This Content Was Last Updated on April 6, 2023 by Jessica Garbett
Business Splitting, also known as disaggregation, is the process of legally restructuring a business into two or more business such that multiple vat registration thresholds can be enjoyed, and one or more of the businesses come outside of VAT.
- This is tax planning, and although legal, it must be properly executed
- HMRC can challenge business structures where the split is not genuine nor properly executed
- There is significant risk if business restructures for VAT are not properly planned and executed
Situations where Business Splitting may be of use
- If you run both classes and retreats – splitting these into separate entities so that one or both are below the VAT thresholds
- If you run both classes and teacher trainings – splitting these into separate entities so that one or both are below the VAT thresholds
- If you run a studio with a secondary income like a cafe or retail – splitting these into separate entities so that one or both are below the VAT thresholds
- If you run a studio which is predominantly used by yourself but others rent facilities – splitting the rentals out so they are not aggregated with your turnover
- If you run a studio and also host a teacher training
And situations where Business Splitting wouldn’t work
- Having different retreats in different entities – if your overall retreat income is over the VAT threshold
- If you run a studio and split class income across entities, eg one entity does classes for one block of teachers, and one for another
- Splitting regular classes you run at different locations into separate entities
- Aggressive tax avoidance schemes, eg separate entities for days of the week or months – this sounds absurd but it has been tried
Put simply Business Splitting has to have a commercial rational behind it.
Criteria for Business Splitting to Work
First, each split business must be in a separate legal entity, eg:
- Sole trader and company
- Two companies
- Sole trader and partnership
- Studio and a number of contractors
Merely using multiple trading names doesn’t work, as the VAT Registration threshold is on an entity basis
Second, the businesses must be economically independent – in practice they can share a branding, including website, and some expenses subject to cross charge, however they must serve substantially different client bases and / or be capable of trading in isolation. This is why splitting teacher training or retreats from regular classes can work, as they are stand alone customer bases/trades, but splitting regular classes within a studio based on times or teacher wouldn’t work – there is not enough distinction / separation, and the stand alone element isn’t there.
Finally the split must be genuine and not a sham. This means practical and substantive operational separation, eg:
- Separate branding if practical. However its not essential if you have significant existing value in the brand which could be lost, so long as the remainder of the separation is genuine.
- Separate websites for each business, or if you are using a cross business branding, separate pages on your website, eg a page for classes, a page for retreats, a page for teacher training, with the relevant entity identified on the page
- Clear explanation in “about ” section on your website, eg “Moonfall Yoga is a trading name of Freda Smith, and provides yoga classes and teacher training. Moonfall Retreats Limited provides yoga retreats and residential courses under the umbrella of Moonfall Yoga”
- Correct entity name on all advertising, flyers, booking confirmations for retreats, application forms etc
- Separate business bank accounts for each entity
- Separate accounting and bookkeeping for each entity
- If possible, separate social media, or at least a sub identities for each entity
- Separate email addresses for each entity, eg retreats@moonfallyoga and separate email signature if possible
- Keep income and expense for each business separate and in the appropriate account
- Keep expenses separate where possible, and cross charge where you cannot
On a individual basis we may advise other steps – the key things here are:
- Customers are aware of the split and know who they are contracting with
- The split is transparent and clear
HMRC can challenge business splitting in two ways:
- If they consider the split was never genuine, the split can be treated as avoidance, ignored are retrospective VAT charged – hence the steps needed above
- If they consider the split genuine, but the relationship between the businesses too close, they can issue a prospective – not retrospective – notice of combination.
- This is why attention to detail is necessary
Our experience is that properly thought through and implemented restructures to split a business create no unusual tax risks; HMRC challenges occur in egregious cases where the split does not make economic sense or has been incorrectly implemented.
An interesting Tribunal case on splitting – they had approached everything wrong, and HMRC unsurprisingly issued combined VAT assessments – surprisingly the Tribunal overturned these and sided with the taxpayer.
Businesses with Separate Owners Sharing Costs
Where the underlying ownership of businesses is genuinely with different people but costs and resources are shared, then in most cases these are treated as different business. However if the relationship us too close then a prospective notice of combination could be issued (second point above) by HMRC.
EG two independent yoga teachers join together to rent studio space
- Scenario one – they each keep their own branding and business identity, albeit there is social media and branding for the shared building. They keep their own students, and split the costs of running the studio 50:50. This scenario is unlikely to see see a challenge from HMRC
- Scenario two – as above – the co-owners also rent the space when they are not using it to a masseur, a pilates teacher and another yoga teacher, for one session a week each – these businesses are independently owned and run. The co-owners share the rent equally. Again this is unlikely to raise concern with HMRC
- Scenario three – the yoga teachers renting the space set up a shared schedule, and shared booking system, and both trade under the same name. This may result in HMRC issuing a notice of combination as the clear distinction between the businesses has been lost.
Risks can be mitigated by being very clear about arrangements in public facing communications.
Agent / Client Arrangements
Another scenario which can cause problems is if a VAT registered studio wishes to save vat by transferring a class to a Self Employed teacher and accounting for the rent/share rather than the class income.
Potentially this is an agency arrangement and for it to work there must be clear disclosure to customers – so called “Disclosed Agency” arrangements.
Business Splitting – Worked Example of VAT Savings