Business splitting to save VAT

Neil Warren, CTA VAT consultant and tax writer. Croner-i

Neil Warren CTA (Fellow) ATT considers the pros and cons of splitting businesses to reduce VAT liability, with a warning about HMRC’s powers to treat separate entities as a single registration for VAT purposes if they are closely connected.

I’ve just had a new carpet fitted in my house, which has produced two major benefits: firstly, it has made the bedroom look much more stylish, a royal suite rather than the forgotten spare room. Secondly, it gave me first-hand experience of how the carpet industry will go to great efforts to save VAT on fitting charges. Let me explain.

Separate supplies

I purchased my carpet for £600 including VAT from a medium sized retailer in Birmingham. The deal was promoted as having a ‘free fitting service’ – in other words, I pay £600 and no more.

The paperwork produced by the salesperson made it immediately clear that I was in fact making two separate purchases, namely a carpet from the retailer (goods) and a separate supply by a self-employed fitter (labour).

And yes, you’ve guessed it, the fitter is a one-person business trading below the compulsory £90,000 annual sales registration threshold, so does not charge VAT on his services. He issued a separate invoice for £100 and I paid him directly to his bank account. I was invoiced for £500 including VAT by the carpet shop and made a separate payment.

The end result? Instead of HMRC getting £100 VAT out of the deal, they got £83.33, ie, £500 × 1/6 rather than £600 × 1/6. My first thought was: is it worth all the hassle and extra paperwork to save £16.67 in VAT? Answers on a postcard please.

Commercial motives

When the fitter arrived at my property, I took the opportunity to discreetly put on my VAT hat and ask him a few questions about the deal. Enthusiasts who deal with business splitting situations will know why I asked these questions.

• Complaint: he confirmed that if I was not happy with the quality of his fitting work, I should email him and complain and not contact the carpet shop; he would directly address my concerns.

• Extras: I asked if I would negotiate the price of extra services I might need on the job with him or the shop. His answer was clear that it was only him.

• Payment: he gave me his bank details and I paid him directly for the labour and not via the shop, as explained above.

As for the commercial benefits of the arrangement for the shop, there would be no irate customers complaining about poor fitting and they could focus on their main business activity which is to sell carpets rather than fit them. As the old saying goes, stick to what you are good at and let others do the rest; it isn’t just about saving VAT.

Does it work?

The legislation is clear that HMRC have the power to treat two separate entities as a single registration for VAT purposes if the entities are closely connected by ‘economic, financial and organisational links’.

Note the word ‘and’, meaning that HMRC must prove all three links and not one. If HMRC decide there is a close connection, their power to correct the register is from a current or future date and not retrospective (VATA 1994, Sch 1, para 1A and 2).

Business splitting is not the relevant issue with my carpet scenario; it is a three-party transaction where the key question to ask is: who is supplying what and to whom? The question is answered by considering two issues:

• commercial reality: this goes back to the questions considered about complaints, extras and payment;

• contracts: what does the sales agreement/supplier contract say?

Overall, there was no doubt in my mind that the shop had structured the deal perfectly and had achieved a VAT saving by legitimate commercial means.

Perhaps their VAT-saving joy will be short-lived if the chancellor reduces the registration threshold to £30,000 in her much-anticipated Budget on 26 November.

Tribunal case

My story is timely because there was a First Tier Tribunal (FTT) case heard in the summer about the VAT liability of fitting charges made by self-employed fitters. HMRC issued an assessment for £496,823 to a carpet shop United Carpets (Franchisor) Ltd ([2025] TC 09596) to collect 1/6 of payments made to the fitters as output tax.

Needless to say, HMRC lost the case and in my view it was the easiest tribunal win for a taxpayer I have ever known. HMRC failed to land a decent punch during the hearing and the taxpayer’s representatives referred to HMRC missing the ‘wood from the trees’, a perfect summary.

Conclusion

To bring the issues together, here are tips about three-party transactions involving two businesses and a customer, where only one of the businesses is registered for VAT:

• Commercial reality and contracts must agree – make sure that the commercial reality of a deal matches what is said in the contracts or other paperwork. In the United Carpets case, the fitters directly negotiated prices and extras with the customers, and this commercial outcome was supported by a clause in the contract between the shop and the customer: ‘A fitter introduced by us will make direct contact with you to agree their engagement with you and subject to that to make necessary arrangements’.

• Websites and marketing – care is needed with marketing gimmicks on websites that could give HMRC the wrong impression of an arrangement. In my deal, the carpet shop did not give me ‘free fitting’; they discounted the price of my carpet so that I had some pennies left to pay the fitter.

Finally, the good news for United Carpets is that HMRC have confirmed that they will not challenge the FTT’s decision. And rightly so!

About the author

Neil Warren CTA (Fellow) ATT is an independent VAT consultant and regular contributor to Croner-i