Tax: Can VAT be simplified?

Birmingham Skyline
Donald-Drysdale By Donald Drysdale for ICAS

20 March 2017

Among aspects being considered by the OTS, Donald Drysdale highlights the VAT registration threshold and the flat rate scheme as potentially controversial issues.

Background

It is 44 years since Value Added Tax (VAT) was introduced to the UK. Originally devised in France, VAT had been adopted across what was then the European Economic Community (EEC). It was implemented in the UK as a consequence of Britain joining the EEC in 1973.

VAT is widely regarded by governments as a very efficient tax for raising revenue. For this reason it has proved popular with legislators and tax authorities, and similar value added tax or goods and services tax (GST) regimes now exist worldwide – in 135 non-EU countries, and in all OECD member countries except the USA.

In its original concept, VAT was intended to be a simple tax.  However, European VAT law has evolved since then, and many changes have been made in UK VAT law within limits imposed by the EU.  As a result, VAT compliance has become increasingly challenging for UK businesses.

OTS review

It was announced in December 2016 that the Office of Tax Simplification (OTS) had been asked by Ministers to review aspects of VAT to assess whether the UK VAT system is working appropriately in today’s economy and to identify simplification opportunities, from both tax technical and administrative viewpoints.

This review is considering:

  • the VAT registration threshold and whether it should it be higher or lower than at present;
  • the extent to which current exemptions, reduced-rating and zero-rating are appropriate;
  • the possibility of having a more widely available system for obtaining formal rulings;
  • the potential for simplifying partial exemption, the option to tax and the capital goods scheme – with a focus on smaller businesses;
  • special accounting schemes;
  • the general administration of VAT, including penalties and appeals;
  • opportunities to align VAT more with other taxes as part of Making Tax Digital (MTD); and
  • the relative significance and impact of the issues identified on businesses of different sizes or in different sectors.

On 8 December the OTS published its terms of reference for this review.  It followed this up on 28 February by publishing an interim report and call for further evidence. Here I shall discuss just two of the key issues on the agenda.

Registration threshold

Should the VAT registration threshold be either higher or lower than at present? At first glance the former looks like simplification and the latter does not. However, the wider economic impact must be considered too.

The UK VAT registration requirements set a threshold of £83,000 for 2016/17 (approximately €95,500), which is significantly higher than the EU average of around €30,000.  But not all small businesses stay outside the VAT regime: some 44% of VAT-registered businesses operate below the threshold, largely as a result of voluntary registrations.

Countries recently adopting VAT or GST have generally set a lower registration threshold than the UK.  However, at the opposite extreme, Singapore has a GST registration threshold of S$1million (approximately £580,000), thus totally excluding all its small businesses.

The OTS observes that the £83,000 threshold seems to have a distortionary impact, with a disproportionate number of businesses reporting turnover just below this level. It seems scarcely surprising that some concerns will deliberately restrict their activities and growth to avoid having the additional administrative burdens of VAT imposed on them and, where applicable, to side-step the need to reflect VAT in their prices to consumers.  But this constraint may be having an adverse impact on the economy as a whole.

Businesses may legitimately manage their activities to stay below the threshold.  In many cases businesses with turnover of around £80,000 may be sufficiently on the ball to monitor their turnover over a 12-month rolling period to ensure they don’t over-step the mark, but they do so at their peril.

If a significantly lower threshold were to apply, smaller businesses might find this hard to do and might incur severe financial penalties for failing to register when they should. If many more very small businesses were forced into VAT by a lower registration threshold, they might face difficulties as a result of the administrative burdens this would impose. Even day-to-day matters such as determining the appropriate rate of VAT for different types of supply might prove too onerous for them.

If, instead, the UK were to set a very much higher registration threshold, as soon as it leaves the EU and is therefore permitted to do so, tax compliance might be simplified for the large number of businesses trading below that new limit.  However, different factors would come into play.

Market distortions that currently exist among competing businesses, where some are registered and others are not, would become more widespread and of greater economic significance.  And those trying to keep their turnover just below the threshold would be larger, more sophisticated businesses which might be encouraged to plan their affairs more aggressively.

Flat rate scheme

There are several schemes designed to simplify the VAT regime – including the flat rate scheme, retail schemes, tour operators’ margin scheme and annual accounting scheme. These do simplify things – with varying degrees of success.

The flat rate scheme is widely used. It was intended to simplify compliance for small businesses that registered for VAT but were not large enough to engage dedicated expertise to deal with some of the more complicated aspects of VAT.  It allows a business to pay a fixed percentage of its turnover as VAT, with relief for input VAT only allowed on capital purchases over £2,000.  A benefit of using the scheme is to escape some of VAT’s complexities, such as partial exemption.

The Autumn Statement 2016 announced the introduction from 1 April 2017 of a new 16.5% flat rate for ‘limited cost businesses’, such as many labour-only concerns.  This was to prevent avoidance, while purporting to keep things simple for small businesses using the scheme as intended.  In practice the change as announced was expected to cause significant administrative problems for scheme users, while still leaving scope for continuing abuse.

HMRC have now published a revised VAT Notice 733 on the flat rate scheme, in which new paragraphs 4.4 – 4.6 define ‘low cost business’ much more widely than originally expected. This will further restrict opportunities for inappropriate use of the scheme, but will add significantly to the administrative burdens faced by many tax-compliant businesses each time they submit a VAT return.

Impact of Brexit

The OTS review will not focus on VAT rates, except to the extent that differential rates add complexity.  It will not be directly concerned with implications of Brexit, such as the treatment of financial services, statistical reporting and EU cross border VAT rules such as MOSS.  However, it will bear the context of Brexit actively in mind in looking at opportunities to simplify VAT for the future.

Call for evidence

ICAS plans to respond to the OTS by 30 June 2017, and is keen to hear views on the questions summarised on pages 27 – 30 of the OTS interim report and call for further evidence and on any other ideas for simplifying VAT. If you’d like ICAS to take your views into account, please email tax@icas.com.

Article supplied by Taxing Words Ltd

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