Revamping VAT system could ‘unlock billions’ for the economy

A “drastic overhaul of VAT is needed”, says the FSB

Revamping VAT system could ‘unlock billions’ for the economy

Revamping the VAT system could be the key to unlocking billions in trapped economic firepower, according to the Federation of Small Businesses (FSB). The VAT threshold, which is set by HMRC every year, currently stands at £85,000. The threshold has remained at £85,000 since 2017, and the government has confirmed this threshold won’t change until 31 March 2024. However, the FSB is calling for an urgent increase in the threshold. In a paper published on Tuesday, the UK’s largest business group is now pushing for a rise in the turnover threshold from £85,000, where VAT currently starts biting, to £100,000. They say that this rise would give small and medium-sized businesses breathing space to grow their turnover without fear of having to charge customers more.

FSB is also suggesting bringing in a smoothing mechanism, to ease the transition for firms who go just over the threshold. Many small firms – estimated to hit 44,000 by 2025 – intentionally keep their turnover just below the £85,000 threshold, according to the Office for Budget Responsibility. Hundreds of millions of pounds of potential economic activity could be lost due to this ‘bunching’ just below the threshold, they said. Rising inflation has also pushed many small firms to hike prices and inadvertently increase turnover without fattening profits, causing many to pass the VAT threshold unwillingly. The key findings of FSB’s analysis paper showed that 38% of firms – with turnovers of between £75,001 and £100,000 – said the £85,000 threshold was a barrier to growth.

Meanwhile, 29% said they would feel encouraged to invest in their business if the threshold was raised. A fifth of small firms (19%) say a discount on the amount of VAT payable after reaching the threshold would incentivise them to invest and expand their businesses. This rises to 41% in the hospitality sector and 23% in the wholesale and retail industry. Alongside a higher threshold, FSB wants the transition from not paying VAT to being subject to the tax to be less of a sudden shock to small firms. The FSB suggested a VAT allowance option, enabling eligible small businesses to reduce their annual VAT liability by a set amount, similar to the existing Employment Allowance, which can be offset against small firms’ National Insurance bill.  

The FSB is also suggesting the government implement a rebate option, where HMRC could administer a rebate proposal for small businesses with a turnover up to £20,000 higher than the threshold level, so they can apply for a rebate on their net VAT paid. According to the FSB paper, if these rules were streamlined, 18% of businesses, 30% of hospitality firms and 27% of small manufacturers would be incentivised to invest and expand. Tina McKenzie, FSB’s Policy Chair, said: “VAT compliance flattens small firms by stifling their growth and emptying their coffers. It’s crying out for a modern makeover to match today’s economic landscape. We can’t let it squash the ambitions of small businesses, strivers, and budding entrepreneurs. 

“The flaws in our current system are glaringly obvious. We are at a breaking point – a drastic overhaul of VAT is needed. Raising the threshold to reflect inflation, introducing a buffer to soften the blow for those just over the limit and demystifying the rules to save small business owners from a VAT-induced headache could unlock hundreds of millions in extra economic activity. As a country, we need to think about how to take VAT to the future. Our paper sets out a way forward that will help small firms and sole traders, from B&B owners and independent shops to plumbers and hairdressers. If the Government wants to show that it’s really on the side of small firms, a commitment to look at our suggestions and ease the VAT burden would go a long way towards that.” 

Meanwhile, Richard Wild, Head of Tax Technical at the Chartered Institute of Taxation, supported the need to review the VAT threshold after many years of it remaining stagnant. “We welcome this report which takes a fresh look at the challenges faced by small businesses by virtue of the VAT registration threshold and the complexity of the VAT rules,” he said. “In particular, the idea of a smoothing mechanism to reduce bunching just under the VAT threshold deserves serious investigation by the Government. It’s six years since the Office of Tax Simplification undertook its review of VAT, and with the Government’s emphasis on growth, it’s time to take the issue out of the too-difficult box.”

Latifa Yedroudj
Latifa Yedroudj

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