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Rob Janering Accordance, U.K.
Rob Janering is Associate Director at Accordance, U.K.
The recent report from the Office of Tax Simplification in the U.K. looked at measures which could help with maintaining the current yield of value added tax (”VAT”) but at the same time make it simpler for businesses to collect the tax and for HM Revenue & Customs (“HMRC”) to administer it.
At the start of November 2017 the U.K. Office of Tax Simplification (“OTS”) published its long-awaited report “VAT: routes to simplification.” This set out a number of findings and recommendations to make value added tax (“VAT”) in the U.K. a simpler tax to manage.
The OTS is an independent office of the Treasury which was set up in July 2010. Its objective is to reduce tax compliance burdens and it does this by providing the government with independent advice on how complex areas of taxation in the U.K. could be simplified. The government is not, however, bound to follow up on this advice, but often pays attention to it and the OTS's output often finds its way to new legislation.
This review into VAT was the OTS's first since its creation, and came on the back of 120 billion pounds of VAT being collected by the government in 2016–17. However, this huge collection of VAT (22.5 percent of all taxes in the U.K.) disguised a heavily complicated tax which has grown over the years to now cover 42 Acts of Parliament and incorporate 132 statutory instruments. As a result, the OTS report looked at a number of measures which could help with maintaining the current yield of tax but at the same time make it simpler for businesses to collect and for HM Revenue & Customs (“HMR”) to administer. We have commented on the key points from the report below.
By far the most significant and consuming part of the review looked at whether the present threshold for registration is appropriate. U.K.–established businesses must exceed a taxable turnover of 85,000 pounds before being required to register for VAT. This threshold is the highest of any European Union (“EU”) Member State (the average is 20,000 pounds) and any other country in the OECD. However, it is a benefit to many U.K. small and medium-sized enterprises, as it enables them to trade up to a relatively significant amount without having to charge customers VAT. More importantly, it exempts them from having to comply with VAT obligations such as submitting returns and issuing specific invoices, which can be time-consuming and expensive.
During its research, the OTS discovered that a significant amount of “bunching” takes place just below the threshold. This is the result of businesses either ceasing to make supplies once the threshold comes into sight or suppressing sales (maybe illegally). In either case, the threshold is treated as a cliff edge and this has implications for the wider economy, such as such as restricting the growth of businesses and consequently tax revenue for the government.
The OTS made three suggestions—to increase, decrease or freeze the threshold. It was noted that a small change would likely result in little behavioral change and only slight adjustments to the revenue generated. Raising the threshold to 500,000 pounds would potentially take 800,000 businesses out of the VAT regime but would also cost 3–6 billion pounds a year in lost revenue. On the other hand, a reduction in the threshold to 43,000 pounds would see up to 600,000 more businesses need to register for VAT and raise between 1–1.5 billion pounds extra a year.
The Chancellor Philip Hammond considered making changes to the threshold in the Autumn Budget 2017 and decided that there would be no change to the existing 85,000 pounds for at least two years. This outcome was not a surprise, with a large increase not plausible because of the potential tax loss, and a reduction, creating a need for hundreds of thousands of businesses to register and with only a relatively small increase in revenue, being politically impossible for the current government. However, the door has been left open for changes to happen in the future and it wouldn't be a surprise if, in a more settled political environment, the threshold was reduced.
The OTS identified that the quality of guidance and assistance provided by HMRC to businesses looking to determine the VAT treatment of a supply could be better. For instance, many times the response of HMRC is to refer the taxpayer to existing Public Notices or Internal Guidance even when this has been found to be insufficient. The OTS have urged HMRC to address this and attempt to provide businesses which want to comply with the law with more support and guidance.
Alongside this, the OTS noted that even where a business corrects an error on its VAT return (as allowed if the value is below certain limits), it must still notify HMRC for penalty purposes. This is an unusual situation and has led to businesses being penalized despite seeming to follow the rules set down by HMRC. The OTS report states that HMRC should attempt to provide businesses with greater certainty and easier administrative steps to assist these processes.
Over the years a build-up of case law has helped business to identify the VAT rate which should apply to supplies they make. However, the OTS was aware that some of the conditions and boundaries that exist to determine the VAT rate that should apply are not clear and can make it difficult for a business to apply. Therefore, benefits could be derived from the U.K. reviewing how the rates are applied.
Unfortunately, as much as such an exercise might give businesses greater certainty, a significant overhaul of this area would probably not be possible due to restrictions imposed by the EU VAT Directive. This legislation sets out the items that can be subject to the reduced rates of VAT and they are limited, which gives EU Member States little room for maneuver if they want to make adjustments.
Take for example the case of sanitary products, which was headline news for quite some time. These products are subject to the reduced rate of 5 percent VAT in the U.K. but a campaign pushed for them to be zero rated. Whilst the U.K. government made provisions in law and petitioned the EU to allow for the products to be zero rated, no change was possible because the 27 other EU Member States did not ratify the change required to the EU Directive.
Despite this background, the OTS recommended that the way different VAT rates and exemptions are applied should be reviewed. Tellingly, the report states that this work should be undertaken considering an impending Brexit, when the U.K. may no longer be under the EU's jurisdiction and hence will have greater scope to do as it wishes with regards to VAT.
The obligation to perform certain calculations is based on values of relevant goods or supplies. For example, items only fall within the Capital Goods Scheme (“CGS”) if over a certain value, or the need to undertake Partial Exemption (“P/E”) calculations is removed if input tax is within defined de minimis limits.
The OTS noted in its report that, in addition to both schemes being difficult to manage and being suitable for simplified procedures, rates and values were applied that had not been updated in line with inflation or changes in technology. For example, computers must be included within CGS calculations but only if valued at more than 50,000 pounds: because of technological advances, it is rare for a computer to be within CGS now because the cost of such items has been dramatically reduced. Likewise, the de minimis limit for P/E remains at 625 pounds per month, unchanged for over 20 years.
The static nature of these values has meant many smaller businesses having to undertake time-consuming and complicated calculations that were not intended at the time of the original legislation. Hence, an update to both the values applied and the methodology could see benefits for a large range of businesses.
The OTS’ report has a number of well-thought-out and logical proposals which could very easily result in greater revenue for government while at the same time freeing up resources for businesses, so they can instead focus on their core objectives of making supplies.
There are some quick fixes that many businesses will hope are followed through on. In fact, the U.K. Chancellor has indicated his support for HMRC's reviewing the penalty regime and guidance/help given to ensure businesses have greater certainty. This can only be applauded because anything that makes life simpler will be welcomed during a time when many uncertainties are making life hard for businesses.
As mentioned though, many of the OTS's more dramatic proposals are unlikely to see the light of day soon, due to a combination of the current political climate and Brexit. However, it is satisfying to see the options discussed in this open way, and it can only be hoped that when more “settled” times return, these proposals are given due consideration and the steps required to simplify the tax are taken.
Rob Janering is Associate Director at Accordance, U.K.He may be contacted at: email@example.com
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