OTS publishes report on the UK VAT system
carolineheath 18 January 2018 No comments
The Office of Tax Simplification (OTS) published its final report on the UK VAT system in November 2017. This follows the first major review of the VAT system in over 40 years. The report contains 23 recommendations for simplifying the tax.
Why was the review conducted?
At the 2016 Autumn Statement, the Chancellor of the Exchequer and the Financial Secretary to the Treasury asked the OTS to conduct the review. The objective was to see whether the current VAT system was fit for purpose in the modern economy and to identify potential areas for simplification. The terms of reference for the review can be found here and see our earlier blog article on the publication of the interim report.
What were the recommendations?
The final report contains 23 recommendations. There are 8 core recommendations and 15 additional recommendations covering the VAT threshold, administration and technical issues.
The 8 core recommendations are:
- 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
- HMRC should maintain a programme for further improving the clarity of its guidance and its responsiveness to requests for rulings in areas of uncertainty
- HMRC should consider ways of reducing the uncertainty and administrative costs for business relating to potential penalties when inaccuracies are voluntarily disclosed
- HM Treasury and HMRC should undertake a comprehensive review of the reduced rate, zero-rate and exemption schedules, working with the support of the OTS
- The government should consider increasing the partial exemption de-minimis limits in line with inflation, and explore alternative ways of removing the need for businesses incurring insignificant amounts of input tax to carry out partial exemption calculations
- HMRC should consider further ways to simplify partial exemption calculations and to improve the process of making and agreeing special method applications
- the government should consider whether capital goods scheme categories other than for land and property are needed, and review the land and property threshold
- HMRC should review the current requirements for record keeping and the audit trail for options to tax, and the extent to which this might be handled on-line.
VAT registration threshold
The VAT registration threshold was identified as the most significant issue. At £85,000 the UK has one of the highest levels in the world – the average threshold across the EU is £20,000.
Whilst the UK threshold is a form of simplification, since it enables many small businesses to stay out of the VAT system, it is an expensive relief which costs around £2bn per annum in terms of VAT foregone.
The OTS found that the high level of the threshold distorts business behaviour and creates a significant cliff edge. Evidence strongly suggested that many growing businesses avoid expanding beyond the VAT registration threshold as this could potentially result in a 20% price increase as well as an additional compliance burden. The resulting bunching effect just below the £85,000 turnover level and a large drop off in the number of businesses with turnovers just above the threshold has a knock-on effect for the UK’s general economic growth.
The report considers options for reducing this ‘cliff edge’ and explores the advantages and disadvantages of lowering or increasing the threshold.
Multiple VAT rates
VAT has many ‘quirks’ resulting from its legislation on reduced rate, zero-rated and exempt goods and services. A well-known example is that a Jaffa cake is a cake which is zero-rated, whereas a chocolate-covered biscuit is subject to VAT at 20%. Also, a gingerbread man with chocolate eyes is zero-rated but if it has chocolate trousers it is standard rated. The OTS found that the boundaries between the different VAT treatment of products often cause unnecessary complexity and administrative burdens for businesses.
Whilst EU law limits options to make changes in this area there is a longer-term opportunity to significantly improve the efficiency, simplicity and fairness of the UK VAT system particularly following Brexit.
Administrative and technical recommendations
Other recommendations highlight areas for improving the day to day administration of the tax, including better and more accessible guidance and a less uncertain penalty system. These would particularly benefit small businesses
The report also recommends that specific technical areas which are particularly complex and onerous for businesses to comply with should be reviewed with a view to simplification. These include the partial exemption regime, the capital goods scheme, the option to tax and other special VAT accounting schemes.
Simplification of these technical and administrative aspects of VAT would help both taxpayers and HMRC alike.
On publication of the report Angela Knight, Chair of the OTS board, said:
“This report presents an opportunity to start addressing the many anomalies of VAT. The tax is awash with layers of complexity reflecting both its evolution over the last 45 years and aspects of the Purchase Tax that VAT replaced. For small businesses, this report will propose ways of simplifying many irritating administrative technicalities and kick off a debate about the registration threshold.”
The Chancellor of Exchequer’s response
In the Autumn Budget 2017 the Chancellor of Exchequer Philip Hammond announced that he would consult on the issue of the VAT registration threshold, including whether it could be redesigned to better incentivise growth.
In the meantime, he decided to maintain it at its current level of £85,000 for the next two years.
He has also sent a letter to the OTS responding to the report and its recommendations in which he concludes:
“Thank you again for the work of you and your team in producing this report. I appreciate your contributions and believe we can make progress against some of these areas relatively quickly. Others will need to considered over a longer time period, against the backdrop of our ongoing discussions about the UK’s future relationship with the EU. In taking this work forward, the government will engage with business, the public and the OTS on specific areas as appropriate, and consider any future legislative changes as part of the normal Budget process.”
It seems there will be no immediate changes to the VAT system in response to the report but businesses should keep a watching brief for further developments.