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Split payment

New VAT collection system proposed in HMRC consultation on VAT “split payments”

Elizabeth Wilson 26 June 2018 No comments

Following HMRC’s 2017 call for evidence seeking views on a split payment system for collecting VAT on online sales of goods, a formal consultation has been launched.

The proposal effectively turns merchant acquirers and payment service providers (PSPs) into the collectors of merchants’ VAT liabilities. VAT would be extracted from online payments in real time and transferred directly to HMRC, reducing the challenge of enforcing online seller compliance.

If adopted, both merchant acquirers and PSPs would face costly changes to their technology. Additionally, they would need to carry out a review of their current contractual fee arrangements, if some of the financial burden is to be passed on to the merchants.

Why is HMRC proposing a new VAT collection system?

The expansion of e-commerce has presented a significant challenge to the UK VAT system. A number of businesses based outside the UK are failing to charge VAT on sales of goods to online UK consumers, resulting in substantial amounts of lost tax revenue.

The government has already taken action to address the issue.  The UK was the first country to introduce joint and several liability rules to hold online marketplaces responsible for the unpaid VAT of sellers on their platforms (see our previous blog and whitepaper for further details).

With this proposal the government is looking to strengthen its fight against online fraud through harnessing new technology. This would create a level playing field by removing any unfair advantage overseas businesses may have over UK businesses.

The current VAT collection system

UK consumers are contractually obliged to pay UK VAT-registered businesses the VAT-inclusive price for goods purchased.

Current UK tax rules require these businesses to submit regular returns to HMRC declaring the amount of VAT owed, and to pay the amount over to HMRC.

HMRC does not intend the introduction of the split payment method to replace or remove the requirement for the submission of regular returns. Following implementation, the only difference would be that the payment to HMRC would effectively have already been made by the merchant acquirer/PSP when the VAT return is submitted.

How the split payment method could work

The consultation sets out the government’s emerging thoughts based on the engagement with stakeholders so far, including how it thinks the potential mechanism could work.

There are two key elements to the split payment mechanism that are set out in the consultation:

  • Identifying the party that is best placed to perform the split; and,
  • Determining the VAT amount to be deducted.

 The party best placed to perform the split

As it is important to know that the supplier is overseas and that the customer is in the UK, the government’s conclusion is that the merchant acquirer is best placed to perform the split, having knowledge of both the location of the merchant and the country in which the card was issued.

HMRC is proposing to create a list, accessible to card issuers, of “fit and proper” acquirers and PSPs that are known or are trusted to comply with the rules.  As a fall-back position, where an acquirer or PSP is not on the list, the card issuer would become the party responsible for making the split.

 The amount of VAT to be split from the gross payment

Three potential options are presented to ensure that as close to the full amount of VAT as possible is collected. To make the process less burdensome, none of them relies on any party knowing the actual VAT liability of any single transaction.

The options are:

  • Assume all sales are standard rated at the current 20%. This would be the simplest option for those performing the split. One advantage is that it would encourage overseas businesses to register for VAT and submit returns to ensure that they are repaid any UK input tax. However, those businesses that do not sell exclusively standard rated goods and could only reclaim input tax at the end of each VAT period would not consider this option fair and proportionate.


  • Mandate overseas sellers to use a flat rate scheme. A small number of rates would be calculated based on the average input tax claims within different industries. Each merchant would be responsible for choosing the rate most appropriate to their industry. This scheme would remove the need to reclaim input tax, but would result in overseas businesses that have a higher than average input tax for their sector underpaying tax and retaining an unfair advantage over UK businesses that are ineligible for the existing VAT Flat Rate Scheme for small businesses.


  • Allow overseas sellers to calculate a Net effective rate. Overseas businesses would be responsible for calculating their own specific ‘flat’ rate based on comparing total output tax and input tax for the previous year. At the end of the year a business would submit a return to HMRC and pay, or be refunded, any difference.


The government’s view is that the third option of a net effective rate is the most suitable, providing the fairest and most proportionate solution.

The scope of split payments

Although the consultation focuses on overseas businesses selling goods online to UK consumers, the scope has not yet been finalised. HMRC asserts that the split payment mechanism is being designed so that it could potentially be extended in the future to include online UK businesses, as well as offline sales within the UK.

How the proposals could affect UK businesses

If the current proposals are adopted, UK merchant acquirers, PSPs and card issuers will be required to make costly changes to their systems and resolve any implementation issues. Most are likely to need to review contracts and renegotiate contractual fee arrangements, which will further increase operating costs.

Due to the involvement of additional parties in VAT payments to HMRC, accounting for VAT may become more complex for the party deducting the VAT (as well as for the overseas merchants) where errors are made in splitting the payment or where customer refunds are due.

Under the proposed “net effective rate” scheme based on a rate that is specific to each individual overseas business, there would be additional work required annually to update system VAT rates and to maintain these for new overseas merchants.

It is worth noting, however, that before any split payment model can be implemented, one hurdle to overcome is that under European law, the European Second Payment Services Directive (PSD2) stipulates that the full amount of a payment made by a consumer must be transferred to the recipient by a payment provider. The EU is, however, looking at split payment as a possible VAT reform in the future. The UK’s withdrawal from the EU may also allow the UK to implement a split payment mechanism without being bound by EU VAT law.

Given the impact the implementation of a split payment model could have on a significant number of UK businesses from both a financial and administrative perspective, the results of the consultation will be worth keeping a close eye on.

We will keep you informed of any future developments on this issue.