If one business is split between two or more people or companies so that each part stays under the VAT threshold, HMRC can either show that there is really a single entity and assess it from the start, or issue a Notice of Direction treating the separate persons as one taxable person from the date of the direction. For a direction HMRC looks at how closely the parts are bound by financial, economic and organisational links, and it does not have to prove that anyone intended to avoid VAT.

What is artificial separation of a business?

Paragraph 1A of Schedule 1 to the VAT Act 1994 exists to stop the maintenance or creation of an artificial separation of business activities carried on by two or more persons from resulting in an avoidance of VAT. HMRC’s VAT Single Entity and Disaggregation Manual (VATDSAG05100) says most cases fall into three types:

  • Functional: different activities in the same business split between persons, such as drinks sales and catering in a pub.
  • Geographical: the same activity in different places, such as a chain of launderettes each run by a different person.
  • Temporal: different persons operating at different times, including a succession of companies that each trade until turnover nears the threshold, or persons said to trade on different days of the week.

The risk only arises where the combined taxable turnover would exceed the registration threshold, currently £90,000 (see VAT registration threshold).

Is it a single entity or disaggregation?

VATDSAG02100 sets out three possible conclusions. First, there may always have been one legal entity carrying on everything, in which case that entity must be registered and HMRC will assess any underdeclared VAT. Second, there may be several legal entities but only one business; if the separation is artificial and avoids VAT, that is disaggregation and a Notice of Direction may follow. Third, the entities may be genuinely separate, and nothing further happens.

The difference has real consequences. Single entity is a question of fact, not best judgement (VATDSAG03100): HMRC must show that overall day to day control of all the activities rests with one person, partnership or company (VATDSAG03150). A sole trader claiming that his two shops are separate businesses, or claiming to be in partnership with a sleeping partner for one line of sales, is a typical case. Because a single entity was always liable, HMRC registers it and assesses underdeclared VAT for past periods, and late registration exposes the business to failure to notify penalties. A direction, by contrast, only operates from its own date.

What must HMRC show before issuing a direction?

Paragraph 2(2) of Schedule 1 sets three conditions. HMRC must be satisfied that the person named is making or has made taxable supplies, that the activities in which those supplies are made form only part of activities carried on concurrently or previously (or both) by others, and that if all the taxable supplies of the business described were taken into account, a person carrying it on would be liable to register. Paragraph 1A(2) then requires regard to be had to how closely the persons are bound by financial, economic and organisational links.

VATDSAG05150 is explicit that HMRC does not need to prove an intention to avoid VAT, only that the artificial separation resulted in an avoidance of VAT. VATDSAG07100 summarises the decision point: a direction may be issued where the entities do not have a normal arm’s length commercial relationship and cannot run independently of each other.

What links and factors does HMRC examine?

HMRC’s detailed checklists covering VAT history, employees, finances, organisation, legal documents and customer base are withheld from the published manual. The case law summarised in VATDSAG08000 shows the kind of evidence that counts:

Points towards one business Points towards separate businesses
No cross charge for shared premises, facilities or utilities (Salmon Tail, Surreal Hair) A realistic arm’s length payment for shared premises and services (Trippitt)
One bank account or one insurance policy Separate accounts, books and records
A till or takings diary that does not separate the businesses; wages and overheads split equally regardless of use (Leonidas) A partnership agreement and a genuine commercial relationship (Newton)
Activities operating hand in glove, or one underpinning the viability of the other (Burrell) A clear intention to operate separately and a genuine attempt to do so (Wallace)

Where one party pays the other a percentage of takings, HMRC asks what would be paid if there were no takings, and whether money actually moves. Separate treatment for income tax is not decisive, and an absent partnership agreement does not mean there is no partnership (Leonidas).

Does being related, or being a franchise, change anything?

Family ties alone should not decide a case (VATDSAG03250). Tribunals have accepted that one spouse can help in the other’s business as a spouse while running a separate business of their own, and in Sea Breeze Café the tribunal said relationships between spouses’ businesses need not be wholly at arm’s length. HMRC’s response is to look at disaggregation rather than single entity in such cases. For advisers acting for both spouses, see acting for spouses and business partners.

VATDSAG05200 lists arrangements HMRC accepts are not artificial separation: genuine franchises, self employed stylists in salons under the agreed hairdressing approach, managed houses of breweries and pub chains, charities separating bar sales to protect charitable status, and certain driving school and taxi arrangements.

What happens when a Notice of Direction is issued?

Under paragraph 2 of Schedule 1, the persons named are treated as a single taxable person, liable to register from the date of the direction or a later date it specifies. The direction is served on each person named, and they may nominate the registration name in writing within 14 days. Supplies by or to any of them in the course of the business are treated as supplies by or to the single taxable person, each is jointly and severally liable for its VAT, and together they are treated as a partnership for VAT purposes only (VATDSAG07200). Any existing registrations of the parts are cancelled.

If HMRC later finds another person involved, it can serve a supplementary direction adding them from the date they began making the supplies, or the date the single taxable person became liable if later. HMRC will refuse a request to account for the combined business under an existing number (VATDSAG07250).

How can a direction be challenged?

HMRC expects these decisions to be disputed and tells officers to interview everyone involved and document everything (VATDSAG02150). A trader can ask for a review and appeal to the First tier Tribunal, which tests the decision to issue a direction on Wednesbury reasonableness: whether HMRC took into account everything relevant and nothing irrelevant (VATDSAG07350). A VAT compliance check that raises disaggregation should be answered with evidence of genuine commercial separation, not assertions.

How does this work in practice?

Illustration only. A husband runs a café with £70,000 of takings; his wife sells takeaway food from the same counter with £50,000 of takings. They share one till, one bank account and the staff, and she pays nothing for the premises. HMRC may argue the café is one business run in partnership, and assess VAT for past periods. If it cannot prove that, it may issue a direction registering them together from the direction date. Separate tills, records and a realistic rent would have strengthened the case for two businesses.

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Sources

Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 8 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.