Panellists

• Stephen Relf, Technical Manager, Tax, ICAEW
• Ed Saltmarsh, Technical Manager, VAT and Customs, ICAEW
• Stephen Dale, Chair, ICAEW VAT and Duties Committee

Producer

Ed Adams

Transcript

Stephen Relf: Hello, and welcome to The Tax Track, the podcast series from ICAEW, where we explore the latest developments in the world of tax. Our subject for this episode is VAT: the challenges it poses for businesses and their advisers, and what recent developments say about the likelihood of reform. We’ll use recent high-profile cases to explore how borderlines in VAT can cause confusion, particularly when it comes to items of food.

Ed Saltmarsh: The size was important for roasting because of the ratios of soft, mallowy goodness in the middle, and this is typical of what we see in tribunal cases on food.

SR: …and we’ll consider the pros and cons of the government’s plans to encourage businesses to adopt e-invoicing.

Stephen Dale: The main reason put forward by governments to introduce e-invoicing is to limit or to stop VAT fraud.

SR: I’m Stephen Relf, a Technical Manager for Tax at ICAEW. Today, I’m joined by Ed Saltmarsh, Technical Manager for VAT at the Institute, and by Stephen Dale, Chair of the Institute’s VAT and Duties Committee.

Let’s begin by discussing marshmallows. Now this may seem an odd topic for The Tax Track, but a recent Court of Appeal decision on the VAT treatment of marshmallows has attracted headlines, and it’s a great illustration of how complex, and odd, our VAT system can be. Ed, can you explain what the case is about?

ES: Yes, thanks Stephen. So, the case concerned Mega Marshmallows, which is a particular brand of oversized marshmallows sold by a company called Innovative Bites Limited. And the case was looking at whether or not those marshmallows should be zero rated for VAT purposes, or whether they should be standard rated as confectionery.

SR: Okay, so on the face of it, fairly straightforward then: zero rating or standard rating. Zero rating for food, standard rating for confectionery. But I guess the problem is how you define the two terms, food and confectionery?

ES: Yes, exactly. The VAT Act specifies that food fit for human consumption is zero rated for VAT purposes, but specifically excepts foods including confectionery, which Note 5 of that group defines as including “chocolate, sweets and biscuits; drained, glacé or crystallised fruits; and any item of sweetened prepared food which is normally eaten with the fingers”.

SR: Okay. I think most people would have a good idea of what they see food and confectionery to be, and think there’s probably a fairly clear line between the two terms. But I know that this has been through three courts now: First-tier Tribunal [FTT], Upper Tribunal, and then Court of Appeal. What decisions have we seen so far?

ES: The FTT found that, on balance, Mega Marshmallows are not confectionary, because they are sold and purchased as a product specifically for roasting. The packaging on the product shows a picture of someone roasting these marshmallows over a campfire.

SR: I guess because they’re larger than your typical marshmallows?

ES: Exactly. And the court even considered that the size was important for roasting because of the ratios of soft, mallowy goodness in the middle of the product. And this is typical of what we see in tribunal cases on food. They also looked at, for example, where the marshmallows are positioned in the supermarket during barbecue season, because that also proves that they’re used for roasting. And not only that, you roast them so that you can use them in another product – s’mores, in this case.

SR: What actually is a s’more?

ES: It’s a biscuit, melted marshmallow, bit of chocolate, another biscuit.

SR: Sounds great.

ES: Doesn’t it? The Upper Tribunal ultimately found that there was no error in the FTT’s analysis, so did not overrule that decision.

SR: So that’s the first two courts dealt with then. The Court of Appeal, did they uphold the decision of the First-tier Tribunal?

ES: No. They didn’t technically say that the First-tier Tribunal was wrong, but they did say that they had approached the question in the wrong way. Going back to that definition about confectionery, which is “sweetened prepared food which is normally eaten with the fingers”, the Court of Appeal thought that it was quite clear actually that marshmallows are sweetened prepared foods, so the tribunal only really needed to consider whether they’re normally eaten with the fingers, and it felt that it hadn’t really done that. In fact, the First-tier Tribunal explicitly stated in their decision that they didn’t give particular weight to the means of eating the marshmallows.

SR: So it’s now back to the First-tier Tribunal to consider whether you should eat these with the fingers or not?

ES: Yes. And the Court of Appeal has given some further guidance on how to do that, and they’ve basically said, don’t overthink it. Does it fit that definition of confectionery – of sweetened prepared food that is normally eaten with the fingers? And just follow that through logically, unless it leads to an absurd result.

SR: I like the advice not to overthink. I think we could probably apply that in a lot of areas of tax, but particularly when it comes to VAT on food. Thanks for that, Ed.

Now, I did say at the beginning that marshmallows were a first for The Tax Track. And that’s true. But of course, cases of this nature aren’t. Stephen, is food a particularly thorny area of VAT?

SD: Yes, I think it is, Stephen. It’s an area which I think reflects the complexity of our VAT system, and I think it reflects it very well. Let’s look at flapjacks. It merits five paragraphs in HMRC’s guidance as to how a flapjack should be considered from a food confectionery perspective, and even then it seems to be still causing confusion – even among the major industry manufacturers of flapjacks, where HMRC seems to think that there is some inconsistencies, should we say, between the treatment of flapjacks as food and flapjacks as confectionery.

In other countries, the situation is perhaps even worse. In France, for example, when we look at chocolate, the rate of VAT applicable to chocolate depends not only on its composition, it’s on its size, its weight, its shape, and actually, through what means is it sold to the consumer.

SR: I’m not sure if that’s better or worse. At least we have a clear test, I guess. But then there’s an awful lot to that test, isn’t there? I do wonder as well, do opinions on food change over time? Because we’re talking about those words of confectionery and food and the difference between them, but maybe opinions change as tastes change over the years and generations, do you think?

SD: I think there’s a number of elements to that. First of all, there are new products coming onto the market all the time, which of course is itself a source of the litigation that we see between the taxpayer and HMRC. If big industrial companies – going back to my flapjacks – can’t actually determine what the VAT rate is applicable to their product, how on earth can you expect a small business, making flapjacks perhaps two, three, four times a week, to get its actual VAT calculations correct?

SR: Yes, these are fundamental points, aren’t they, where clarity is needed. Now, Ed, I did notice that you recently posted on LinkedIn about ideas for an alternative way of determining the VAT liability of food. Could you explain that to us?

ES: Yes, so this was only really a semi-serious suggestion, but it was just an idea I’d been thinking about, about reforming VAT on food based on ingredient count. I had been thinking about this because obviously there’s been a lot in the news recently about ultra-processed foods. They’re getting a lot of bad press, and generally the definition of that is that things with six or more ingredients tend to be ultra-processed, and things with five or fewer tend not to be. Not always. And I just thought, well, maybe we have a zero rate for products with five ingredients or fewer and a standard rate for products with six ingredients or more. There is already lots of legislation about what counts as an ingredient and when you have to list ingredients. So can we not just use that and sort of piggyback off that for VAT purposes?

SR: And it would encourage manufacturers to use less ingredients in that case then, in their products as well?

ES: Yes, I think it would subtly incentivise healthier choices. We know that the manufacturers or the retailers don’t always pass on that zero rating to consumers, but as you say, it might be that a manufacturer who’s putting in unnecessary additives takes them out, and they increase their profit margins. As I said, I haven’t thought this through in any detail. I haven’t done the economic modelling. But it was just an idea of what could be done.

SR: Well, I think you followed the Court of Appeal reasoning and you haven’t overthought it, have you, so that probably recommends it, if nothing else. We can definitely see the benefits from what you’ve said, but how was the post received on LinkedIn?

ES: Surprisingly well, actually. It got quite a lot of attention, and I think most people were like, I actually quite like this idea, including some people who advise on VAT on food, and acknowledge that they were turkeys waiting for Christmas if we simplified the VAT legislation here. I got a whole range of responses, including some people saying, why is there VAT on any food? And then the opposite of that is, well, let’s just put VAT on all food and then you don’t have to have any arguments. Now, clearly putting VAT on all food is politically very unpopular, and I can’t see many governments doing that, but there are ways that you can offset that.

SR: You’ve obviously been quite heavily involved in the ICAEW campaign, How to Fix VAT. I did notice from the articles that quite a few ideas came forward from that, especially around a progressive VAT. Could you explain what that would involve?

ES: Yes. This is an idea that Rita de la Feria [Professor and Chair of Tax Law, University of Leeds] has worked on, and it’s to do with actually refunding VAT to consumers in real time. Essentially, you charge VAT on everything to everyone, but at the point of payment the VAT element of food is refunded to those on lower incomes, for example. Some countries have actually started to implement forms of this, so technically it’s possible. But I think we’re a long way off doing it in the UK.

SR: It does sound very, very challenging, doesn’t it, from a technology point of view?

ES: Yes. And I think we are not necessarily set up for that in the UK in terms of digital identifiers of people’s tax affairs and that kind of thing.

SR: So we’ve talked a fair bit about food, but obviously we have other boundary or borderline disputes in VAT as well, including around exemptions. Now, in doing my research for this, I did notice a VAT case around hair loss services.

ES: Yes.

SR: Ed, have you seen that one too?

ES: I have, and I think it’s really important that you actually raise this case, because I think the tendency is for people to think that these things only occur on food.

SR: Food gets all the headlines.

ES: Food gets the headlines. They’re quite funny cases often, but it’s important to realise that these borderline decisions affect so many businesses in the UK. This one was a company called Advanced Hair Technology, which provided hair transplant surgery, primarily to treat androgenetic alopecia, which I think most people would probably know as male pattern baldness. They argued that these transplants should be exempt from VAT as medical care. HMRC disagreed and said that they were just cosmetic in nature and so should have VAT on at the standard rate, and there was a lot of VAT at stake. It was about £2.5m, plus penalties. A big, big case for the company.

SR: And again, it’s just come down to terms, isn’t it? So we’ve got medical or cosmetic essentially?

ES: Yes, exactly. The clinic was arguing that it’s not just cosmetic, because people are psychologically affected by hair loss, and they came with YouTube videos of case studies of their patients saying how much better they felt after they’d had their hair transplant. But actually, I think it was one of the barristers noted that if you consider baldness to be an illness, then actually most of the men in the courtroom were ill. And the judge even asked the lead surgeon from the clinic whether the patients considered themselves to be unwell. And his reply was, the patients don’t consider themselves to be unwell, but we do. Let’s hope that doesn’t make it onto their advertising.

SR: What was the outcome in the case, Ed?

ES: The tribunal actually rejected the claim by the company that it should be exempt. They said that there was no evidence of therapeutic treatment of diagnosed disorders. And they actually said that the androgenetic alopecia is a common physiological change associated with ageing and not a medical condition. So it will be standard rated.

SR: Stephen, I think you’ve had an interest in the past, haven’t you, in VAT exemptions and whether they work, whether they don’t work, whether they go too far? Any views on that case, or any exemptions in particular?

SD: Yes. The exemptions in the financial services sector are essentially historic. The main issue was in relation to interest income, as to how you actually calculate the tax base, and therefore the VAT system introduced when the UK joined the EU provided for an exemption for the financial services sector, and a very, very broad exemption, essentially because it’s actually quite difficult, if not impossible in some cases, to work out what the tax base otherwise would be.

The issue, of course, again is one of borderlines. In other words, what’s exempt, what’s taxable? There’s considerable case law on this question, going through the tribunals, through the courts, even up to Supreme Court, in terms of what actually should be subject to VAT and what should be exempt. It’s an area again, I think, of complexity. Again, I think, an indicator that we need to fundamentally rethink our VAT system.

SR: Going back to ICAEW’s How to Fix VAT campaign, this point was raised again and again by pretty much everyone involved, I think, that there needs to be a rethink. Again, as well, these cases have attracted a lot of attention. Does that make it more likely now that the government will consider change, do you think?

SD: The difficulty I think with change always is that we find that businesses quite often prefer the status quo. They know how to deal with the system as it is. They know how to apply the rules as they are. What they don’t often look to government to do is to change the rules, consequence of which we find that, you know, business adapts to the rules. It makes the rules work in the most effective and efficient way, despite all of the downsides which those rules might generate for the business and for the tax administration as well.

SR: Ed, have you picked up any signs that the government is open to change?

ES: I think they are considering it. I think people within the government appreciate how much opportunity there is in VAT reform. But just building on Stephen’s point about change being difficult, we’ve seen in the past change in VAT backfire. We had the ‘pasty tax’ debacle in 2012, and I think it’s just politically very difficult to change VAT, because there will nearly always be some losers. I think it’s very difficult to tweak VAT without making it more complex. I think it’s telling that in the recent Spring Statement, the only mention of VAT was about the increase to the penalties, and there was no other changes.

SR: I think, from a political viewpoint as well, wholesale reform, as you say, has winners and losers, so it’s probably best done early in a Parliament, and as time creeps on, perhaps the likelihood of it happening in the near future diminishes.

ES: Yes, exactly. I think it’s something that you probably need to promise in your manifesto. We know that the Chancellor tied her hands on VAT a little bit by saying that she wouldn’t raise it. You could argue, I suppose, that you could broaden the VAT base without raising the rate, and that wouldn’t be raising VAT, but it’s a political tightrope to walk, I think.

SR: Another theme that we explored in the recent campaign was increasing digitalisation and the opportunities that that could present. There has been some movement on this thankfully, Ed, hasn’t there?

ES: Yes. In February, the government launched a consultation on encouraging the uptake of e-invoicing among businesses and the public sector in the UK. I think it’s important just to think about what e-invoicing actually is. To start, it’s not a PDF of a paper document. It’s actually a structured data format that businesses can raise in their software, it automatically gets sent to their customer software, and then once that customer has approved that e-invoice, it will automatically feed into their accounting software. And so there’s far fewer points in that process where you can have human error than the manual input side of invoicing.

SR: Now that we understand what it is, what are the pros and cons?

ES: The government talks about the pros of e-invoicing as being reduced costs in the long run – once it’s set up, it’s much less time consuming to use e-invoices; fewer errors – as I mentioned about the reduced manual input; and it also leads to the potential for simplified tax compliance in the future. You could even start talking about potentially pre-filled VAT returns. There are complications with that, and I think exemptions are a key one, so that’s potentially another reason to think about, do we still need these exemptions. But yes, there are definitely benefits to it.

SR: Given the list of benefits there, this certainly seems to outweigh the cons from what I’ve heard so far. Is the government considering making e-invoicing mandatory?

ES: It is considering that. The consultation is very early stage, and they are really genuinely seeking views across the spectrum. And they’ve said nothing’s off the table. They are looking to set an e-invoicing standard, and something we’ve heard from members is that they have looked at implementing e-invoicing already, but they don’t know which e-invoicing standard to use. Some customers are already using it and using a different standard to what they want to use. So what might happen is that the government sets a standard that must be used in the UK if you are using e-invoicing; whether they go that next step and actually make it mandatory remains to be seen.

SR: If there is action to be taken, it could be a fairly long lead-in time, do you think?

ES: Yes, I think so. I think the government will take the rest of this year to think about e-invoicing and the responses that they get, and then we might by the end of the year have an idea for where they want to go with this. Certainly it requires software changes for businesses, and we know that businesses will need, as an absolute minimum, 18 months, but probably longer really, to implement this. So I can’t see it really in the UK coming in before maybe 2028, but that’s just a bit of a guess at this stage.

SR: Okay. Now, Stephen, I believe that the EU is also on the path to e-invoicing. Is that correct?

SD: Yes, that’s right, Stephen. I think it’s actually gone a stage further than that, in the sense that it’s no longer just thinking about it. The long-awaited directive was adopted finally last month [March 2025], takes effect from the beginning of this month [April], and actually lays down a set of rules whereby e-invoicing will become compulsory for intra-EU flows of goods and services, with effect from 2030.

SR: Okay, so that’s it. They’re on the pathway in that case then, where we’re considering it.

SD: That is, if you like, in addition to what member states themselves might have implemented for their domestic transactions. A number of countries have already had or already introduced e-invoicing domestically: Italy, Spain, Hungary, for example; France will be joining in September of next year; Belgium, Germany, Romania; many of the EU member states have adopted their own particular version of e-invoicing.

SR: So it’s quite well advanced then…?

SD: It is, but then of itself that creates problems. You end up with what’s called fragmentation, because each country has its own version, its own system, its own specific e-invoicing system, with digital reporting perhaps added on top to deal with transactions which fall outside the normal kind of B2B business cycle. Consequence of which, in the directive again, the one that was adopted last month, the member states have agreed in principle to bring together, to harmonise, to converge the domestic e-invoicing systems towards the EU standard by no later than 2035.

SR: It sounds like the individual countries have been convinced that the benefits of e-invoicing, have gone off in their own directions, and now the EU project is bringing that together and having a standardised approach.

SD: Yes, absolutely. In fact, the main reason put forward by governments to introduce e-invoicing, at least in the EU, is to limit or to stop VAT fraud, in the B2B circuit in particular. Italy, one of the precursors of e-invoicing, maintains that with e-invoicing they’ve enabled the government to generate an extra €6bn of VAT simply by virtue of having an e-invoicing system – a very detailed, complex e-invoicing system that’s now been in place, as I say, for a number of years in Italy.

SR: It’s not just Europe, is it? I know other countries in the world are also leading on this as well: Singapore, for example.

SD: Singapore, absolutely, is going to introduce it shortly. Other countries like Brazil have had e-invoicing for a number of years – they’re amending their system currently. And even in fact China has e-invoicing already in place. China has a VAT system. So yes, I think the UK in this respect is very much a late runner, should we say, and we’ve got to catch up quickly to make ourselves competitive in the international marketplaces.

SR: Okay, thanks,Stephen. Keeping with e-invoicing for the time being, I believe that’s going to be a topic for discussion at the VAT Conference on 18 June. Is that correct, Ed?

ES: Yes, we have a panel discussion in the afternoon about e-invoicing, and we actually have the lead for VAT infrastructure from HMRC attending that, and we also have a couple of representatives who work in VAT tax technology on that panel, so it should be a really good discussion.

SR: And what else is planned for the VAT Conference?

SD: It’s not just invoicing. We’re going to be talking about lots of other things – about how to simplify the VAT system at a more general level. The date, Stephen – just a reminder – is 18 June in Chartered Accountants’ Hall, with an amazing series or set of speakers taking part.

ES: Yes. We have a whole day event, and then in the morning we have a couple of panel discussions, one about practical fixes for UK VAT. These might be small tweaks that we could make. We also have one about tax policy making in general, and how we can actually achieve VAT change that will actually improve the system.

SD: With a number of breakout sessions as well, a kind of deep dive into very specific issues, whether it’s around the Tour Operators Margin Scheme, whether it’s about taxpayers’ ability to rely upon HMRC’s guidance. We’ve got a number of those sessions that we’re going to spend some time looking at very detailed technical issues.

SR: Great stuff. I think we’ve demonstrated today that there’s already an awful lot to talk about, and you’ve just mentioned a few other things we can bring in there as well. So yes, I’m sure it’ll be a packed here.

In summary then, deciding on the correct VAT treatment can be difficult, for marshmallows and for hair loss services and in a lot of other circumstances. Although there is no sign yet that the government is looking to fix this, it does seem to be interested in pursuing the benefits of increased digitalisation.

You can learn more by visiting our How to Fix VAT campaign hub, and as Ed and Stephen have explained, by coming along to our VAT Conference on 18 June.

That’s it for this episode. Many thanks to Ed and Stephen for your contributions… and thank you for listening.

All of the topics we’ve discussed today are covered in more depth in the articles linked in the show notes. If you found this useful, then don’t forget to subscribe so you never miss an episode. You can rate and share the podcast too.

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I think he may say ‘in northern Europe’ here - but not 100% clear