You’ve been winding down one of your businesses so that now it’s trading well below the VAT registration limit. You want to stay registered so you can continue to reclaim VAT on purchases but can HMRC override your decision?

Are you in or out of VAT?

VAT is often seen as a necessary evil but it can be a tax-saving opportunity. Where your VATable supplies exceed the registration limit (£85,000 per year) you don’t have a choice but to be part of the VAT club. But if your turnover falls below the limit you can remain registered voluntarily as long as you make some VATable supplies or intend to make them in the course of your business or other “economic activity”. Conversely, you must deregister if you stop making VATable supplies altogether. Plus, HMRC has the power to step in and cancel your registration which would mean losing the right to reclaim VAT on purchases.

Deregistered by the VATman

In the First-tier Tribunal (FTT) case of Babylon Farm Ltd and HMRC 2019 HMRC cancelled Babylon Farm’s (BF’s) registration. BF had reduced its farming activity until it was only producing hay. It claimed input tax of nearly £20,000 paid on the cost of building a new barn. HMRC argued BF wasn’t engaged in an economic activity in the course of business. Among other factors it pointed out that BF’s only customer was a business run by BF’s owner. What’s more, until HMRC asked questions, BF had no sales invoices or contract to supply goods and had received no payment for the hay produced. The FTT agreed with HMRC that BF wasn’t carrying on a business.

What’s a business?

There isn’t a clear definition of what counts as a “business” for VAT purposes. However, over the years the courts have come up with six key questions which need to be answered to determine whether a business exists. They are:

  • Is the activity a serious undertaking earnestly pursued? In other words, are you doing it for work or pleasure?
  • Is the activity pursued with reasonable continuity? Sporadic transactions are ignored unless they are very high value.
  • Does the activity have substance in terms of the value of supplies? (BF fell down on this one)
  • Is the activity conducted in a regular manner and on sound and recognised business principles?
    Is the activity predominantly concerned with making VATable supplies for payment?
  • Are the supplies of a sort that are commonly made by those who want to profit from them? In other words, if you’re part of a recognised trade, HMRC will probably be happy. Whereas if you claim to be in business doing something it thinks is “completely improbable and unique” you might have a problem.
  • BF lost the case because it couldn’t answer yes to at least the second, third and probably the fourth questions. The value of its supplies were around £500 per year and the activity certainly wasn’t conducted on sound business principles – spending over £100,000 on a barn to store hay which produced very little income.

Tip. As a rule of thumb, HMRC is unlikely to try to deregister you if you’re making a profit. But you can improve your chances of staying registered by keeping the sort of records you would expect a business to have, e.g. issuing invoices, and generally operating in a way that’s consistent with a continuing business, even if you’re running it down before closure.

HMRC has the power to cancel your registration if it believes you aren’t carrying on an economic activity as a business. You’ll improve your chances of staying registered if you continue to operate your business on normal sound commercial terms and maintain records which are consistent with this.