Artificial separation refers to when a business is split into smaller entities to avoid exceeding the VAT registration threshold (£90,000 from April 2024). HMRC considers this an abuse if the separate entities are not genuinely independent.
How Does HMRC Assess VAT Splitting?
HMRC looks at whether the separated businesses are truly distinct or artificially split to avoid VAT. They assess factors such as:
Financial Interdependence – Do businesses share bank accounts or finances?
Economic Interdependence – Do businesses serve the same customers or have intertwined activities?
Organisational Interdependence – Do they share employees, premises, or equipment?
Contractual Arrangements – Are contracts structured to give the appearance of independence while maintaining control?
Shared Branding & Marketing – Are businesses marketed together or presented as one?
If HMRC determines that businesses are artificially separated, they can enforce VAT aggregation, meaning they treat the entities as a single taxable business for VAT purposes.
Issues with Artificial Separation
VAT Liability – If HMRC deems businesses artificially split, they must register for VAT and charge VAT on past sales.
Cash Flow Impact – A business may lose its competitive advantage if it has to charge VAT.
Compliance Costs – Increased administrative burden to rectify non-compliance.
Penalties & HMRC’s Reach
VAT Backdating – HMRC can go back up to 20 years in serious cases but usually 4-6 years.
Penalties
Failure to register for VAT: Up to 100% of unpaid VAT.
Inaccurate VAT returns: 30%-100% of the VAT due, depending on the level of concealment.
Interest Charges on unpaid VAT.
Criminal Prosecution (in extreme fraud cases).
Risks of VAT Splitting
Unexpected VAT Bill – HMRC can demand VAT plus penalties and interest.
Legal Consequences – Risk of investigations and legal challenges.
Damage to Reputation – Risk of being publicly exposed for tax avoidance.
Cash Flow Disruptions – Business may struggle to pay backdated VAT and penalties.
Conclusion: If businesses are considering splitting for VAT purposes, they should seek professional advice. HMRC scrutinizes cases heavily, and the risks of non-compliance can be severe.