VAT – what is disaggregation (artificial separation) of a business?
Understanding Disaggregation (Artificial Separation) and VAT
Disaggregation, also known as artificial separation, refers to the practice of splitting a business into multiple entities to avoid exceeding the VAT registration threshold. Some business owners attempt this by setting up multiple limited companies or dividing their sole trader activities into separate trades. While there are legitimate business structuring reasons for having separate entities, HMRC strictly prohibits disaggregation when it is done to avoid VAT registration.
If HMRC determines that businesses have been artificially separated, it has the authority to enforce VAT registration for all entities, assess backdated VAT liabilities, and impose significant penalties. This makes understanding the rules around disaggregation crucial for businesses operating near the VAT threshold.
VAT Registration Threshold and Disaggregation Rules
A business must register for VAT if its taxable turnover exceeds £90,000 (for the 2024/25 tax year) within any rolling 12-month period. Some business owners believe that by creating separate businesses and distributing revenue among them, they can avoid surpassing this threshold and remain unregistered for VAT. However, HMRC considers this an attempt to avoid tax and applies strict anti-avoidance rules.
To determine whether a business has been artificially split, HMRC will assess whether the businesses have financial, economic, or organisational links that indicate they are, in reality, a single entity.
How HMRC Identifies Artificially Separated Businesses
HMRC takes a case-by-case approach when determining whether businesses have been artificially disaggregated. It assesses three primary types of links between businesses: financial, economic, and organisational. The presence of any of these links may indicate that disaggregation has taken place and that the businesses should be treated as one for VAT purposes.
Financial Links
HMRC will look at whether there is financial interdependence between the businesses, such as:
- Shared bank accounts across multiple businesses
- A common financial interest, where the profits of one business directly benefit the other
- One business being financially dependent on the other (e.g., one business regularly providing loans or credit to the other)
- Shared ownership structures, where the same individuals hold financial stakes in both businesses
Economic Links
Economic links suggest that businesses operate as one entity despite being registered separately.
Key indicators include:
- Shared equipment, tools, or stock between businesses
- Operating from the same premises without distinct trading areas
- Joint advertising and marketing, where one business promotes another as if they were one
- A shared customer base, where customers see no clear distinction between the businesses
Organisational Links
Organisational links indicate that the businesses are controlled and managed together.
HMRC considers the following factors:
- Common employees or directors across both businesses
- Shared management structure, where decision-making is centralised
- Interchangeable staff, where employees work across multiple businesses with no formal distinction
If HMRC finds that these links exist, it may conclude that the businesses have been artificially separated and take action accordingly.
Consequences of Artificial Disaggregation
If HMRC determines that a business has been artificially separated to avoid VAT registration, it has the power to:
- Retroactively register the businesses for VAT from the point where they should have been treated as a single entity
- Demand backdated VAT payments on revenue that should have been taxed
- Impose penalties and interest charges for non-compliance
- Potentially pursue legal action in cases of deliberate tax avoidance
These financial and legal consequences can be severe, making it essential for businesses to ensure they are structured correctly.
