Andrew Needham looks at some possible traps a business can fall into when deregistering from VAT that can result in an unexpected bill from HMRC.
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Businesses have been going through difficult times recently and some smaller businesses selling to the public, particularly services, find that they have fallen below the VAT deregistration threshold (currently £88,000 p.a.) and think that they would be better off deregistered.
The reasoning behind considering VAT deregistration is that they can either decrease their prices by the VAT amount and become more competitive, keep their prices the same and increase their profit by the VAT amount or even do a mixture of the two.
Potential problems
However, there is a potential pitfall to be considered before contemplating deregistering for VAT. When a business deregisters from VAT, if the VAT on the current value of the assets on hand at the time of deregistration is more than £1,000, it has to be repaid to HMRC; it includes any stock or capital equipment, etc. This could wipe out any potential savings from deregistering from VAT unless the deregistration is going to be permanent rather than temporary until the economy picks up.
Even more of a worry are the effects of the capital goods scheme (CGS). The CGS applies to the purchase of land or buildings and the refurbishment or extension of existing buildings with a value of more than £250,000 where VAT has been reclaimed. If you change the use of the asset from taxable to exempt (or vice versa) or deregister from VAT within a ten-year period, then you have to adjust the amount of VAT reclaimed.
You could end up either reclaiming more VAT or, more likely, paying some back to HMRC on deregistration.
Example: An unexpected VAT bill
Mr and Mrs Brown bought a small seaside hotel four years ago for £400,000 and the previous owners had opted to tax it (decided to charge VAT on the sale). The VAT was on top of the sale price and totalled £80,000, which they recovered on their VAT return because their business was fully taxable.
Their turnover was originally about £90,000 p.a. but has fallen slowly until they now only turn over £62,000 p.a. They are now below the deregistration threshold and are considering deregistering so they can increase their profits (increased profit = £62,000 x 7/47 = £9,234). They would obviously also have to take account of the input VAT that they could no longer reclaim of ongoing costs which would reduce this amount.
If they deregister now, the CGS will come into play, and they will have to repay some of the VAT. The deregistration will result in a deemed exempt supply of the property in year four of the CGS adjustment period. The remaining six years will be viewed as exempt use, so the calculation will be:
£80,000 x 6/10 (60%) = £48,000
Mr and Mrs Brown would be extremely unhappy to find that they owe HMRC £48,000 plus the VAT on the stock and fixtures and fittings as well!
One might think that they could avoid the CGS adjustment by opting to tax, but then it would be regarded as a taxable supply at deregistration and they would owe the VAT on the current value of the property which could be even more than the £80,000 claimed!
Based on this, Mr and Mrs Brown would be much better off remaining registered for VAT and continuing to trade until business improves and their turnover once again goes over the VAT registration threshold, as it would take about five years to break even if they deregistered!
Practical tip
If a business is considering deregistering from VAT, it will need to take account of any input tax it needs to repay to HMRC on deregistration as well as the input tax on purchases it will no longer be able to reclaim, so taking advice before deregistering would be recommended.
