Anyone who runs a business will be aware that VAT is rising to 20% on 4 January 2011. Research by the Institute of Chartered Accounts in England and Wales (ICAEW) found that 6 out of 10 small businesses feel that the increase will affect their cashflow to some degree. For many small businesses that already run very tight cashflow, this is a real concern.

There is also the wider impact of the VAT rise on the rest of the economy. A recent study by the Centre for Economics and Business Research (CEBR) which was commissioned by the Federation of Small Businesses found that if the VAT threshold for businesses were to be lowered from £90,000 to £70,000 it would save £700 million in VAT payments. This saving could be used to create 35,000 new jobs and save up to £162 million a year on the red tape surrounding VAT compliance.

Whilst this would affect the amount the Treasury gains in VAT receipts, it would be more than offset by the £13 billion expected to be gained by the VAT increase. And of course, the benefit for the small business would be immeasurable. It is hard for small businesses to absorb the VAT increase in the same way that a larger business could. Inevitably the increase will be passed on to the customer.

However, lowering the threshold would mean that small businesses could free up their cashflow, without over burdening their customers and clients and still allow them to consider growing their workforce. This is crucial right now as FSB research showed that 10.4 per cent of firms expect to decrease employment over the final quarter of 2010; business confidence drastically weakened over the months of July and September.

Regardless, the VAT increase will be with us. So how can you best prepare your business. If you are unsure of the impact make sure to speak to a qualified professional. The ICAEW had these pointers for anyone looking to avoid being caught out:

  • If there is an overlap of goods and/or services around 4 January 2011, the VAT charge can be split on a fair and reasonable basis so that 17.5% tax is charged on the value of supplies before 4 January 2010 and 20% on work carried out after this date.
  • Any credit note or refund given to a customer is based on the same rate of VAT that was charged on the original sale. The same principle applied to VAT claimed on bad debts.
  • If you are a non-VAT registered business considering making a capital investment, you may want to bring it forward to benefit from the cheaper rate.
  • HMRC are likely to be less lenient than with previous VAT changes as companies are more used to the changes and there a lot of notice given. Penalties and interest could be charged by HMRC if mistakes are made.
  • Start preparing as much as possible for the rate charge. Are the relevant employees in accounts going to be available at the beginning of January to sort out queries? Are there any supplies that will cross over the two rate period?

And don’t forget the business opportunities offering to help you customers ‘beat the rise.’ Anyone considering a serious purchase should look to make it before the rate goes up.

Hannah Holdroyd is London Policy Officer for the Federation of Small Businesses; she can be contacted on Hannah.holdroyd@fsb.org.uk. Read more about the FSB in London at www.fsb.org.uk/London