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Why VAT Is Killing Small Businesses in the UK – Neil’s Opinion

Introduction

The Hidden Cost of VAT for Small Businesses

The recent increase in the UK VAT threshold from £85,000 to £90,000 may seem helpful on the surface, but in reality, it’s had little to no impact on the financial health of many small businesses—particularly in hospitality, hairdressing, and other service-based sectors.

For business owners whose main costs include wages, rent, and business rates—expenses that don’t include VAT—crossing the threshold often results in huge tax bills that eat into already slim profits.

Experts Since

2010

My Personal Experience

A Small Café Strangled by VAT

As a former café owner, I speak from first-hand experience. My turnover hovered just below the £85,000 VAT threshold at the time. Yet even at this level, making a profit was near impossible due to rising costs for ingredients, energy, wages, and rent.

If I’d increased prices by 10%—something my loyal customers would have tolerated—I would have crossed the VAT threshold. The result? The business would’ve been liable for VAT and likely gone under. There was no room to grow without being penalised.

The Same Struggle in Other Industries

The Hairdresser Example

It’s not just cafes which have this problem – I have a good friend who owns a ladies’ hairdressers. She has a good reputation and has built up a loyal clientele who would readily recommend her to their friends.

The problem is that they became so busy that they had to take on extra staff and – crucially – increased their turnover to more than the VAT-threshold. The result – instead of making a profit, they had to hand over thousands of pounds to the VAT-man, thus making them a loss-making business; had to make staff redundant to cut costs, lost customers and had to return to being the small business they were previously.

The Scenario

Why the Current VAT Rules Punish Growth

Here’s a simplified example of how the VAT system impacts small business profitability:

Scenario 1: Below the VAT Threshold

  • Sales: £88,000
  • VATable Expenses: £20,000
  • Non-VATable Expenses: £50,000
  • Profit: £18,000

Scenario 2: £10,000 More in Sales (Crossing the VAT Threshold)

  • Sales: £98,000

  • VATable Expenses: £20,000

  • Non-VATable Expenses: £50,000

  • VAT Due: £13,000 (£16,333 VAT on sales minus £3,333 reclaimed)

  • Profit: £15,000

So, despite an extra £10,000 in sales, the business loses £3,000 in profit. Growth is punished. There is no incentive to scale under the current system.

In fact, I calculated that I would’ve needed to increase turnover by nearly 50% just to maintain the same profit margin once VAT was applied.

Helping Small Businesses Thrive

How the VAT System Could Be Reformed

Here are two simple suggestions that would make a huge difference for small businesses:

  • Introduce a lower VAT rate for small businesses – Applying a reduced VAT rate on all sales would ease the burden and encourage growth.
  • Only apply VAT to sales over the threshold – A tiered system would allow small businesses to grow gradually, without being penalised for marginal increases in revenue.

Neither suggestion would reduce tax revenue if the rates were calculated fairly. But both would support entrepreneurship, discourage hidden income, and help small businesses thrive—not shrink.

Final Thoughts

The VAT system as it stands today is stifling small business growth across the UK. Until these issues are addressed, many cafés, salons, and other service-led businesses will continue to hover just below the threshold—afraid to grow.

It’s time for real reform that supports local businesses, not penalises them for their success.

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