Smooth operator

National Chair of the Federation of Small Businesses (FSB), Martin McTague, looks at how the VAT system operates

calculator on a desk with paperclips around it Reaching a half century is often a point in life where we take some time to assess our lives, health, and finances, and think about what we want to change. With value-added tax (VAT) having reached that milestone in 2023, we at FSB thought it past time to look at how the VAT system operates – and whether there are ways it could be reformed and rethought, so as to unlock economic potential among the UK's small businesses and the self-employed. There's evidence that VAT is holding back growth among a significant sub-set of small businesses, making an overhaul of the tax all the more urgent as we look for ways to grow the economy.

Take the £85,000 threshold for turnover, above which you become liable for VAT, which has been in place since 2017. Had the threshold kept pace with inflation, it would be over £100,000 now.
Two in five businesses with a turnover between £75,001 and £100,000 told us that the current threshold is a barrier to growth, with three in ten saying that raising it would encourage them to invest in their business.

Some firms whose turnover is approaching the threshold understandably do all they can to stay under it, even if that means throttling their own income – a business which is viable at £84,000 turnover might find itself in a very different situation at £85,001 turnover with an extra 20 percent VAT added onto its goods and services.

This 'bunching' just under the threshold is estimated by the Office for Budget Responsibility to result in lost turnover of £350 million by 2025-26, with 44,000 firms predicted to be keeping themselves just below the £85,000 line.

Raising the threshold will unlock some of this potential economic activity, but it seems obvious that the financial hit upon moving into the VAT system should also be softened, to encourage scale-ups. That's why we're proposing that, alongside a higher threshold, the Government should introduce a smoothing mechanism.

We've set out in our paper two possible models for such a mechanism: a rebate on VAT paid for eligible small firms, akin to the Employment Allowance for National Insurance contributions; or a set discount up to certain turnover thresholds, i.e. 20% discount on net VAT paid for those with a turnover between £100,000-£109,999, and a 10% discount for turnover of £110,000-£119,999.

There are also – as any accountant can tell you – numerous quirks and labyrinthine rules regarding what does and doesn't attract VAT, which make it a headache for small firms, with less resource to devote to red tape, to administer. Taking a broom to some of the more arcane and byzantine aspects of the VAT system would be welcomed by almost everyone.

'Going for growth' is the buzzy phrase of the moment, with political leaders climbing over each other to proclaim their devotion to the idea. Picking up and running with our suggestions to make the VAT pill easier to swallow would be an excellent starting point.

As the UK's business support group, FSB is the voice of the UK's small businesses and the self-employed. Established over 40 years ago to help its members succeed in business, FSB is a non-profit making and non-party political organisation that's led by its members, for its members. As the UK's leading business campaigner, FSB is focused on delivering change which supports smaller businesses to grow and succeed. FSB offers members a wide range of vital business services, including access to finance, business banking, legal advice and support along with a powerful voice in Government. Each year FSB also runs the UK's Celebrating Small Business Awards. More information is available at You can follow us on twitter @fsb_policy and on Instagram @fsb_uk.

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