To Be or Not to Be... The De-registration Trap

To Be or Not to Be... The De-registration Trap
If you have fallen below the VAT de-registration threshold recently and are thinking of changing your status, beware of the potential pitfalls that lie ahead.

The last couple of years have been a difficult time for businesses and some smaller businesses selling to the public, particularly services, find that they have fallen below the VAT de-registration threshold and think that they would be better off de-registered. 

The reasoning being that they can either decrease their prices by the VAT amount and become more competitive or keep their prices the same and increase their profit by the VAT amount or even do a mixture of the two.


However, there is a potential pitfall to be considered before contemplating de-registering for VAT.   When a business de-registers from VAT, if the VAT on the current value of the assets on hand at de-registration is more than £1,000 it has to be repaid to the VATman; this includes any stock etc, and could wipe out any potential savings from de-registering from VAT unless the de-registration is going to be permanent rather than temporary during the recession. 

Even more of a worry is the effects of the Capital Goods Scheme (‘CGS’). The CGS applies to the purchase of land or buildings and the refurbishment or extension of existing buildings with a value of more than £250,000 where VAT has been reclaimed. 

If you change the use of the asset from taxable to exempt, or vice versa, to de-register from VAT within a 10 year period then you have to adjust the amount of VAT reclaimed.  You could end up either reclaiming more VAT or, more likely, paying some back to the VATman on de-registration.


Mr and Mrs Fawlty bought a small, seaside hotel 4 year ago for £400,000 and the previous owners had opted to tax it (i.e. decided to charge VAT on the sale).  The VAT was on top of the sale price and totalled £70,000 which they recovered on their VAT return because their business was fully taxable.

Their turnover was originally about £85,000 pa but has fallen slowly until the turnover is now only £62,000 pa.  They are now below the de-registration threshold and are considering de-registering so they can increase their profits (increased profit = £62,000 x 7/47 = £9,234).  He would obviously also have to take account of the input VAT that he could no longer reclaim of ongoing costs which would reduce this amount.

If they de-register now the CGS will come into play and they will have to repay some of the VAT.  The de-registration will result in a deemed exempt supply of the property in year four of the CGS adjustment period.  The remaining 6 years will be viewed as exempt use so the calculation will be:

£70,000 x 6/10 (60%) = £42,000

Mr Fawlty would be extremely unhappy to find that he owes the VATman £42,000 plus the VAT on the stock and fixtures and fitting as well!  

You might think that he could avoid the CGS adjustment by opting to tax, but then it would be regarded as a taxable supply at de-registration and he would owe the VAT on the current value of the property which could be even more than the £70,000 claimed!

Practical Tip

People in this situation, Mr and Mrs Fawlty included, would be much better off to remain registered and continue to trade until business improves and their turnover once again goes over the VAT registration threshold as it would take about 5 years to break even!

By Andrew Needham