VAT review must put simplification front and centre

The Office of Tax Simplification (OTS) will shortly publish a report setting out a range of proposals for simplifying VAT as after over 40 years, the tax is showing its age. What was meant to be a simple tax has become highly complex and it has not kept pace with changes in society.

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.

The OTS’s core recommendations will include:

  • 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 VAT system and charge VAT on its sales. At £85,000 the UK has one of the highest level

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.

Responding to the announcement Mike Cherry, Federation of Small Businesses (FSB) National Chairman, said: “Complying with VAT obligations is massively time-consuming for small firms. Over a quarter identify it as the most complex tax to deal with.

“Small firms aren’t like big corporations – they don’t have accounting expertise on tap. Our small business owners should be spending their time and money growing their firms, not navigating an array of different VAT schemes and an inconsistent list of exemptions as long as your arm. VAT should also not be used as a back-door to bringing more firms into mandatory quarterly tax reporting.

“Given that the VAT regime is so awash with complexity, there needs to be substantial simplification before any more small firms are brought into its scope. It’s promising to hear that an OTS review of VAT is on the way and we are calling for it to have simplification, not threshold reduction, front and centre.”

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