The artificial separation of businesses (also known as disaggregation) happens when a business with two or more activities (for a public house this could be the sale of drinks and the sale of food) are split and each ‘separate’ entity continues to operate below the VAT registration threshold (currently £85,000). HMRC does not look favourably on such arrangements and has legal powers to direct that businesses that have been artificially separated to avoid VAT can be treated as a single entity for VAT purposes.
The legislation that seeks to prevent VAT avoidance from the maintenance or creation of any artificial separation of business activities carried on by two or more persons is contained in VATA 1994 Schedule 1, Paras 1A and 2.
The legislation requires HMRC to consider the extent to which businesses are ‘closely bound to one another by financial, economic and organisational links’ when determining if there has been an artificial separation of businesses for the purposes of VAT avoidance. HMRC must be able to prove that businesses are linked by all three measures set-out in the legislation. If HMRC can do this then the businesses will need to be treated as one entity for VAT (subject to the usual appeals process).
Businesses that have deliberately avoided VAT registration may be liable to penalties and prosecution following a direction by HMRC to aggregate their businesses. This measure can also have retrospective effect dating as far back as 20 years, with the outcome that significant amounts of additional VAT and penalties are due.
Planning note
Taxpayers that are seeking to avoid VAT registration in this way are likely to be caught by HMRC’s rules. However, as many Tribunal cases on this issue have demonstrated, it is inherently possible for business activities to be separate even if they appear closely related at first glance. Care should be taken to ensure that separate businesses are operated independently of each other and be able to demonstrate this to HMRC. For example, by having separate accounts, employees, premises, contact numbers, websites etc. Please call if you would like advice on this topic.
