Roll of 50 pound notes

When the news came in that Treasury Minister David Gauke had been slating tradesmen who accept cash for work as well as the homeowners who pay them it was not a huge surprise to me. I had been preparing a blog post on the subject of why builders ask for cash in hand. I was a tradesman myself before I started this business and many of the thousands of builders who use our service often engage me on this topic. It came up again just the other day when we had some roofing work done (by one of the excellent roofers on MyBuilder). After coming back from the cash machine, my wife asked rhetorically: “Why do builders always want to be paid in cash?”. Rhetorically, because she already knew the answer. Or at least she thought she did.

I asked her if she knew why, and she said: “Of course! Taxes.”.

She was partly right. Taxes is the answer, but not the sort most people assume. An employed person thinks about income tax, which at somewhere between 20 and 45 percent, is the big and noticeable tax for most people. For tradesmen however, the bogeyman is VAT.

But VAT is only 20% you say… and don’t you just pass that on to your customers? Yes and yes. But still, the bogeyman is indeed VAT.

Firstly, for a jobbing builder or tradesman, effective tax rates can be lower than for an average employee. Tradesmen can either set up as self employed or as a Limited Company. Being self employed gives you expense deductions and as a Limited Company you can pay yourself in dividends at a lower rate. But it is far from unusual for a tradesman to have annual revenue in excess of £77,000, which is the threshold at which a business needs to be VAT registered.

This may sound like a lot, but you have to remember that £77,000 is revenue, not profit. If I supply and fit a new boiler, I might charge £2,500 and have to turn around and spend £2,000 to buy the boiler. Let’s say I manage to do about one of those a week – 50 a year. My revenue would be £125,000 for the year, but I’m really only making £25,000 from that £125,000. And then I have to pay for my van, diesel, tools etc. Imagine I have £10,000 of expenses for the year. I’m pulling in a paltry £15,000 of profit, but at least I only have to pay income tax on that £15,000, not the £125,000.

VAT however, is a very different story. With £125,000 in revenue, I’m well over the VAT threshold. This means that I have to charge my customers an extra 20% on every job. I’m walking through the door to quote on a job and I might as well be wearing a T-shirt that says ‘Don’t hire me, I’m 20% more expensive’. I can’t drop my prices to compensate for the VAT. Remember, I already only have £15,000 of profit per year. So the end result is that I lose business to heating engineers who are not VAT registered. What can I do? The only obvious thing I can do is to avoid VAT registration.

You can’t be VAT registered and avoid paying VAT. HMRC will hang, draw and quarter you. Getting paid in cash does not solve the problem when you’re VAT registered. You can’t insist that customers pay you in cash. Your quote has to include VAT because you don’t want to get stuck in a situation where you’ve omitted VAT and the customer doesn’t pay cash at the end.

So the key to survival is ducking under the VAT threshold by doing some cash in hand work. The reduction in income taxes is an added bonus, but this is not the prime reason for working cash in hand. Asking to be paid in cash becomes the modus operandi, because some customers will simply say no to paying an extra 20% on their bill just to be seen as morally correct by a Government minister.

Is this wrong? Yes. Is it tax dodging? Yes. Whose fault is is? HMRC and, at the end of the day, the Government who allow this to persist in these difficult economic times. VAT should be zero-rated on building work, just the same as it is on new builds. Tradesmen are well-known for ensuring that their income circulates back into the economy, whether this is by paying other tradesmen to do work for them, buying new cars or family holidays. Sure,  many tradesmen will have savings and even investments in property, but they will not be squirreling money away in tax havens.

The current VAT system is stopping money from circulating in the economy, is reducing the amount of building work being done and is, however inadvertently, making tax dodgers of otherwise honest workers. It is time for a change.

Picture by Images of Money.