Policy paper

Statement of Practice 4 (1983)

Published 1 April 1983

1 Introduction

This statement of practice sets out how HM Revenue and Customs (HMRC) will apply the updated provisions aimed at countering the artificial separation of businesses to enable them to trade below the VAT registration threshold. The purpose of this statement is solely to clarify HMRC’s policy in this area. It does not qualify the relevant legislation, nor does it affect a taxpayer’s right of appeal to an independent VAT and duties tribunal.

2 Why the legislation is required

The measures were originally designed to counter avoidance in circumstances in which a business is artificially separated, so that one or more of its parts trades below the VAT registration threshold.

The impetus was twofold:

• firstly, unfair competition results from artificial separation because the split businesses, trading below the threshold, do not have to charge VAT on their supplies and may therefore be able to charge lower prices than their registered competitors, and
• secondly, tax loss accrues to the Exchequer because, in the absence of separation, the whole business would be trading above the registration threshold and liable to register

The new legislation became necessary because the existing measures proved ineffective and this type of avoidance remained widespread. Having to establish the intention of the parties proved difficult, as businesses were able to offer apparently legitimate reasons for the separation, which were, in fact, secondary to the real reason, which was the avoidance of registration.

3 The legislation

The provisions, which were contained in the Finance Act 1997, section 31, make the following main changes:

• paragraph 1A is inserted into Schedule 1 to the Value Added Tax Act 1994. It clearly states that the purpose of paragraph 2 is to counter any artificial separation of business activities resulting in an avoidance of VAT. In determining whether or not any separation is artificial the extent to which the parties involved are closely bound to one another by financial, economic and organisational links must be taken into account
• paragraph 2(2)(d) of Schedule 1 is repealed. It prevented the Commissioners taking action unless they were satisfied (amongst other things) that one of the main reasons for the separation was the avoidance of registration

The purposive clause is an over-arching provision against which a direction made under this legislation must be tested. Its inclusion is a conscious attempt to indicate Parliament’s aims in passing the legislation, and to encourage tribunals and courts, when considering appeals, to test not only the legal technicalities but also whether the disaggregated business arrangements result in a VAT loss.

4 How the new measures will be applied

Whilst it is true that the new measures focus on the effect rather than the reason for the separation, it must be stressed that their purpose is to counter artificial separation, which results in an avoidance of VAT. HMRC will therefore not aggregate businesses unless they are satisfied that the separation is artificial.

Under the new measures HMRC may only make a direction when:

• the separation is artificial
• the separation results in an avoidance of VAT
• the parties involved are closely bound by financial, economic and organisational links
• the other legal requirements are satisfied

5 What HMRC will consider to be artificial separation

HMRC will be concerned with separations, which are a contrived device set up to circumvent the normal VAT registration rules. Whether any particular separation will be considered artificial will, in most cases, depend upon the specific circumstances.

Accordingly it is not possible to provide an exhaustive list of all the types of separations that HMRC will view as artificial. However, the following are examples of when HMRC would at least make further enquiries:

Separate entities supply registered and unregistered customers

In this type of separation, the registered entity supplies any registered customers and the unregistered part supplies unregistered customers.

Same equipment/premises used by different entities on a regular basis

In this type of situation, a series of entities operates the same equipment and/or premises for a set period in any one week or month. Generally the premises and/or equipment is owned by one of the parties who charges rent to the others. This situation may occur in launderettes and take-aways such as fish and chip shops or mobile catering equipment such as ice cream vans.

Splitting up of what is usually a single supply

This type of separation is common in the bed and breakfast trade where one entity supplies the bed and another the breakfast. Another is in the livery trade where one entity supplies the stabling and another, the hay to feed the animals.

Artificially separated businesses which maintain the appearance of a single business

This type of separation includes pubs in which the bar and catering may be artificially separated. In most cases the customer will consider the food and the drinks as bought from the pub and not from 2 independent businesses. The relationship between the parties in such circumstances will be important here as truly franchised “shop within a shop” arrangements will not normally be considered artificial.

One person has a controlling influence in a number of entities which all make the same type of supply in diverse locations

In this type of separation a number of outlets which make the same type of supplies are run by separate companies which are under the control of the same person. Although this is not as frequently encountered as some of the other situations, the resulting tax loss may be significant.

6 The meaning of financial, economic and organisational links

Again each case will depend on its specific circumstances. The following examples illustrate the types of factors indicative of the necessary links, although there will be many others:

Financial links

• financial support given by one part to another part
• one part would not be financially viable without support from another part
• common financial interest in the proceeds of the business

Economic links

• seeking to realise the same economic objective
• the activities of one part benefit the other part
• supplying the same circle of customers

Organisational links

• common management
• common employees
• common premises
• common equipment

7 How the measure will apply in particular circumstances

Franchised businesses

HMRC do not expect this measure to affect genuine, as opposed to artificial, franchising.

Hairdressers

The existing agreement between the National Hairdressers Federation and HMRC is used to determine whether or not a stylist working in a salon is an employee or a self-employed person. The new measure applies only to self-employed persons. HMRC will amalgamate those self-employed stylists who are artificially separated provided that the legal criteria are met.

Self employed taxi drivers

The ways in which taxi firms operate can vary. Only those firms, which operate in such a way that the legal criteria are met, will be registered by HMRC as a single business.

Businesses already registered for VAT

The measures enable HMRC to register businesses which otherwise would not be registered for VAT. Consequently HMRC will not use their powers to amalgamate when all of the parties involved are already VAT registered. However, where the powers are invoked, existing registrations will be cancelled from a current date and the newly amalgamated businesses will be registered with a new number.

Registration date for amalgamated businesses

When HMRC invoke the measures, the liability to be registered as a single business will take effect from the date of the direction, or such later date as may be specified in the direction.

Penalties

The new measures do not introduce any fresh penalty provisions. However, should artificial separation continue as a means of avoiding VAT, the position on penalties will be reconsidered.

Appeals

Businesses, which disagree with HMRC’s decision, will be able to appeal to the VAT and duties tribunal. The basis of the Tribunal’s decision will continue to be whether HMRC could reasonably have been satisfied that there were grounds for treating all the separated parts as a single taxable person, given the legal criteria and the purpose of the legislation.

8 Advice on proposed separations

It is a matter for the parties concerned, after due consideration of all the relevant factors, to determine how to structure their business activities. Accordingly HMRC will not advise on the VAT consequences of any proposed structure but we will give a decision when faced with an actual situation.

9 Responsibility for issuing directions

Responsibility for issuing directions will remain with local offices, which should be contacted if you have any enquiries.