Small business and VAT

24^th January 2011 – Progress

Philip Ross takes a look at what the government's 'all in it together' claim means for small business in the light of the VAT rise, arguing that small businesses trading with the public will be inordinately hit.

Of the many things we have been told by the coalition (Tory-led) government the statements I find hardest to believe are that ‘we are all in this together’ and that the ‘least damaging way to handle the deficit’ is to raise VAT. Firstly when they say ‘all’ I think they mean mainly us, not them, and secondly when they say that raising VAT will be the least damaging way – least damaging for who? It certainly won’t benefit families – that has been shown already – but it will also hurt and damage small businesses too, affect their long term competitiveness and in doing so damage the economic revival.

The Chartered Institute of Directors estimate that raising VAT to 20 per cent will result in the loss of a further 250,000 private sector jobs. Also, the Charity Tax Group has estimated that this increase will cost the sector an additional £140 million. The impact of this may harm the capacity and resources needed to address the government’s big society agenda. It does sound like the ‘wrong tax, at the wrong time’.

Introduced in the 1970s, VAT replaced various sales taxes that had existed until then. It started with a lower band of eight per cent and a higher band of 12.5 per cent, Geoffrey Howe’s first budget abolished the upper rate and raised the rate to 15 per cent to pay for income tax reductions and attempts at budget deficit reductions. They then extended it in 1984 to include hot takeaway food and building improvements, then in 1991 raised it to 17.5 per cent to pay for John Major’s cuts in the poll tax. Then in 1994 it was extended to heating fuel which was charged at eight per cent. Labour’s record on VAT is that it reduced the heating tax from eight per cent to five per cent and, last year, introduced a temporary reduction of the rate down to 15 per cent. Now it is up to an all-time high of 20 per cent. It is the tax of choice for the Tories, taxing people not wealth or income. Just like their other cuts and rises we have the same Tories doing the same, as they have always done; all that has changed is the camouflage for its reason.

VAT is a ‘consumption tax’ because it is borne ultimately by the final consumer. It is not a charge on businesses. Businesses can reclaim any VAT that they are charged. So for business-to-business firms it is not such an issue. But for lots of small business that set up to trade with the public whether providing services or goods, then their prices have just gone up. How can small businesses remain competitive in such an environment?

One way is to look the income threshold you must pass after which you must register as a VAT company – before that you can trade without it. The registration limit is £70,000 having gradually risen from £49,000 in 1997. The Federation of Small Businesses is lobbying government to raise this threshold again to take more firms out of VAT, to give them a chance to grow and prosper and spend less time doing stressful paper work. In recognition too that unlike larger businesses they will find it harder to absorb the VAT rise in their prices.

The coalition has laudably set up the Office of Tax Simplification, which, in principle, is a good idea. But that is not just their agenda it is a Labour agenda too. Taking just the example of VAT Labour simplified the Cash Accounting Scheme to let small firms defer paying their VAT until they has received payment from their customers) and more than doubled the threshold for CAS from £660,000 to £1.35 million helping an extra 56,500 business at the time. Labour also introduced the Flat Rate Scheme, which allows businesses to apply a flat rate percentage to their annual turnover – particularly helpful for some smaller retailers.

The Tory-led government has introduced a plethora of small business ‘initiatives’ and we should take each on their merits and I hope to write on these in turn, but, at the end of the day, price of goods and services is what helps make firms competitive, especially small firms. On this the government has got it wrong.