When the UK first introduced VAT in 1973, the registration threshold – the amount of sales you could make before registering for the tax – was set at £5,000. Initially, the threshold increased sporadically, but it eventually began to rise, generally annually, in line with inflation. 

Notably, in 1991, Chancellor Norman Lamont increased the threshold from £25,400 to £35,000 as part of a wider package of measures aimed at reducing the regulatory burden on small businesses. The idea was to encourage enterprise by exempting smaller businesses from the complexities and costs associated with VAT registration and compliance. It was increased significantly again in Ken Clarke’s first Budget as Chancellor in 1993.

Later chancellors took a different approach. In the autumn budget of 2017, Philip Hammond froze the threshold at £85,000 for two years so that HM Treasury could consult on the design and level of the threshold. This was in response to a report from the Office of Tax Simplification (OTS), which had reviewed the threshold as part of its report on simplifying VAT. The outcome of the consultation was ultimately inconclusive, and – perhaps as a way of raising VAT revenues without changing the headline rate – the threshold remained frozen until April 2024, when it was given a one-off increase in line with annual inflation to £90,000.

As a result, the UK’s VAT registration threshold is now the joint highest in the OECD. This disparity raises questions about whether the UK’s approach is sensible or if other countries have valid reasons for their much lower thresholds. In this article, we present arguments from VAT experts – one side advocating for lowering the threshold and the other for raising it – to shed light on this important issue in tax policy design. 

It’s worth noting that the UK is still partly bound by EU rules regarding the level of its VAT registration threshold. Under the terms of the Windsor Framework, the VAT registration threshold in Northern Ireland cannot exceed its current level subject to movements in the exchange rate.

Increasing the threshold

When Jeremy Hunt announced in his Spring 2024 Budget that the VAT registration threshold would be raised for the first time since 2017, to £90,000, he argued it would take 28,000 businesses out of paying VAT altogether and encourage many more to invest and grow. To most businesses, an increase of £5,000 made little difference. But the reasoning behind the rise certainly sounds attractive.

If the UK were unhampered by EU rules and the Chancellor wanted to encourage small businesses to grow, it would be much more effective to raise the threshold to, say, £250,000. This is supported by the government’s statistics, which show that in 2022/23, £117bn, 75% of the total net VAT collected in the UK, was paid by traders with an annual turnover of more than £10m. Raising the threshold to £250,000 may not therefore have a significant impact on the UK’s total VAT receipts, but it would allow HMRC to save costs and to focus its time controlling the largest VAT payers and ensuring that they pay the right amount of tax.

Businesses are reluctant to cross the VAT threshold because of the burden VAT registration brings and some businesses deliberately restrict their growth to remain below the threshold, which cannot be good for the country’s economy.

Outside of the VAT net, businesses would be willing to grow as they would have fewer administrative hoops to jump through. Those with a turnover of £90,000 are unlikely to have many employees, so time spent on VAT compliance takes up a larger proportion of staff time. Moreover, the sheer number of VAT rules (and their many exceptions) are incredibly complicated and keeping on top of it all can be an impossible task for a small business owner with a limited knowledge of VAT.

Alternatively, a business might choose to employ a professional to handle the VAT, but this is expensive. Increasing the registration threshold would mean only bigger businesses with more resources need battle with VAT requirements.

On top of having to navigate such an administrative minefield, the consequences of one wrong step can be severe. HMRC may offer a reduction in a penalty if an error is unintentional, but interest and penalties can be a big financial blow for small businesses. 

When most businesses register for VAT, it is because they make standard rated supplies. They are then faced with a choice: either increase their prices by 20%, or lose 20% of their existing prices as VAT. The former makes them less competitive and likely to see a drop in sales. The latter eats into the profits of the business and ultimately reduces the amount of money a business can use to expand. Neither of these options advocate for small business growth.

Not having to register for VAT at such a low turnover means that small businesses providing goods and services to consumers can charge less overall, which should encourage the UK public to spend more, thus growing the economy.

In short, raising the VAT registration threshold significantly would allow small businesses to allocate a larger share of their time and resources to growth, without being held back by the burden of VAT compliance.

Contributed by Sue Rathmell, VAT Partner, and Euan Rintoul, VAT Junior, MHA

Lowering the threshold

The main argument in favour of lowering the VAT registration threshold is that it would promote economic growth.

If the number of businesses trading in the UK is analysed by turnover, there is a dramatic fall in the number of businesses when their turnover hits the VAT registration threshold (see, for example, the work of Tax Policy Associates undertaken when the VAT registration threshold was £85,000). 

In research undertaken for HMRC in 2016, it was found that 20% of unregistered businesses trading close to the VAT threshold had taken action to remain below the VAT threshold. Of those businesses, almost half said that they had closed their business for part of the year to avoid having to register for VAT, and one in five said that they had turned down work.

This strongly suggests that a significant number of businesses are actively managing their turnover in order to stay below the VAT registration threshold. Lowering the VAT registration threshold would prevent businesses suppressing their trade in this way, which would, in turn, encourage economic growth.

There are two reasons why a business would want to keep its turnover below the registration threshold. First, to avoid the associated compliance costs and HMRC scrutiny. The UK VAT registration has always been set at a level that enables a sole trader (whether they are incorporated or not) to earn a decent ‘salary’ (assuming the business’s costs are not high in relative terms). As a result, some businesses take steps to ensure their turnover does not cross the VAT threshold to save themselves the ‘hassle’ that a VAT registration would bring.

Second, the ‘cliff edge’ nature of the VAT registration threshold presents a particular challenge to businesses that would struggle to pass the VAT cost onto their customers through higher prices (eg, because they supply consumers). Depending on the amount of VAT it can claim as input tax, registering for VAT would mean a business in this position would lose up to one-sixth of its income. It would need to grow significantly in order to compensate for registering.

In conclusion, it is undeniable that the high level of the UK’s VAT registration threshold encourages some businesses to actively manage their turnover in a variety of entirely legal and ethical ways (eg, by turning work down, not raising prices or even closing for part of the year). Lowering the registration threshold such that only extremely small businesses would be outside the VAT net would remove this barrier to business growth.

A dramatic reduction in the VAT registration threshold might be politically unpopular, at least in the short term, so it is something that could only be attempted by a new government with a sizeable majority that had some years in power before the next general election. As the UK’s new government campaigned on a platform of addressing public finance through growth rather than tax increases, maybe the time is ripe for this change?

Contributed by Sarah Kay, Lead Technical Writer, Croner-i

So – higher or lower?

The debate surrounding the UK’s VAT registration threshold is complex, with compelling arguments on both sides. 

Proponents of raising the threshold argue that it would alleviate administrative burdens on small businesses, allowing them to focus on growth and innovation. They contend that a higher threshold could stimulate economic activity by enabling smaller enterprises to remain competitive without the added complexity of VAT compliance. In this respect, perhaps simplifying VAT would allow for a lower VAT threshold.

Meanwhile, those advocating for a lower threshold suggest that it would promote overall economic growth by removing the incentive for businesses to artificially suppress their turnover. This ‘bunching’ effect (see the chart in an earlier TAXline article), where firms deliberately limit their growth to stay below the VAT threshold, is seen as a significant barrier to business expansion and, by extension, economic progress. Of course, it is possible that moving the threshold in either direction is simply moving the problem and other solutions, such as smoothing mechanisms, might be needed. 

The current threshold of £90,000, while recently adjusted for inflation, clearly remains a contentious figure. It represents a delicate balance between fostering small business growth and ensuring a robust tax base. However, the stark contrast between the UK’s threshold and those of other OECD countries suggests that there may be room to reconsider.

As the debate continues, it is clear that any changes to the VAT registration threshold must be carefully considered, taking into account the diverse needs of businesses across various sectors and size and the capacity of HMRC to deal with any change, as well as the broader economic implications.

Ed Saltmarsh, Technical Manager, VAT and Customs, ICAEW