VAT recommendations are not what they seem

Sad little gingerbread man covering his face
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Neil Warren analyses the Office of Tax Simplification (OTS) recommendations for the VAT system and concludes that reform is needed, but the Chancellor must proceed with great care.

Don’t panic

There has been a lot of excitement in the last few days that the Chancellor could slash the VAT registration threshold from £85,000 to £26,000 in his November Budget, bringing an extra one million businesses into the VAT net.

This follows the publication of the OTS report “VAT: routes to simplification”. But I want to reassure readers: it won’t happen, and a close reading of the report shows that this is not what the OTS has recommended.

Frozen thresholds

The OTS report considered many of the thresholds which exist in the VAT world. For example, it correctly noted that the capital goods scheme (CGS) threshold of £250,000 for land and buildings had not been increased since 1990. Surely a big increase to, say, £500,000 would reflect the movement in property prices over the last 27 years and take out smaller projects from the clutches of the CGS?

Under the CGS the input tax originally claimed on either buying a non-residential building or improving, refurbishing or extending it, must be adjusted over a ten-year period to reflect the potential change in the use of the building between exempt and taxable activities.

The annual partial exemption de minimis threshold of £7,500 has also remained static for over 30 years, and the flat rate scheme joining threshold of £150,000 (expected taxable sales in the next 12 months excluding VAT) has not moved since April 2003 either. The error correction threshold of £10,000 (or 1% of Box 6 outputs and £50,000 for larger businesses) has remained unchanged since April 2009.

Registration threshold

The OTS exact recommendation for the registration threshold is: “The government should examine the current approach to the level and design of the VAT registration threshold, with a view to setting out a future direction of travel for the threshold, including consideration of the potential benefits of a smoothing mechanism”.

I am personally in favour of a reduced threshold. The OTS report provides facts and figures to show what we all know: many business owners work a bit less to keep their annual sales below £85,000 (this is more practical with a business selling services rather than goods), and many retailers and cash businesses do not declare some of their takings.

But the danger is that if you reduce the registration threshold by £50,000 over, say, a five-year period, then you are just creating a different “cliff edge” figure. So the problem is not solved.

However, the reason why there won’t be a sudden announcement by Philip Hammond to drop the threshold from £85,000 to a much lower figure is that the Government doesn’t have a strong enough majority for such a bold measure.

Also, the businesses affected would include a lot of the ‘just getting by’ households highlighted as a priority for special attention by Theresa May when she first became Prime Minister.

Zero rating and exemptions

The OTS recommends a comprehensive review of the goods and services that are exempt or zero-rated in the VAT Act schedules 8 and 9. This is very welcome, but I am reminded of the omnishambles Budget of 2012 when George Osborne tried to clear the muddy waters of VAT and hot food with his famous “pasty tax”. He also upset hairdressers, storage businesses, caravan retailers and owners of listed properties in the same budget – and he never went near VAT again.

The main concern of advisers at the time was that the proposed measures seemed to make things more complicated rather than simpler. Do you remember the phrase “ambient room temperature” that caused great confusion among tax advisers and bakers alike? You may also recall how we started off with two different VAT rates for residential caravans but ended up with three rates as a result of the “simplification” measure in that Budget.

Conclusion

The OTS report has focused on the major problems in the VAT system that we all know exist. The underlying issue with VAT is that a tax invented in 1973 is not particularly well suited in a lot of cases to the modern global economy we now have in 2017.

If we were starting with a clean sheet of paper, we would certainly have a very different VAT system to what we have now – perhaps a reduced rate of 5% on all food items rather than the exceptions, exceptions to the exceptions, and exceptions to the exceptions to the exceptions that we now have in VATA 1994, schedule 8, which provide both amusement and confusion alike.

This was perfectly highlighted by the OTS example of a gingerbread man biscuit being zero-rated if he had chocolate eyes but standard-rated if he wore chocolate trousers. What a game it all is!

About Neil Warren

Neil Warren

Neil Warren is an independent VAT consultant and author who worked for Customs and Excise for 14 years until 1997.

Replies

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10th Nov 2017 18:54

A good article as always from Neil Warren and shows that he's actually read the OTS report, unlike Sift's business editor who came up with the headline "VAT cut proposal stokes MTD fears for SMEs".

The earlier piece said that "the blockbuster recommendation is to drastically lower the VAT threshold from its current level of £85,000 (one of the highest in the world)".

It then said "the report doesn't make an outright recommendation .... " - OK so which is it?

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11th Nov 2017 12:25

The Chancellor has already killed off the flat rate scheme for small service businesses with unworkable rules in his first budget

One hopes his next foray into VAT will be more measured and balanced.

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By SXGuy
13th Nov 2017 10:21

What worries me is those businesses just about getting by who can not increase their turnover to include vat will suffer a hit on their profit margins. Reducing the vat threshold in my opinion isn't fair, if anything you would think that inflation would mean the threshold should increase since the pound is worth less.

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13th Nov 2017 10:26

The OTS seems to be jolly good at identifying problem areas, but not so good at coming up with alternative ideas. The compulsory VAT registration threshold is just a number. I can see how you can take another look at the level, but what about "design"? Just what do they mean? And how might a "smoothing mechanism" work? Do OTS members get paid for these vague indications?

Then they want a "comprehensive review" of zero rating and exemption. Careful: somebody might slip off the fence! I suppose they'd call it delegation.

How about a comprehensive view of OTS achievements to date: IR35 and tax calculation "exceptions" might be mentioned, but there must be a few other candidates.

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