Stephen Dale reflects on how the past 50 years informs the future for the UK VAT system – the topic of ICAEW Tax Faculty’s conference on 22 May.
On 1 April 1973, the UK introduced value added tax (VAT) as a broad-based consumption tax. The introduction of VAT was a European Economic Community (EEC) Treaty obligation, replacing purchase tax.
The EEC had already adopted VAT by the first two VAT Directives in 1967, the system (following a review and analysis in the Neumark Report from 1962) being based essentially on the French VAT system introduced in April 1954, which was itself based partly upon certain theoretical work undertaken in Germany just after the First World War.
A major advantage of a VAT system is that it boosts exports and capital investment, as they are not subject to VAT (any tax on inputs being fully recovered). It operates by eliminating the VAT charge in the manufacturing and distribution chain, by ensuring that VAT charged by the supplier business further up the chain is deducted by the business further down the chain, with VAT ultimately only being imposed at the retail level.
VAT is no longer a ‘simple tax’
Today, UK VAT legislation is complex. Introduced in the 1972 Finance Act, the primary legislation was last consolidated in the Value Added Tax Act 1994 (VATA 1994), having been substantially amended and updated through various Finance Acts since that date. VAT legislation is not just to be found in VATA 1994, but also (and equally as importantly) in a substantial volume of secondary legislation contained in, for example, the Value Added Tax Regulations 1995, SI 1995/2518, and other statutory instruments. There is also a very important body of ‘tertiary’ legislation contained in public notices.
VAT remains the UK’s third largest source of tax revenue (raising £157.5bn in 2021/22) after income tax and national insurance contributions.
As the Office of Tax Simplification (OTS) noted in its report Value added tax: routes to simplification, presented to Parliament in November 2017, there were, apart from the level at which the registration threshold is set, a number of areas where action could be taken to simplify the VAT system – even while the UK was still within the EU. For example, a reduction in the number of rates of tax; partial exemption; the capital goods scheme; the option to tax land and buildings; and special accounting schemes. Some progress has been made on a few of these issues (eg, the simplification of the process for notifying the option to tax land and buildings). There is, nonetheless, significant scope for further simplification, as echoed again by the Chancellor recently.
Leaving the EU
One of the biggest difficulties facing any simplification effort of the VAT system in the UK, in the past, is that until the UK left the EU at the end of 2020, the UK, by virtue of its EU (EEC) Treaty obligations, was required to apply the EU VAT system. In ensuring that the VAT system applied in the UK was EU ‘compatible’ a large number of cases, concerning the interpretation of EU (EEC/EC) law, were referred by the UK courts to what is now the Court of Justice of the European Union (CJEU).
In fact, while the UK was an EU member the UK courts referred one of the largest number of prejudicial questions to the CJEU of any EU member state. These rulings by the Court, referred from the UK courts, have influenced the interpretation of EU law, the consequences of which will continue to have an enduring impact on the remaining 27 member states. The UK’s contribution to the evolution of EU law in the field of VAT should not be underestimated. The Fenix International case (Case C-695/20) of 28 February 2023 is a good example of the importance of a UK court’s referral (right at the end of the transitional period) on the interpretation of EU VAT law.
While the UK courts were working hard to get clarity on the correct interpretation of EU law, the EU Commission, in its role as guardian of the EU Treaties, took a number of actions (or had indicated its intention to do so, for example in relation to the tour operators’ margin scheme (TOMS)).
The UK VAT system is too complex
To echo the Chancellor’s comments, the UK’s tax system is far too complicated. The zero-rating schedule, Sch 8, VATA 1994, was one of the specific areas that the OTS considered should be reviewed. Numerous cases have been brought before the tribunals as to whether a food product is zero-rated or standard-rated (eg, United Biscuits (LON/91/160), the Jaffa Cakes case, which came to a different conclusion to the earlier case of Adams Foods Ltd (MAN/83/62)). The more recent case before the First-tier Tribunal of Innovative Bites Limited v HMRC further illustrates the unnecessary complexity of the provisions applying the zero rate to certain categories of food.
As Neil Gaskell noted in TAXline in March last year, in relation to the supply of electricity for electric vehicle recharging, the application of different VAT rates to the supply of essentially the same product causes confusion and potential distortions.
Even using VAT as a “green tool” (see the current call for evidence on extending the zero rate to the supply, in certain circumstances, of energy saving materials), is debated and creates complexity. As the OECD noted in 2014, the standard advice to governments would be to apply a single VAT rate and address distributional considerations via well targeted measures, such as targeted tax credits or direct benefit payments for poorer households rather than applying reduced VAT rates to encourage good environmental behaviour. This is clearly a very sound approach in preventing our VAT system becoming even more complex and potentially more distortive, but would require a fundamental upheaval in how the current VAT (and benefits) system operates.
The food sector is not the only one where borderlines create issues. The financial services (and the real estate) sector encounters major difficulties with the VAT system, due, in part, to the boundaries between taxation and exemption, generating significant levels of legal uncertainty and inevitably leading to disputes and litigation. Is now not the time to reopen the debate around the remaining need for many of the exemptions in Sch 9, VATA 1994?
A clear role for technology
The UK’s (and the EU’s) VAT system is an invoice-based system with the tax collected at each level of production and distribution (fractionated payments). In the 21st century a valid question to address is whether we still need to have a VAT system based on invoices – there was a clear need in France in 1954, when VAT was introduced. Seventy years later, the whole economic and technological environment has changed and alternative VAT systems, with a greater degree of automation, pre-population of VAT returns, etc, are successfully applied around the world.
Of course, the key in any tax system, and in particular one such as VAT where the tax is collected by business, is to ensure that the VAT is remitted to the relevant administration (the UK’s third largest source of tax revenue) at the right time. Could this be more effectively undertaken through a split payment system (which will be examined again shortly in this country) or even a withholding at source?
On its 50th anniversary, should we not consider how technology via real time data reporting, electronic invoicing, online cash recording systems etc could be used to a far greater extent to reduce compliance burdens on business, bad debts and to minimise fraud?
Stephen Dale, Chair, VAT and Duties Committee, ICAEW