There are some businesses that seek to avoid registering for VAT using something know as artificial separation, where their business activities are split into two so that each businesses turnover falls below the registration threshold.
This situation can occur when dealing with contractor accounting as artificial separation can occur between any business structure. A sole director of a PSC, for example, may decide to provide some of their services as a sole trader, which would lead HMRC to reason that the company has been artificially separated to avoid VAT and treat the business as one for VAT purposes.
Signs of contrivance
In identifying the signs of contrived arrangements to avoid VAT, HMRC looks for things such as:
1. Same equipment/premises regularly used by different entities
In this type of situation, a series of business entities operate the same equipment and/or premises for a set period in any one week or month. Generally, the premises and/or equipment is owned by one of the parties who charge rent to the others.
2. Splitting up of what is usually a single supply
This type of separation was once common in the B & B trade, where one entity supplies the bed and another the breakfast.
3. Artificially separated businesses which maintain the appearance of a single business
This type of separation includes pubs, in which the bar and catering may be artificially separated. In most cases, the customer will consider the food and the drinks as bought from the pub and not from two independent businesses.
In determining whether any separation of business activities is artificial however, it is necessary to consider the extent to which the different persons carrying on the activities are closely bound to one another by financial-economic and organisational links.
Such factors include:
1. Financial links
- financial support is given by one part to another part
- one part would not be financially viable without the support from the other part
- common financial interest in the proceeds of the business
2. Economic links
- seeking to realise the same economic objective
- the activities of one part benefit the other part
- supplying the same circle of customers
3. Organisational links
- common management
- common employees
- common premises
- common equipment
The Belcher Case
In a recent First Tier Tax Tribunal case, Graham and Christine Belcher v HMRC, a husband and wife who operated a barber’s and ladies hairdressing salon from the same premises, were found to be running a separate business, despite filing partnership tax returns!
From 1991 – 1997, Mr Belcher ran a butcher’s shop from their home premises in Crewe. The property had a shop on the ground floor and behind and above there were domestic premises. In 1997, the shop was converted to a barber’s shop which was run by Mr Belcher.
In 2005, Mrs Belcher left her job at the DHSS and opened a ladies’ salon in the converted garage of the home premises. This was a separate building from the house and had a separate entrance from the barber’s shop.
Partnership tax returns were filed showing Mr and Mrs Belcher as partners trading under the name of “Crewe Cuts”. The total income was split equally between the pair.
HMRC decided that rather than two separate businesses there existed a single partnership which should have been registered for VAT from 1st January 2006, estimating the liability to be nearly £137,000. In addition, a penalty of around £16,000 was levied.
It was explained to HMRC that there were two separate businesses, the barber’s shop at the front of the premises and the ladies’ salon at the back. The two businesses employed separate staff used separate tills and paid separate business rates to the council. There was, however, only one single business bank account and a single set of consolidated accounts.
The same utilities were used for both the barber’s shop and the ladies’ salon, but they were utilities supplied to the premises which served as both the Belcher’s home and the two hairdressing premises.
Insurances and a music licence were arranged to cover both the barber’s shop and the ladies’ salon.
Quite surprisingly, the Tribunal judge found in favour of the Belcher’s for the following reasons:
- Mr and Mrs Belcher bore their own responsibility for hiring and firing staff;
- Each business met its expenses from their own takings; and
- Mr and Mrs Belcher never expressly agreed between themselves to operate the two businesses as a partnership, and therefore there was no ‘conscious intention’ to run a single business in partnership.
The Belcher’s could quite easily have lost this case and businesses should not place too much reliance on the judgement, although the ruling, while setting no legal precedence, can be used in support of arguments.
If you would like to know more about artificial separation of businesses, get in touch!
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