The government should raise the turnover  threshold for VAT from £85,000 to £100,000, according to the Federation of  Small Businesses (FSB).
The business group said that this would give  firms stepping into the VAT-paying ring crucial breathing space. It would also  be an incentive to grow their turnover without fear of having to charge  customers an extra 20% overnight, the FSB added.
The FSB also suggested bringing in a smoothing  mechanism to ease the transition for small firms, owner-managed companies and  some of the self-employed who go just over the threshold.
At the moment, thousands of small firms keep  their turnover just below the £85,000 threshold, according to the Office for  Budget Responsibility (OBR).
The OBR said that hundreds of millions of  pounds of potential economic activity could be lost due to this 'bunching' just  below the threshold.
Tina McKenzie, FSB's Policy Chair, said:
'VAT  compliance flattens small firms by stifling their growth and emptying their  coffers. It's crying out for a modern makeover to match today's economic  landscape.
'We  can't let it squash the ambitions of small businesses, strivers, and budding  entrepreneurs.
'The  flaws in our current system are glaringly obvious. We are at a breaking point –  a drastic overhaul of VAT is needed.
'Raising  the threshold to reflect inflation, introducing a buffer to soften the blow for  those just over the limit and demystifying the rules to save small business  owners from a VAT-induced headache could unlock hundreds of millions in extra  economic activity.'
Internet  link: FSB website