A new report by the Office of Tax Simplification (OTS) has made a number of recommendation to improve and simplify VAT.  The OTS’s core recommendations includes:

  • that 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
  • that HMRC should maintain a programme for further improving the clarity of its guidance and its responsiveness to requests for rulings in areas of uncertainty
  • that 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 most significant issue identified in the report is the VAT registration threshold – the turnover level above which a business must enter the VATsystem and charge VAT on its sales. At £85,000 the UK has one of the highest levels in the world.

By enabling many small businesses to stay out of the VAT system the high threshold is a form of simplification, but it’s an expensive relief, costing around £2bn per annum, and evidence strongly suggests that many growing businesses are discouraged from expanding beyond this point. The report looks at options for reducing the current ‘cliff edge’ effect resulting in a very visible bunching of businesses just before the VAT threshold, and an equally large drop off in the number of businesses with turnovers just above the threshold. Also examined are the advantages and disadvantages of lowering or increasing the threshold.

VAT has many ‘quirks’. For example, it is well known that a Jaffa cake is a cake (zero-rated) rather than a chocolate-covered biscuit (taxed at 20%). Less well known is that while children’s clothes are zero-rated, including many items made from fur skin, items made from Tibetan goat skin are standard-rated. And a ginger bread man with chocolate eyes is zero-rated but if it has chocolate trousers it would be standard rated. VAT zero rates cost over £45bn per annum to maintain. EU law limits options to make changes in this area but there is a longer-term opportunity to significantly improve the efficiency, simplicity and fairness of the UK VAT system.

The report also

  • makes recommendations for improving the day to day administration of the tax, including better and more accessible guidance and a less uncertain penalty system. This would particularly benefit small businesses
  • considers specific areas of technical difficulty, including the partial exemption regime, the capital goods scheme, the option to tax and other special schemes

Angela Knight CBE, 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.”

Paul Morton, OTS Tax Director, said “This report will flag up the effects of the registration threshold, how entry into the VAT system might be smoothed and many other areas where simplification would be beneficial, particularly the complex and often subjective boundaries between those supplies which are standard rated and those which fall within the reduced or zero-rates or which are exempt. In addition, there will be opportunities to build on the good work of the last few years in improving the administrative aspects of the running of the VAT.”

Responding the report, Frank Haskew, Head of ICAEW Tax Faculty, said:

“VAT was introduced in 1973 as a ‘simple tax’. Since then it has become vastly more complicated to administer and is a significant burden that falls disproportionately on smaller businesses. It was for this reason that the limit was raised substantially in the early 1990s, and the current VAT registration limit of £85,000 is the highest in the EU. In 2015 the Government confirmed that ‘We believe that the UK’s current registration threshold achieves a reasonable balance between competing interests and reduces the administrative burden on the smallest businesses.”

 “Although the current VAT registration threshold of £85,000 is high, it is in practice a major simplification measure for smaller businesses. We believe it should be retained at its current level or consideration be given to increasing it further, perhaps with measures to ease businesses into VAT to avoid the ‘cliff edge’ effect.”