I awoke yesterday morning to the announcement on LBC that The Chancellor has instructed The Treasury to “scrap” VAT from everything, to stimulate consumer spending and boost the economy. Whilst this may seem like a good move, there are a number of reasons why it may not be.
Consumer knowledge of VAT
The average consumer has no real idea as to which transactions are subject to VAT and which are not. Consumers are driven by price points and, unless the Government legislates to force the suppliers to pass on any VAT saving, the price points will not change. Thus is a television costs £799 before a VAT rate change, it will still be £799 after the change from the consumer’s view. The retailer or supplier will benefit, which is not necessarily a bad thing, but a VAT rate reduction per se will not encourage consumers out to spend.
Reducing the rate to zero could be problematic when it comes to reapplying VAT after the set period and making this public gesture shines a spot light on what will become standard rated again and could cause a public outcry. One example of this was the so called “pasty tax”, when hot pies and pasties were standard rated. There was much noise in the press over the possible increase in a well- loved food ingredient, even though the consumers were blissfully unaware that VAT had not been charged in the past. In reality, it was the food retailers who bore the brunt of the VAT increase and, although the price of a pie crept up over a period of time, consumers forgot that it was the VAT increase that was causing it.
Impact on businesses
Those businesses that pass any decrease in VAT onto the consumers face a nightmare of changing systems to make sure the correct VAT is charged, even if this is reduced to zero, as most businesses have multiple transactions that would need each tax code to be changed. In particular, retailers will find this hard to do on a mass scale. Even small retailers and pubs will struggle, given the number of lines that are stocked or sold. Many will not attempt to change the rates or pass on the VAT saving, as it would not be economically viable to do so.
Impact on the Government purse
Reducing the VAT rate to zero will mean a significant loss of tax on a temporary basis for the Government. There may also be repayments of VAT to be made where goods and services have been purchased with 20% VAT just before the change and then sold at 0% VAT after the change, resulting in a double gain for business and a double loss for the Government purse.
If the Government were to reduce the VAT rate to zero, it would be ultra vires at this point in time, as the UK is still aligned to the EU rules. Whilst infraction proceedings take a while to be done and the UK is unlikely to be aligned so closely at the point that they come to fruition, it would be a distraction that the UK Government could do without. It would be dangerous to assume that the EU would not try to infract as it is still sore over the UK’s refusal to extend the transition period and the fact that several key issues for a Free Trade Agreement appear to be unable to be resolved in the EU’s favour.
Alternatives to a temporary reduction
The sectors that have been most hit have been:
- Smaller construction jobs
In the hospitality and leisure sectors, in particular, the impact has been significant. However, the Government has it within its gift to apply a reduced rate of VAT to supplies in these sectors. It would also put restaurants/pubs, accommodation and similar suppliers on a par with supplier in other EU countries which would be wanting the UK tourists to spend money outside the UK.
Article 98 VAT Directive 2006/112/EC (The Principal VAT Directive, “PVD”) allows reduced rating on the following services:
- Accommodation in hotels and similar establishments, including the provision of holiday accommodation and the letting of places on camping or caravan sites. Only the UK currently applies the standard rate to these services. Range of rates in the EU is 3.0%-13.5%
- Restaurant and catering services, it being possible to exclude the supply of (alcoholic and/or non-alcoholic) beverages; (Although note the wording “possible” and not “required/mandatory”). 18 of the Member States apply a reduced rate, but only 4 appear to apply the reduced rate to alcoholic beverages. Range of reduced rates is 3% to 14%;
- Hairdressing. 6 Member states apply the reduced rate to hairdressing (but not beauty parlours). Range of rates is 5%-13.5%
- Admission to sporting events. 14 of the Member States reduce rate the admission to sporting events with a range of 3% to 13.5%;
- Use of sporting facilities (the UK does exempt block bookings to clubs etc. at the moment). 10 Member States apply the reduced rate to sporting facilities where this is not already exempt. Range 3% to 10%;
- Renovation and repairing of private dwellings (excluding materials which account for a significant part of the service provided). 11 Member States apply the reduced rate to these services. Range 5% to 10%;
- Window-cleaning and cleaning in private households. 6 Member States apply the reduced rate to these services, with a range of 8% to 10%;
- Domestic care services such as home help; (The UK exempts some care services, but this measure would stimulate the home care provision and day care services). 7 Member States apply the reduced rate to these services, where they are not previously exempted (7 Member States exempt these services). Range of reduced rates is 5.5% to 15%;
- Admissions to cultural events not already covered by the UK cultural exemption (i.e. these not run by not for profit organisations. In particular admissions to cinemas and amusement parks). 19 Member States apply the reduced rate to cultural services not covered by the exemption and include cinema tickets in this bracket. Range of rates is 2.1% to 18%. In addition, 11 Member States apply the reduced rate to admission to theme parks, with a ranve of rates from 2.1% to 13.5%;
- Pharmaceutical products including contraceptives (UK only applies the reduced rate to contraceptive products). 23 Member States apply a reduced rate to pharmaceutical products, although 6 Member States restrict reduced rating to Prescription Only Medicines (“POM”) and 2 Member States restricts the a lower reduced rate for human medicines only. Germany restricts its reduced rate to women’s sanitary products only. Several Member States apply a reduced rate to nappies within this heading. Ireland distinguishes its reduced rate according to orally on non-orally administered products. Range of rates is 0% to 10%.
The smaller businesses in these areas may well operate the flat rate scheme and a change of rate may not impact quite as much if it is long term, but will allow them to have greater flexibility in pricing.
By applying a more permanent reduced rate to some of these goods and services, the public perception will be of a reduction of VAT on the costs, without the need to “scrap” VAT entirely.
Because the rate change will be more permanent, there will be less resistance to passing on the VAT to consumers and to changing systems.
Reduction of the VAT registration threshold
As a quid pro quo, it may be necessary to reduce the VAT registration threshold. This may not need to be at the time that the rates are reduced, but may be applicable from say, 1 January 2021. There are three reasons for picking this date. The first is that it gives those affected time to get used to the proposed change.
Secondly, if any “smoothing mechanisms” (as discussed in the Office of Tax Simplification report “Value added tax: routes to simplification” 2017) are required to mitigate the reduction, the UK will not be aligned to the EU and can apply some assistance to affected businesses.
Thirdly, HMRC is planning to move all VAT registered taxpayers under the current threshold to the new ETMP system used for Making Tax Digital. A reduction in the VAT threshold will mean that more of the existing VAT registered taxpayers would be caught by the Making Tax Digital rules, making the migration more cost effective for HMRC, as those currently under the VAT threshold but VAT registered will need to be in the MTD regime and those that are then required to register will automatically be within it from the start. This should encourage good housekeeping in the accounting records for the smaller businesses.
On the surface of it, the reduction in the VAT registration threshold will be a brave move. However, with the current Government’s pledges not to raise taxes and its desire to stimulate the economy and try to ring fence the debt arising from the COVID-19 pandemic, there are not many options. Many of the businesses in the sectors above may have received some assistance from central Government and a permanent reduction in the VAT rate in these areas would likely to be positively received and, by 1 January 2021, the economic outlook may be more positive.
Extension of the proposed domestic reverse charge for construction services
The one glaring hole in this policy to prevent fraud in construction chains is that non-VAT registered businesses in this sector are not included in the reverse charge. Amongst the sector, this is the area perceived to be the most at risk of fraud because many businesses fall beneath the “radar” and there is a general feeling that some of these are the ones issuing VAT invoices but not paying the VAT.