What VAT options could be available from January 2021?
Frank Haskew, Head of the Tax Faculty, reviews the tax opportunities – with a focus on VAT reform – that may be available from 1 January 2021. He looks at the likelihood of VAT being abolished, eliminating the zero rate, higher rates of VAT and reducing the VAT threshold among other things.
Could VAT be abolished?
VAT was introduced from 1 April 1973 following the UK joining the European Communities at the beginning of that year. The existing UK VAT rules are closely based upon the EU VAT Directives, so the UK has an opportunity to reform the VAT rules in ways that were not possible when it was part of the EU. Whether the Government would take them up is another matter. In the short term, major changes look unlikely. Indeed, the UK Government has said that, at least to begin with, the existing UK VAT framework would be retained.
In the longer term, it looks highly unlikely that the UK would abolish VAT: since the UK joined the EU, VAT has been adopted by many other countries around the world, so kicking it out would go against the grain of worldwide developments. VAT looks here to stay.
Broadening the VAT base
The UK standard rate of VAT of 20% is charged on the supply of most goods and services, although there is also a lower 5% rate, which is charged on a limited range of products including domestic fuel. We should also remember that certain supplies are also subject to VAT but at a zero rate. Given the cost of the COVID-19 crisis, it doesn’t take a genius to see that the UK is likely to want to raise more money from VAT. This could involve a review of rates and also the VAT base, which is limited by exemptions and reliefs.
Abolishing the zero rate
Turning first to zero-rating, this is regarded as a ‘non-structural’ relief and there are estimates available of the potential revenue lost by charging a zero rate rather than the 20% standard rate. What is clear is that the potential extra revenue from removing zero-rating could be substantial. For example, zero-rating of new dwellings is estimated at £15.8bn and food at nearly £19bn. To put those figures in context, total VAT receipts in 2019/20 were about £130bn. If zero-rating was removed on these two items, the resulting figure (£34.8bn) would exceed comfortably the revenue from business rates (£30.9bn in 2019/20).
On these figures there is clearly plenty of scope to raise serious amounts of money from removing zero-rating. However, the political acceptability of doing so is an entirely different matter – especially given that VAT is regarded as a regressive tax.
It would be a brave Chancellor who, for example, put VAT on children’s clothes (£2bn), although whether all of these increases would be passed on to consumers would depend upon pricing policies: many businesses might be forced to swallow some (or even all) of the hit themselves. A more limited, and less politically damaging, approach could be to charge VAT on some goods and services currently zero-rated but at a rate lower than the standard rate. Of course, the irony is that the UK could have done this even when it was part of the EU.
Higher rates of VAT
Is there a possibility that a higher VAT rate could be reintroduced for luxury goods? This was, after all, a feature of purchase tax and VAT for part of the 1970s. Higher rates of VAT are no longer a feature of EU VAT systems, so adopting such a course would put the UK out of step with what has happened in the VAT systems of EU member states. Although such a move would be possible from 1 January 2021, it looks unlikely that the UK would go down this route.
Could the standard VAT rate (currently 20%) be increased? Again, this could have been done even when we were part of the EU. The bigger problem, however, is closer to home. In this case, the Government has already boxed itself in because, in their 2019 election manifesto, the Conservatives ruled out changes to headline rates of income tax, national insurance and VAT.
After the backtracking by Philip Hammond over the proposed increases in national insurance contributions (NICs) for the self-employed, which was announced in the March 2017 Budget and reversed the following week as it potentially overrode a manifesto pledge not to raise NIC, raising the VAT rate would look politically brave in any normal political climate. However, we are not living in a normal political climate: the impact of COVID-19 could provide the necessary justification for higher rates. There is an interesting question, the sort tax specialists love, about whether the pledge not to raise the VAT rate applies also to the reduced and/or zero rates? The experience from 2017 suggests that, while the Chancellor might wish to believe it did not, Parliament may have other ideas.
Removing VAT exemptions
So, if changing the rate(s) is likely to prove tricky, what other options are there? As mentioned earlier, the VAT base could be broadened. One option is a review of the existing VAT exemptions and the associated partial exemption rules.
Abolishing exemptions would simplify VAT and could allow input tax incurred for business or charitable purposes to be claimed in full. This would remove the need for partial exemption methods and the capital goods scheme. The only type of adjustment required would then be for business/non-business use, which would affect a relatively small number of those who are VAT registered. There would be no need to complete complex partial exemption calculations and it should simplify the VAT return process.
What’s there not to like? Well, it would come at a cost to citizens as supplies that are currently exempt would then be likely to become subject to VAT, potentially at the standard or perhaps the reduced rate. Obtaining information on the likely revenue from removing exemptions is harder to determine because they are counted as structural reliefs but, like zero-rating, the potential revenue raised could be substantial.
Reducing the VAT threshold
Another alternative would be to reduce the VAT registration threshold, currently £85,000 a year. This has now been frozen since 1 April 2017 and the estimated cost of maintaining the threshold at £85,000 is over £2bn. The current strategy appears to be to let inflation take its course and let the real value of it reduce. However, with (currently) very low rates of inflation, the real value of it is declining very slowly. There have been commentators calling for the threshold to be reduced, but it would bring many more smaller businesses within the scope of VAT with all the complexity and costs that it entails.
Postponed accounting
What other changes will we see? The Government has already announced that it will move to postponed accounting of VAT for all imports to the UK. Under this system, UK VAT-registered persons will account for the import VAT on goods imported into the UK on their VAT returns, and both pay and recover import VAT on the same VAT return. This will give cashflow benefits to UK importers. It has been widely welcomed, including by ICAEW who suggested it to the Government a few years ago. It should help importers at a time of considerable uncertainty.
Conclusion
The scope to change the VAT system is vast and many changes could be implemented very quickly. The potential to raise significant extra money from VAT from relatively simple changes is considerable – an attractive proposition to a Government that needs to rebuild the UK’s financial position.
It is, however, ironic that many of the changes that could be made are not only quite straightforward but could have been done at any time when the UK was a member of the EU. The fact that they have not been adopted highlights that, as is always the case with tax changes, raising taxes is fraught and that the political judgements that are required make the job of the Chancellor an unenviable one.
About the author
Frank Haskew is Head of the Tax Faculty