When is a business not a business? When it no longer qualifies for VAT registration

It is well understood in the business world that an entity must have an economic activity to be VAT registered and eligible to recover VAT on related costs. While this basic concept has been in place ever since VAT was introduced, the UK courts and HMRC have been refreshing their view of it lately in light of some more in-depth European case law that has emerged in recent years.

This has been highlighted in an appeal brought by Babylon Farm Ltd, whose directors, Mr and Mrs McLaughlin, also operated a farm as a partnership. Babylon Farm Ltd was set up to undertake certain farming activities alongside their main farming business, and had been VAT registered separately since 1991. Mr McLaughlin also owned several other non-farming businesses which he operated through separate limited companies.

By the time HMRC looked at the company’s affairs in 2018, Babylon Farm Ltd had only one remaining activity, that of cutting and baling hay, which it sold to Mr McLaughlin for use in his own livery business. Income from this amounted to just £440 per year. HMRC’s attention was drawn to the company by a claim for input VAT of £19,000 which Babylon Farm Ltd had made on the construction of a new barn to house its haymaking equipment.

HMRC decided that the company no longer had a business activity for VAT purposes and disallowed this VAT recovery. The Upper Tribunal has now supported this decision. While Babylon Farm Ltd’s haymaking activity still continued, was producing regular, albeit seasonal income, the tribunal found that this activity was not conducted on sound and recognised business principles. The company had no staff, did not hold insurance to cover the activity and there was no evidence that it actually had title to the hay it sold, which was harvested from land owned by Mr and Mrs McLaughlin.

There had been no efforts to obtain other customers, and the company’s profitability was entirely dependent on Mr McLaughlin’s judgment as to where costs and revenue should be allocated between his various activities. The tribunal also noted that the company had fallen out of the habit of invoicing for and collecting its income from the livery business for a few years, until this was identified as necessary to support claims for input VAT, There was also a significant mis-match between the cost of the new barn versus the income it would generate.

While the Babylon Farm case may be appealed further, the Upper Tribunal decision shows that a small amount of regular taxable income may not be enough to support a business’s continued registration and VAT recovery. The impact of this is by no means restricted to farming. Most sectors have operators who have left subsidiary entities to ‘tick over’ while their owners concentrate on other interests. If they also recover input tax from HMRC, this could be at risk. 

The relevant factors that determine whether there is a legitimate business activity will vary widely according to individual circumstances. Also, the Upper Tribunal’s decision does not pinpoint a moment in time when Babylon Farm ceased to be in business for VAT purposes, only that this had already happened by 2014, the beginning of the period covered by its VAT inspection. Owners of VAT registered businesses who have scaled back their activities or left one of their entities in an almost dormant state should take steps to review the risk to their VAT recovery in the light of the Babylon Farm case and other recent case law.

Of course, VAT is only one tax where it is complex yet very important to determine whether the taxpayer is trading as a business. What constitutes a business for one tax may not for another, with varying consequences. Business owners operating more than one entity should ensure their activities still qualify as a ‘business’ for VAT purposes.