises?
  • Do they share equipment and/or facilities?
  • Do they have separate tills and records?
  • Do they have unique/unrelated websites?
  • Do both have different business rate bills?
  • Do they have their own business licenses?

What happens if you are caught artificially separating a business?

Organisations/sole traders that are found to be artificially separating a business may face high legal fines, including a backdated VAT bill since the operation started, which may prove to have severe consequences for small businesses in particular.

These fines can vary according to the severity of VAT registration avoidance and the perceived intent of the business owner.

In a worst-case scenario, HMRC may prosecute the business which could lead to closure, and possibly, jail time for the owner and those involved.

Need VAT advice? Contact VW Taxation

As a team of accountants and tax specialists, we are only a phone call away to offer a free initial consultation on all VAT-related matters: 02392 324587.

Frequently asked questions about splitting a business

Can I have two businesses, one VAT registered and one not?

If you want to genuinely split up your business into two separate entities for purposes other than VAT avoidance, then you can – well, that is, as long as you meet HMRC’s criteria.

So, if either one of your businesses reaches an annual threshold of £85,000, then you will have to register for VAT.

Is VAT disaggregation legal?

No, it is not – HMRC is actively on the lookout to prosecute companies and impose heavy fines which are practicing disaggregation for the purpose of avoiding VAT.

Further reading about VAT:

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Picture of Gary Ellis | Director | VW Taxation
Gary Ellis | Director | VW Taxation

VW Taxation are self employment tax specialists based in Portsmouth. We specialise in tax accounting for contractors, limited companies and the self-employed.

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