The future of VAT in the UK after Brexit

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Jeremy Cape unearths some surprises in a report from Parliament’s European Scrutiny Committee on the future of VAT in the UK after Brexit.

The European Scrutiny Committee, chaired by long-time eurosceptic Sir William Cash, published its report on VAT: EU proposals for reform and the implications of Brexit on 3 April 2018. While this report attempts to look in isolation at the EU’s proposals for the “true” single EU VAT area, Brexit intrudes at every turn.

A trade-off

The committee identified that in relation to VAT, Brexit presents a trade-off. These are two of its conflicting conclusions:

  1. If the UK comes to an agreement with the EU on continued adherence to the VAT Directive and its supplementary legislation, it may be able to avoid the barriers to trade described above, including the need for VAT-related border controls on goods exported to an EU country after Brexit. However, this would come at the cost of having to follow legislation over which the government will have substantially less influence than it does now (considering that, under the Treaties, Member States can veto EU tax legislation).
  2. If the government does not want an arrangement with the EU to remove VAT-related obstacles that entails continued adherence to EU VAT law, there are likely to be new - and substantial - barriers to trade with the EU. This would pose a particular problem for the Irish border: without either UK participation in the EU system used to track movement of goods or physical border controls, products could pour into the UK (and the EU) without VAT being paid.

Frustration at the border

In the report, a clearly frustrated committee stated that it had “again urged the government to set out how it intends to balance these competing pressures, and how collection of VAT on imports can be guaranteed on goods entering the UK via Ireland in the absence of any physical infrastructure on the border”.  

The committee stated that it remained “seriously concerned about the inability, or unwillingness, of the government to share a detailed proposition for the mitigation of VAT-related barriers to trade flows between the UK and the EU as and when the UK leaves the single EU VAT area”. 

Although the committee did not explicitly say so, the position would be complicated enough even if the single EU VAT area proposals did not exist, but the trade-off is more nuanced.

To align or not to align

Even if after Brexit the UK is no longer bound by the VAT Directive, it has to decide not only whether and to what extent it wishes to align its system with the EU VAT system on 1 January 2021 (the first day after transition), but also the EU VAT system in 2022 or later if, as it is not unreasonable to assume, there are delays on the EU side.

The committee indicated in a number of places that it thought that Mel Stride, Financial Secretary to the Treasury “is considering remaining closely aligned with, if not directly bound by, EU VAT law”. This may or may not be true.

Crossing the red line

I note that the EU Commission’s draft negotiating guidelines anticipate a limit on the UK’s ability to “undercut” on tax, which may at the very least put some negative restrictions on the ability to amend its VAT regime. But it’s possible that the UK government is preparing to concede that the UK’s VAT system should continue to fall under the competence of the EU and the ECJ – notwithstanding that the UK would lose its current right to veto VAT changes.

Politically, I can’t see that’s possible. It doesn’t so much as cross a red line, as have that red line hung, drawn and quartered.

Unforeseen consequences

The committee states that: “any decision by the UK to diverge from the harmonised standards that underpin the common VAT system could have unforeseen consequences, potentially rendering the whole cross-border system that allows for border controls to be waived technically unworkable”.

On the positive side, the committee notes that the 2022 VAT reforms, as well as leaving the EU, enables the UK to, for example, apply a zero-rating to women’s sanitary products.

In relation to applying lower rates of VAT, the committee is unable to resist point out that “The UK’s ‘rate gap’ is 3.3%, lower than the 5.3% EU average, indicating that it does not make use of the flexibility granted by the VAT Directive to the same extent as other EU countries”. In other words, the UK has the ability to reduce the VAT base to a greater extent if it wanted to, although it’s fair to say the UK can’t currently zero-rate tampons.

Third country

The committee reiterates its worry about the impact of the UK becoming a third country for VAT purposes: “exports of goods from the UK to the EU and vice versa would be subject to physical custom controls to ensure the correct amount of VAT is paid”. This is in contrast to the current situation, where there are no such controls and movements of goods are monitored via the EU’s VAT information exchange system.

If you were in any doubt as to what that means, it goes on to say: “This will make UK suppliers less attractive to EU customers (and vice versa), while also presenting cash flow issues for businesses which can currently pay VAT on cross-border purchases after they have already taken possession of their imports”.

VAT fraud

The committee queried whether measures “would require the UK to effectively remain in the single EU VAT area to avoid instances of double-taxation, or non-taxation, that could arise if the Government changes domestic rules about when VAT liabilities arise and who is responsible for VAT returns”.

Some have suggested that the EU-Norway VAT co-operation agreement might present a template for co-operation on VAT. The committee mentioned it, noted its limited scope, and then added witheringly that “the Minister [Mel Stride] has only felt able to say that the agreement is ‘useful’”.

Conclusion

The committee was not impressed with the current state of the UK government’s engagement with, and thinking about how to solve, the VAT problem. The committee also appears to have concluded that the UK government accepts that to at least some extent, and possibly to a considerable extent, it will need to stay part of the EU VAT area, possible breaching the red lines set down by the Prime Minister.

What is astonishing is that this largely eurosceptic committee, could see no answer other than remaining in the EU VAT Area.

I’ve long thought that the VAT position is capable of falling fairly easily into place once other points on the form of Brexit are agreed. This committee report shows that VAT will be a useful bellwether as to whether these other points are, or are capable of being, agreed. 

About Jeremy Cape

Jeremy cape

Jeremy Cape is a tax and public policy partner in the London office of Squire Patton Boggs, advising on a wide range of issues, including M&A, private equity, finance, restructuring and insolvency, and VAT. He is a member of the legal advisory panel of the Red Tape Initiative, which will identify the most important, least controversial opportunities for cutting red tape in a post-Brexit world. He can be followed on twitter @jeremydcape.

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10th May 2018 12:45

The EU have and will put obstacles all over the place on our leaving. Let's face it the main reason for our leaving is the tie in with trade and movement of people. I really don't know why the EU cannot compromise. I personally think that the movement of people is a great thing, but each country has to be able to say "hang on" we got too many, let's hold off a while. I also cannot see how the EU will be able to form a federal Europe, even with Macron at the helm. As VAT is a sales tax there shouldn't be any problems when we leave. What a lot of people forget is that VAT is not a tax on business. It is a tax on the consumer. So in reality there should be no VAT charge between VAT registered business.

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