The VAT Trap

As crossing the VAT threshold means passing on a 20% price increase to clients, it’s no wonder many salons avoid it, but isn’t there a better way? Hellen Ward weighs in

Picture the scene: my window cleaner has arrived – my house is a London townhouse so isn’t that wide but has lots of storeys, a traditional Victorian build, hence lots of windows. It’s been a long winter and I haven’t seen him for some time. I can’t remember what he charges. Surely he takes card payments. Or online? Surely not just cash still? He must have a SumUp machine, right? I can’t even remember the last time I saw some readies.

“How much will it be?”, I venture timidly. He tells me. I decide I must be in the wrong business, especially when I remember that window cleaners in Fulham are like unicorns. “Would you prefer cash?”, I ask. Stupid question really. “Yes,” he says, then proceeds to tell me in great detail exactly why. I begin to wish I hadn’t asked.

“Do you know,” he says, “that I have to pay around £5k a quarter to the Government now because of VAT?” He seems astonished. “Yes,” I reply. “That’s how it works.” He carries on mumbling and cursing and explaining why the cash is so necessary and preferable. As a business that has been registered for VAT since 1992, I feel like taking his ladder away.

Regardless, off I trot to the cashpoint and come back feeling like one of the Eastenders Mitchell brothers, thumbing a wad of notes.

Joking aside, the problem with VAT is that it might work in theory, but it doesn’t really work in practice, least of all for our sector. Technically, once a business needs to register because it exceeds the threshold for annual turnover (currently £85k), it needs to start charging VAT to its customers. Quite simple really, except it’s not.

The equation

In practical terms, if you hit the threshold, you simply change your billing system to add 20% (tax on your output) and reclaim the VAT you pay on any invoices you receive (input tax).

You subtract the difference between the two and pay it over to HMRC on your quarterly return. So, if you are a manufacturer, for instance, you charge more to your customers, but they can claim back the VAT on your bill against their output because they are probably VAT registered too. Easy.

But not so easy if your customer is the end user. They just end up paying 20% more because there is nothing to offset it against. In effect, the price has just gone up by 20% in a heartbeat.

In our sector, if we go VAT registered, we don’t just put our prices up by 20% to cover it. Even with inflation tracking at current levels, a hike of 20% is a serious risk to our customer base, a threat to our livelihoods. People can stomach a few pounds and still justify their indulgence in this cost-of-living crisis, but a 20% overnight rise across the board is a stretch too far. We simply can’t pass it on in this way if we become VAT registered without it posing a serious threat to our business.

No wonder lots of small businesses will go to any lengths to avoid reaching the threshold (including my window cleaner). Furthermore, unlike lots of businesses, we use minimal stock, so we don’t have much chance of offsetting the tax we pay against any invoiced VAT we fork out for.

"Any sector whose customer is the end-user will inevitably try to AVOID VAT and going over the threshold, especially if they are CLOSE TO IT but not quite over it"

Any sector whose customer is the end-user will inevitably try to avoid VAT and going over the threshold, especially if they are close to it but not quite over it, teetering on the brink of registration, like many SMEs (small to medium-sized enterprises) in our industry. We are largely made up of this business model so if you can limit your income, accepting the odd cash payment to stay under the threshold, it’s no wonder people are tempted.

But deliberately staying under the £85k in a trading year threshold can only serve to limit growth. Dress it up any way you like but it’s tax evasion. Restricting your success is kicking the can down the road, isn’t it?

The solution?

In Ireland, there is a split rate on goods and services so people in our sector selling to an end user pay a lower percentage of VAT, then pay full rate on their retail sales (this cements the argument as they can recoup the VAT their suppliers charge on this element). But the key to the split rate’s success is that the threshold for VAT registration is much lower than the UK (€37,500) so any business trading well has no hope of staying under it.

This effectively serves to wipe out the black market and it also levels the playing field and doesn’t punish people who want to play by the rules. Salon Employers Association (SEA, which I co-founded) will never stop campaigning for the Irish VAT model to be adopted in the UK – and that’s why.

I recently heard that there are rules coming into force in the EU that nobody can pay cash for goods or services – legitimately or not – over €1,000. So, if you want to pay cash for something out of your hard-earned, taxed income, you could be treated like a criminal. Talk about tackling things the wrong way round!

Back to my window cleaner. As aggrieved as I was to find him practising tax avoidance, I do understand why he asked me for cash. Should I have given it to him, knowing that he was doing that? No. But it was that or dirty windows. Sometimes you have to suck it up.

Hellen Ward is managing director of Richard Ward Hair & Metrospa in London and co-founder of Salon Employers Association (SEA).