Can vat registration be avoided by splitting the business?

What is disaggregation?

Disaggregation is the artificial separation of business activities to avoid compulsory VAT registration. HMRC challenges such arrangements where one business has been split into two or more “parts” to keep each part’s turnover below the VAT threshold.

Who is a ‘taxable person’?

A person or organisation in business for VAT can be a:

• Individual (sole trader)
• Partnership (two or more individuals/businesses)
• Limited company
• Club or association
• Charity (charities still face VAT/PAYE compliance, even if not liable to income tax on charitable activities)
• Any group acting together (e.g., exhibition, educational, conference or health body)

Examples of disaggregation

1. A sole trader providing similar services via two different businesses.
2. Two related limited companies supplying connected/overlapping services.

There can be genuine commercial reasons to operate multiple entities; getting this wrong can lead to significant consequences.

How far can HMRC go back?

For VAT registration failures, HMRC can assess retrospectively for up to 20 years. (The four-year cap applies to corrections of errors on returns already filed.)

HMRC link tests (financial, organisational, economic)

HMRC looks for links between the supposedly separate parts. Typically they need to establish at least one indicator from each of the three categories below; the more factors present, the stronger the case:

Financial links

• Common bank accounts or shared cash
• Shared profits or financial interest benefiting both parts
• Financial dependency between the parts

Organisational links

• Common employees and/or managers

Economic links

• Shared equipment or stock
• Operating from the same premises
• Shared advertising/marketing

Best practice for genuine separation

If there are legitimate reasons to split activities, align reality and documentation:

• Separate bank accounts and full accounting records
• Each entity registered with HMRC (and submits its own returns)
• Make it clear to customers they are dealing with separate businesses
• Inter-business charges at arm’s length with proper invoices
• Distinct contact details (phone, websites, emails), and signage
• Separate premises or clearly distinct floor space
• Separate payrolls and employees
• Separate IT systems, plant/equipment, fixtures and fittings, and stock
• Independent management and decision-making

Legislation & intent

Finance Act 1997, s.31 inserted VATA 1994 Schedule 1 paragraph 1A, which expressly counters artificial separation that results in VAT avoidance. When deciding whether a separation is artificial, tribunals must consider how closely the parties are bound by financial, economic and organisational links. The previous limitation in para 2(2)(d) (requiring a main purpose of avoidance) was repealed, tightening HMRC’s hand.

The purposive clause guides tribunals to consider not only legal form but also whether the arrangements cause a VAT loss in substance.

Case example: Graham & Christine Belcher (TC5891)

Mr Belcher ran a barbershop (from 1991) and Mrs Belcher a ladies’ hairdresser (from 1997, part-time; later full-time). They traded as “Crewe Cuts”, shared some features (e.g., supplier account, insurance, music licence, phone line, a single bank account) and filed SA partnership returns. HMRC registered the partnership for VAT from 1 Jan 2006, assessing £136,691 VAT plus penalty.

The First-tier Tribunal allowed the appeal, noting, among other factors:

• Cash expenses were paid separately from respective tills
• Hiring/firing decisions were made independently
• No conscious intention to operate a single business in partnership

The tribunal was persuaded by consistent evidence that two businesses existed, despite several indicators pointing the other way. The takeaway: to sustain separate entities—especially among family members—commercial reality and day-to-day operations must clearly support independence.

How HMRC applies the measures in practice

Franchised businesses

Genuine franchises are not the target; action focuses on artificial separation only.

Hairdressers

HMRC uses its agreement with the National Hairdressers Federation to distinguish employees vs self-employed stylists; only the latter are in scope for amalgamation where the legal criteria are met.

Self-employed taxi drivers

Operating models vary; HMRC will aggregate only where the legal tests are satisfied.

Businesses already VAT-registered

HMRC will not use amalgamation powers where all parts are already VAT-registered; instead existing registrations could be cancelled and a new single registration issued where the powers are invoked.

Effective registration date

If HMRC directs amalgamation, the liability to be registered as a single business takes effect from the date specified in the direction (or a later date the direction sets).

Penalties

No new penalties arise specifically from these measures, but continuing artificial separation to avoid VAT can trigger penalties and interest under general rules.

Appeals

Businesses can appeal to the VAT and Duties Tribunal. The question is whether HMRC could reasonably be satisfied that the parties should be treated as a single taxable person, given the statutory criteria and purpose.

Advance advice

HMRC generally does not provide binding advice on proposed structures; it will decide on actual fact patterns when presented. Responsibility for issuing directions sits with local HMRC offices.