UK VAT turns 50 years young

April 2023 marks the 50^th anniversary of the introduction of VAT in the UK – but is that golden event exempt from VAT or subject to the standard rate of 20%? Or could it be zero-rated if sold as an export? It’s these sorts of questions, together with the often quirky definitions and distinctions, but with significant financial consequences that have made VAT such an interesting tax over the years.

The background

VAT was described as a ‘simple tax’ when introduced in the UK in 1973; however, it is anything but that. There are currently three rates of VAT in the UK, plus exemption and outside the scope treatments. Each has its own consequences – not just for what VAT is due on sales, but also for what VAT can be reclaimed on purchases.

The broad base of activities to which the standard rate of VAT applies, but with exceptions or sometimes exceptions that override the exceptions means that the VAT regime perhaps was more accurately described by the UK Court of Appeal as being a fiscal theme park. Unfortunately, these complexities appear likely to continue in the future, rather than become easier for organisations to manage.

Most of the rules were written in the 1970’s and haven’t kept up with modern technologies and practices; the recent clarification that e-books can now be taxed in the same way as their paper counterparts is just one example.

For a long time, the UK’s VAT rules were based on EU law that set a framework for how the UK’s rules should operate. Since Brexit, VAT has become solely a national tax and it is possible that the UK’s rules will deviate from those of the EU over time.

Developments over the years

The most famous UK VAT trivia is in relation to Jaffa Cakes and a legal dispute over whether these were cakes, which would mean they were VAT free, or whether they were chocolate covered biscuits and subject to standard-rate VAT – the answer being they were cakes, and therefore zero-rated. But there has been a long list of often quirky developments and questions, including below.

• Is the VAT treatment different for takeaway pasties described as being sold hot rather than freshly baked? Yes, being advertised as hot would mean that they are subject to the VAT rules for catering and so standard-rated.
• Pringles are potato crisps and subject to standard-rate VAT, despite their maker arguing the lower potato content and the manufacturing process meant they were more like a cake.
• Should gingerbread men with chocolate coated trousers be standard or zero-rated? The answer – biscuits covered in chocolate are subject to standard-rate VAT, not zero-rated.
• The free bottle of wine with a supermarket meal deal is not really free, so is subject to VAT.
• At one time, sales by an animal rehoming centre had different VAT treatments depending on whether the animals were donated (zero-rated sales) or strays (standard-rated). The UK tax authority, HM Revenue & Customs, changed its position to accept that zero-rating could apply irrespective of whether the animals were provided to the charity by the public, local authority or police.
• Are medical testing services for the primary purpose of the “protection, restoration of maintenance of human health,” and who needs to perform or supervise the testing in order for a medical care exemption to apply? This question had particular prominence following the rise of COVID-19 testing and the tax issues are now evolving into other areas such as DNA and blood testing.
• The rise of electronically supplied services (such as digital downloads) led to new rules being introduced in 2010 that have been further refined over the last decade. There continue to be developments in e-commerce so that VAT is paid where the consumer of the content is located.
• An old favourite is whether holding companies have an economic activity giving rise to an ability to reclaim VAT.

Why it matters

The addition of VAT can have a significant impact on the selling price and/or profit margin achieved by a seller, and getting the VAT treatment wrong can lead to significant and unexpected costs. The possibility of penalties being imposed for careless errors, as well as where the error was deliberate, is also a concern for organisations.

As well as the financial costs of getting VAT wrong, tax has become a reputational risk for businesses. Organisations now operate in a world where tax is considered a moral issue and is front page news. Consequently, many leaders focus on ensuring that they don’t face negative publicity from their tax affairs. These complexities are compounded when organisations have multi territory responsibilities, as VAT is implemented differently in each country.

Something that organisations sometimes overlook is the high amounts of VAT they are managing. If their sales and purchases are all subject to 20% VAT, that is a combined figure of 40%, and even a small error rate can lead to high value costs.

Where next?

Increasingly technology is being used to automate VAT compliance processes. This should help reduce the risk of human error giving rise to VAT costs, but the use of technology also brings additional challenges. HMRC has previously announced its vision to be a leading digital tax authority, and the introduction of Making Tax Digital for VAT in 2019 is the start of this move.

Most organisations in the UK now need to prepare and file VAT returns digitally, but there’s no change to the data received by HMRC. This is likely to change in the future as we can expect HMRC to require transactional data to be provided; there is no specific time frame for this development, nor details of what data is likely to be required, but it is the direction of travel in the UK.

Another development under consideration is split payments, whereby the VAT element of money paid to suppliers is automatically remitted to the tax authority and doesn’t get paid into the supplier’s bank account at all. This would reduce the instances of missing trader VAT fraud but would require significant investment in new technologies and processes for all VAT registered organisations subject to the rules. It also would only be applicable to electronic payments.

In summary

VAT touches all aspects of daily life for businesses, non profit organisations, and consumers. In the financial year ending March 2022, official UK government statistics show that over £150 billion of UK VAT was collected – around 16% of total tax receipts. This compares to about £68 billion for corporation tax and £225 billion for income tax. The amount of VAT collected by the government continues to rise, so we can expect this ‘simple tax’ to be a stalwart of government fiscal policy in the future.

VAT is 50 years old, and it’s likely to be with us for another 50 years.

Further information

For further information or to discuss how we can help you, please contact Robert Marchant or your usual Crowe contact.

This article was first published in Bloomberg Tax Online on 3 April 2023.