As the calls to cut taxes for UK-based micro and small businesses multiply, concerns are being raised over the most recent proposals. Those concerns are the cost to the Treasury (the plans are currently unfunded) and who the main beneficiaries would be (likely the biggest corporate groups in one or more specific sectors).
Take the campaign to halve the VAT rate to 10% on hospitality supplies. If applied to businesses of all sizes, and including those operating in the closely related accommodation sector, HMRC estimates the net cost would be £10.5bn a year.
Considering that more than 75% of net VAT receipts collected by HMRC in 2024/25 from all industries came from companies with an annual turnover of at least £10m, it is reasonable to conclude that the vast majority of that £10.5bn VAT relief would be enjoyed by the biggest hospitality and accommodation players.
Raising thresholds
An alternative, fully costed proposal would be to limit support to micro businesses in all sectors and increase the VAT registration threshold from the current £90,000 of taxable turnover to £500,000, while simultaneously raising the standard rate of VAT from 20% to 21%.
Making VAT registration compulsory only when a business makes taxable supplies of at least £500,000 in any given 12-month period could reduce the VAT population across the UK from about 2.3 million entities (as of now) to 1.5 million.
There are 800,000 businesses with a turnover under £500,000
According to the official 2024/25 VAT data, there are around 800,000 micro or very small traders reporting an annual taxable turnover of between £90,000 and £500,000. Not all these businesses would benefit from deregistering, of course (exporters typically benefit from being VAT-registered, for example), but for those whose customers cannot recover VAT as input tax (eg retailers), the end of VAT charging would result in either higher margins or increased competitiveness – or both.
Those who prefer to keep their VAT registration even if their turnover is below the new threshold should be able to do so and not forced to deregister.
Raising the VAT registration to £500,000 would have further advantages. There would be less admin for the businesses affected (fewer VAT returns to prepare and file) and it would also free up HMRC resources given that the VAT population would shrink considerably and such special regimes as the VAT flat rate scheme (currently applicable only to those with a taxable turnover under £150,000) would become redundant.
Raising rates
You may think that losing up to 30% of the VAT population could result in a huge loss for the Treasury, which counts on VAT to raise about £180bn a year. But VAT-registered traders with a taxable turnover of between £90,000 and £500,000 remit ‘only’ £11bn in annual net payments to HMRC.
To bridge that gap, the second part of my proposal comes into play: raising the standard VAT rate by 1 percentage point to 21%.
According to a recent HMRC report, increasing the standard rate by 1 percentage point would raise about £9bn more a year. The additional £2bn required to make up the £11bn shortfall created by the VAT threshold increase could easily come from corporation tax.
£11bn VAT relief for micro businesses would translate into higher margins
At least part of this £11bn VAT relief for micro and small businesses would translate into higher margins for these traders, which would in turn mean higher profits subject to corporation tax and ultimately more corporation tax receipts for the Treasury.
Downsides
Despite these proposals being fully costed, readers may have two possible objections.
First, the proposals could be inflationary because of the 1% increase in the rate of VAT. But the part of the current VAT population that will deregister will no longer charge VAT, and when these businesses pass some of that benefit to their customers by way of reducing their prices, there will be a deflationary effect too.
The second objection may be that these proposals would break the government’s manifesto not to raise VAT rates. But find me a government that has kept all its election promises!
The views expressed here are the author’s own
