With VAT rising from 17.5% up to 20% what does this mean for businesses? How will the small business be affected?

Well essentially, the change is fairly simple. Goods or services provided by VAT registered businesses on or after 4th January 2011 should include VAT at a rate of 20% and there are no changes to the current VAT exemptions.

Businesses will have to think about pricing – will you pass the VAT increase onto customers or absorb this cost to keep prices the same, remembering that you will still have to pay over the additional 2.5% to HMRC.

This will be a commercial decision based on what competitors are doing, whether suppliers are increasing their prices and elasticity of customer demand.

So does the rise in VAT also mean the end of 99p pricing?

The psychologically significant figure of £9.99 would now become £10.20 after the VAT increase. The importance of the psychological figure of 99p is demonstrated by a 2008 French study of the phenomenon, which found that reducing the price of a pizza from €8.00 to €7.99 boosted sales by 15%.

So with retailers unlikely to want to move away from psychological pricing products may see a rise of more than 20%. For instance rather than charge £10.20 prices may rise to £10.99.

Then again many products are already marked up to reach that magic figure of 99p and therefore could absorb the cost. Overall it may well balance out.

Reports suggest that the VAT rise will lead to £2.2bn in lost sales.