Does becoming a limited company reset the VAT threshold?

When a sole trader becomes a limited company, does the turnover of the sole trade count towards the limited company’s VAT threshold, or does it reset? This article explores why converting from a sole trade into a limited company resets your VAT threshold.

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Does becoming a limited company reset the VAT threshold?

Short answer: Yes. Becoming a limited company resets the VAT threshold for sole traders.

To learn more about the technicalities and, more importantly, to find out why, read on below.

Many new businesses dread crossing the VAT threshold. They see VAT not only as a huge administrative burden, but also as a threat to their profit margin. Because of this, many people look for ways to mitigate the impact and the following is a common question that we receive on the topic:

'When a sole trader becomes a limited company, does the turnover of the sole trade count towards the limited company’s VAT threshold or does it reset to NIL?'

Put into plain English: If a sole trader makes £84,999 in taxable supplies within 12 months and then incorporates, does the new limited company need to register for VAT as soon as it makes a sale?

Note: Currently (2020) the UK VAT threshold is breached if you make £85,000 in sales or more within a rolling 12 month window - learn more about when to register for VAT here).

Transfers of Going Concerns (TOGCs)

In accounting terms, the process of transferring a trading business between entities is known as a Transfer of a Going Concern (TOGC).

When you incorporate a sole trade into a limited company, although you might own 100% of each, both are considered separate legal entities. You are, essentially, transferring the trade from one entity (yourself, the individual) to another (the limited company). Because of this, the transfer is subject to the TOGC rules.

The rules around TOGCs are what tell us that the taxable turnover resets when incorporating a sole trader, so long as certain conditions are met.

See HMRCs guidance on the topic here.

This guidance shows that IF the transferor (the sole trader) IS NOT a taxable person (i.e. VAT registered) at the time of the TOGC, the transferee (the new limited company) shall not be deemed to have carried on the business PRIOR to the transfer (i.e. the taxable turnover threshold resets).

What if a sole trader was already VAT registered or already crossed the VAT threshold?

In short, if you were already VAT registered or if you already crossed the VAT threshold as a sole trader, then the new limited company must be registered for VAT from the start.

This can be seen in the same guidance as above. It shows that IF the transferor (the sole trader) is already a taxable person prior to the TOGC then the transferee (the new limited company) is liable to be registered. In this situation, becoming a limited company DOES NOT reset the VAT threshold and the Limited Company must be VAT registered straight away.

The guidance on that page also states that even if they aren't VAT registered when forming the limited company, so long as they crossed the VAT threshold (i.e. if the sole trader should have been registered), then the threshold is not reset and the limited company will need to be registered from formation.

Any other questions?

Are you a sole trader thinking about becoming a limited company? You might be interested in our article on the benefits of a limited company vs a sole trader. At Ecommerce Accountants LLP we work with online businesses and ecommerce entrepreneurs. If you are looking for a new accountant, get in touch with us today.

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