With the budget less than a month away, there are strong rumours that the Chancellor is considering making changes to VAT to increase the amount of tax collected and boost investment.
The run-up to a Budget inevitably sees a swirl of rumours and speculation and this year is no exception. In fact, it’s hard to identify a tax that some pundit or other hasn’t speculated could be in Dear Rachel’s sights. Looking specifically at VAT, I’ve seen suggestions that the registration threshold could be reviewed, with both potential increases and decrease mooted. So, what is most likely to happen?
Background
At £90,000, the UK has one of the world’s highest VAT registration threshold. It is significantly higher than any EU member state and along with Switzerland, it’s the highest threshold in the OECD.
All of the UK’s accountancy bodies as well as most economists, have long held concerns that having such a high threshold reduces growth. Both anecdotal and empirical evidence shows that many businesses restrict their level of income (by fair means or foul) to stay just below the threshold.
According to the Office for Budget Responsibility (OBR) this bunching of businesses just below the VAT threshold is getting worse, and whilst there is disagreement on just how much VAT is being lost to the Treasury, the consensus of opinion puts this figure at around £350m for the current tax year.
What can be done?
Changing the VAT threshold by just a few thousand pounds up or down, is most unlikely to have an impact of any significance. We would still continue to see bunching of small businesses at just below the new threshold.
The only way to eliminate the bunching completely would be to either increase the threshold significantly, so that most small businesses never need to worry about getting near it or decrease the threshold to such a level that any business run on a commercial basis, would find itself having to register.
Both of these options pose potential problems. One shouldn’t simply assume that changing the VAT threshold will result in those businesses currently ticking over at between £80k and £89k, expanding into much larger businesses. After all, not all small businesses have ambitions to grow into large ones, many simply be content to operate at their current scale, especially niche businesses.
The case for an increase in the threshold
A major increase, say to £150,000, would undoubtedly be welcomed by many smaller businesses, as it would spare them the administrative burdens associated with being VAT registered. They also wouldn’t have to worry about tipping over the threshold in the future.
Also, it is likely that it would also result in owners increasing investment into their businesses, as well as reducing the incentive for businesses to offer ‘cash only’ deals, which of course are illegal, but we all know that it goes on.
However, there are two main reasons why a VAT threshold increase is unlikely:
- Firstly, Rachel Reeves is getting increasingly desperate to find ways to increase the amount of tax collected and will be very conscious that the increase in the threshold from £85k to £90k in April 2024 resulted in a reduction in the VAT collected of around £90 million in the tax year to April 2025.
- Secondly, under the post-Brexit rules it is not possible to further increase the VAT threshold in Northern Ireland, without renegotiating the Windsor Framework with the EU.
The case for reducing the threshold
A significant reduction in the threshold would bring tens of thousands of small businesses into VAT, with the knock-on increase in administration costs. This would run counter to Dear Rachel’s earlier promise to slash red tape and may discourage people from starting new businesses, particularly small-scale ones, which would run counter to her broader policy objective of promoting growth and innovation.
Another consequence of such a reduction is the likelihood of increased prices for consumers. Businesses selling to the general public that are brought into the VAT regime would have to put up their prices, as most tend to operate on very tight profit margins. Apart from being politically unpopular, it would also have a modest inflationary effect, which in fairness would be the effect of any tax rise..
What is likely to happen?
Unfortunately for Dear Rachel, the Office for Budget Responsibility threw a hand-grenade into the mix on 27th October when they announced a large drop in the UK’s productivity performance. This has been estimated to lead to the Chancellor facing an additional £20bn gap in meeting her tax and spending rules.
Whilst this has been dreadful news for Dear Rachel, especially as she was already struggling to fill her existing ‘black hole’, there is one option available to her that will not result in her breaking her promise of not putting up the rates of Income Tax, NI or VAT.
Her unlikely potential saviour is the looming introduction of Making Tax Digital for Income Tax on 6th April 2026. Most small businesses, whether they are VAT registered or not, will have to file quarterly MTD tax returns if their qualifying income is over £50,000, which drops again to £30,000 on 6th April 2027.
The main argument against reducing the threshold for small businesses is the additional administrative burden, but the reasoning goes, if a business is completing a quarterly tax return anyway, it is not a huge additional burden to do a VAT return as well. The suggestion is to give these small concerns advance notice and bring in a dramatically lower in threshold in 2027 to coincide with the MTD for IT threshold of £30,000.
Accountant’s view
As with most other accountants, I’ve been scratching my head in recent weeks, trying to work out how Dear Rachel will bridge her fiscal gap, without breaking one or more of her golden rules and whilst there have been a number of innovative suggestions, there is no obvious answer.
So, if Dear Rachel bites the bullet and ties VAT threshold to MTD thresholds her fiscal hole will be well and truly filled without having to raise the headline rate of 20% VAT.
