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Decoding Business Disaggregation: Strategies & Implications

Published by Susan Basnet
Published Date: May 3, 2024
Categories: Business

Businesses often create separate entities to avoid reaching the VAT registration threshold, a practice known as artificial separation. This leads to unfair competition, as these split businesses can undercut VAT-registered competitors. Additionally, it also results in lost tax revenue for the HMRC.

In this article, we will delve into the background of legislation, gaining insight into how the HMRC assesses whether a business is artificially separated, and gaining a clearer understanding of the notice of direction. Let's get started!


To combat the issue of businesses artificially dividing themselves to avoid reaching the VAT registration threshold, HMRC introduced targeted legislation. This legislation, outlined in Schedule 1 of the VAT Act 1994, aims to address any artificial separation of business activities aimed at evading VAT obligations.

HMRC evaluates the financial, economic, and organisational connections between businesses to determine the extent to which they are closely linked to one another.

Understanding Financial, Economic, and Organisational Links

As a part of the artificial separation assessment, HMRC will ascertain the presence of all three links—financial, economic, and organisational—between the parties involved. The degree of closeness between individuals or entities will vary based on the specific circumstances of each case. In this section, we will look at those in detail.

Financial Links

When evaluating the financial links between businesses, HMRC may examine factors such as the level of financial assistance provided among the parties, the individual financial viability of each activity, and whether there is a shared financial interest across all the activities being conducted.

Understanding Financial, Economic, and Organisational Links

Economic Links

Regarding the assessment of economic links, HMRC may consider factors such as whether the parties involved share a common economic objective, whether their activities mutually benefit each other, whether they provide similar goods or services, and whether they serve the same or similar customer base.

Organisational Links

Similarly, in assessing organisational links, factors such as the shared use of employees, management, equipment, and premises are considered to determine the extent of interconnection.

Understanding the Notice of Direction

Once HMRC has collected all relevant information, if it finds that the entities lack a normal ‘arm's length’ commercial relationship and cannot operate independently of each other, HMRC will consider issuing a Notice of Direction.

A Notice of Direction establishes a single taxable entity with its own VAT registration number, formed from the partnership of the individuals listed in the notice. This entity is effective for VAT purposes starting from the date of the notice.

According to the VAT Act 1994, Schedule 1, Paragraph 2, the Notice of Direction establishes a partnership solely for VAT purposes and does not have any bearing on the formation of a partnership for other intents. Additionally, the partnership created through this notice is distinct from any other partnerships already in existence.

Appeals Against a Notice of Direction

A Notice of Direction can be challenged through an appeal process. Depending on the circumstances, it may be possible to demonstrate that the individuals named in the Notice are not financially, economically, or organisationally linked, but instead operate as separate independent businesses.

Examples of Artificially Separated Businesses

Examples of artificially separated businesses

Determining whether a specific separation is deemed artificial depends largely on the circumstances of each case. As mentioned earlier, HMRC evaluates the financial, economic, and organisational connections between businesses to assess the extent of their interconnectedness. Nevertheless, HMRC has provided some examples of arrangements that are likely to be regarded as artificially separate, including:

  • Separate Entities Supply to Registered and Unregistered Customers - In this type of separation, the registered entity supplies any registered customers and the unregistered part supplies unregistered customers.
  • Same Equipment/Premises Used by Different Entities on a Regular Basis - In such scenarios, multiple entities utilise the same equipment and/or premises during specific periods within a week or month. Typically, one of the parties owns the premises or equipment and rents it out to the others. This situation commonly arises in businesses like launderettes and takeaway establishments such as fish and chips shops, as well as with mobile catering equipment like ice cream vans.
  • Splitting up of what is usually a single supply - This type of separation is common in the bed and breakfast trade where one entity supplies the bed and another the breakfast. Another is in the livery trade where one entity supplies the stabling and another, the hay to feed the animals.
  • Artificially separated businesses which maintain the appearance of a single business - This type of separation includes pubs in which the bar and catering may be artificially separated. In most cases the customer will consider the food and the drinks as bought from the pub and not from two independent businesses. The relationship between the parties in such circumstances will be important here as truly franchised “shop within a shop” arrangements will not normally be considered artificial.
  • One person has a controlling influence in a number of entities which all make the same type of supply in diverse locations - In this type of separation, a number of outlets which make the same type of supplies are run by separate companies which are under the control of the same person. Although this is not as frequently encountered as some of the other situations, the resulting tax loss may be significant.


In essence, the practice of artificially disaggregating businesses to evade VAT obligations not only undermines fair competition but also results in substantial tax revenue losses for HMRC. While HMRC provides examples to guide assessments, each case requires careful scrutiny to determine genuine independence between entities. By navigating these complexities with diligence and adherence to regulatory standards, businesses can uphold integrity in their operations and contribute to a level playing field in the marketplace.

Susan Basnet
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