Should VAT be standardised again?

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Value Added Tax (VAT) was devised by the French in the 1950’s and introduced here in the UK on 1 April 1973.

It was introduced as a condition of entry to the European Union (European Economic Community as it was then) and has subsequently swept the world with over 150 countries adopting it.

Originally introduced at a single rate of 10% it wasn’t long until differential rates were applied. Soon after introduction a 25% rate was applied to electrical goods, although that didn’t last long.

Today the UK effectively has four different VAT treatments; the standard 20% rate, the 5% reduced rate, a zero-rate and exemptions (there are a couple of other obscure ones such as the 4% agricultural rate).

As well as an increasing number of rates, the threshold at which VAT becomes payable has also risen significantly. So much so that the current UK VAT registration threshold of £85,000 is the highest in the EU.

The EU average is approximately £25,000. In fact, the threshold in several EU countries including Italy, Spain and Sweden is £0.

As VAT has become more complex, more challenging and more important (it raised over £115bn in 2015-16) and as Britain has now triggered article 50 to leave the European Union, the time has come to review its operation in the UK.

Should the rates be standardised as was originally the case? Should the threshold be raised or reduced? Is the VAT penalty system fit for purpose and what opportunities does Making Tax Digital present for VAT reform? All these questions need to be answered.

The Government has therefore asked the Office for Tax Simplification (OTS) to conduct a simplification review into the VAT system.

The OTS is interested in the views of AAT members on this important issue and with this in mind AAT has devised a quick and easy survey on the subject which we are encouraging all members to undertake. It takes just 5-10 minutes to complete and will be invaluable in formulating AAT’s response to the OTS on the subject.

Before undertaking the survey, some food for thought

Firstly, with regard to the threshold, whilst many assume that few businesses would voluntarily register to pay VAT, 44% of businesses registered for VAT in the UK actually operate below the threshold.

A lower threshold may boost productivity as it would mean nobody stopped working to avoid exceeding the threshold. It would also be a simplification measure as most companies would be treated the same.

A significantly increased VAT threshold may also act as a simplification measure by removing the majority of small businesses from the VAT regime – as happens in Singapore which has a threshold of approximately £500,000.

Secondly, on the issue of rates, whilst some in Government may be nervous about returning to a single standard rate of VAT it should also be noted that a single rate would inevitably bring in more money. So, to ensure revenue neutrality the rate would be substantially less than the current headline 20% figure.

Obviously if VAT was to be applied across the board there would be complaints about its regressive nature. The thorny issue of children’s clothes in particular would be the focus of much political attention. However, given other countries who charge VAT on children’s clothes manage to have similarly priced, or in some cases cheaper, clothing available, the likelihood of sellers absorbing much of the cost increase rather than passing it on to consumers cannot be discounted.

A single standard rate applied to everything would also deal with much of the absurd complexity around exemptions. Arguments around cakes and snacks serve as a useful example, where HMRC contended that Jaffa cakes were chocolate-covered snacks and liable to VAT but lawyers successfully argued they were cakes – and therefore zero-rated.

If your biscuit is wholly or partly coated in chocolate then VAT is applied at the standard rate and yet bizarrely Bourbon Creams are not subject to VAT. Apparently this has something to do with the fact they have a chocolate sandwich layer between the two halves.

As these examples demonstrate, the system appears somewhat nonsensical.

Finally, there are a number of areas where HMRC’s Making Tax Digital (MTD) plans could have implications for VAT, and may also bring simplification opportunities.

The requirement for quarterly reporting for businesses may mean it is appropriate to re-examine some VAT rules and procedures. Given the £1.3bn investment in MTD and the likelihood of overlap, it would be incredibly short-sighted not to take this opportunity to review how MTD could help businesses to meet their VAT obligations.

To complete the AAT VAT Survey please go to the survey page.

Phil Hall is AAT's Head of Public Affairs and Public Policy.

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