UK VAT reform: multiple rates and partial exemption

By Susan Cattell, Head of Taxation (England Wales)

2 June 2017

Donald Drysdale discussed two aspects of the OTS review of the VAT regime (the registration threshold and the flat rate scheme) in an earlier article.

This article looks at some of the other aspects of VAT which the OTS is considering: multiple rates and partial exemption.  A separate article considers option to tax and formal rulings.

The OTS will be publishing recommendations in the autumn. 

Multiple rates

The UK has four separate VAT categories: the standard 20% rate, the 5% reduced rate, a zero-rate and exemption. If ‘outside the scope’ is included there would be five. This can cause difficulties, particularly where it is hard to decide the scope of the definitions applicable.

The OTS mentions a couple of food related problem areas. Firstly, the zero-rating of cakes and bread – originally designed so that everything sold by the local baker would be zero-rated. This worked in the 1970s but is less successful now, when supermarkets sell a wide range of products and bakers usually sell standard rated products as well as traditional bread and cakes. Secondly, the distinction, for VAT purposes, between corn chips and potato crisps.

The questions in the consultation are directed to identifying whether it would be possible to improve the definitions and boundaries in the existing system.

OTS questions include:

  • What are the categories which most often give rise to complexity – and why? Is it product development/technological advance or for other reasons?
  • Could some definitions be simplified to give more leeway for reasonable trade decisions?
  • Would it help if there were broader definitions in areas such as food? Or one rate for food and one for all other goods?

Partial exemption

Businesses can only recover input tax relating to taxable supplies ie those which are taxed at the standard, reduced or zero-rate. A partially exempt business is one which incurs input VAT on costs which relate to exempt supplies as well as taxable ones.

Traditionally, the sectors mainly affected by partial exemption were financial services and businesses making land and property supplies. The OTS points out that the number of partially exempt businesses has not only grown but has particularly grown beyond these traditional sectors. The consultation gives the example of a farmer diversifying beyond farming activities by renting out former barns as industrial units – and asks why those affected do not opt to tax.

The OTS identifies several difficulties arising from partial exemption which is arguably the most complicated part of VAT; even the Standard Method can cause problems – and agreeing other methods with HMRC can take months or years. The OTS intends to examine partial exemption in more depth in the next stage of its review and would like input on various questions, including:

  • Where does partial exemption arise in practice unexpectedly? What is the impact on the businesses concerned?
  • Would it be practical to exclude more of these ‘accidental’ partially exempt businesses in some way? Would that just mean raising the de minimis amounts and changing incidentals guidelines?
  • Could the calculation be simplified?
  • What alternatives or improvements could be put in place to make the process of agreeing a partial exemption special method with HMRC simpler, easier and quicker?

What do you think?

ICAS plans to respond to the OTS review 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 us.


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