Cutting the VAT registration threshold – a lifeline for the chancellor

As we await the date of the Budget in the Autumn, it seems clear that the focus will be on measures to grow the economy, as Rachel Reeves has previously outlined during the campaign and that she is 'not looking to tinker with tax rates'. 

There is however one area of the VAT rules that could come under the spotlight in the coming months. Barring a few exceptions, businesses must register for VAT when their taxable turnover exceeds £90,000 in any 12-month period. The threshold was frozen at £85,000 from 2018 until 1 April 2024. 

There is evidence to suggest that many small businesses are managing their income to ensure they don’t reach the £90k cliff edge and stay below the VAT threshold to avoid the need to register for VAT or account for VAT on income. We have seen businesses turn down projects or close online shops when income gets precariously near the threshold to ensure they remain competitive with their non-VAT registered competitors.  

The £90,000 threshold is at the top end of the range of VAT/GST thresholds in OECD countries and more than double the OECD average. Research indicates that halving the threshold to £45,000 would bring around 500,000 businesses into the VAT net and raise over £1bn for the Treasury. 

In principle this sounds ‘good’ for government and ‘bad’ for businesses, but it is not straightforward. 

Without the ‘cliff edge’ many businesses could see growth and generate employment opportunities. Competitors will likely be required to be registered for VAT making it a fair playing field. 

A potential downside for businesses affected will be the increased administration and compliance costs that can come alongside being VAT registered. In addition, a big expansion of the number of VAT registered businesses would put even more pressure on an already stretched HMRC. Therefore, investment in HMRC would be needed to educate and support newly admitted businesses to the ‘VAT club’. 

Economic growth and pricing will be heavily impacted by any reduction in the VAT threshold and there is a risk the measure could have an inflationary effect which would need to be considered. Treading carefully given the impact on productivity and the public is vital. Carefully planning any changes to the VAT threshold and/or the introduction of VAT reliefs for small businesses would likely be a top priority. 

Any change to the VAT threshold attracts considerable media attention, and any government that makes a major cut to the threshold is likely to face a backlash while businesses go through the ‘pain’ stage of the change before arriving at any ‘gains’ that may emerge. But Labour’s huge majority in the commons may make it feel that this is the right time to weather that storm.  

Ultimately, it’s quite possible that the new Labour government will be seriously considering cutting the VAT threshold to be in line with OECD average. If it decides to cut the VAT threshold it will be a question of whether they will cut it gradually or reduce it significantly at a Budget.