Office of Tax Simplification VAT Review
In its review of VAT, the Office of Tax Simplication (OTS) recommended that the UK government examine the registration threshold for VAT because the current level of £85,000 ($111,300) is unsuitable. The UK has the highest VAT threshold in the European Union, where the minimum threshold is €10,000 ($11,800) but the average is €22,000. The high threshold means that there is a “cliff-edge” for businesses, which offers an incentive to find creative ways to lower turnover in order to avoid paying VAT.
Many businesses will limit expanding their operations to stop themselves from going over this cliff-edge. It could be as simple as not taking on an extra employee or closing up for a few weeks to keep turnover just below the threshold. This is the so-called ‘bunching’ of businesses. These practices are perfectly within the law, though there are cases where companies seek to conceal their overall turnover and this is where avoidance becomes evasion.
Bringing down the VAT threshold could help align the UK’s regime with EU standards as it withdraws, but this is just one possibility for reform. The OTS report notes that because the VAT system is largely prescribed by EU rules, Brexit may present an opportunity to consider areas which could be clarified, simplified, or just made easier.
The report also laid out three main options for how the UK could change the VAT system:
- Reduce the threshold to a level closer to other EU countries, potentially bringing more than a million businesses into the VAT system; or
- Raise the threshold further, thereby reducing the impact on economic growth; and
- In either case, implement a ‘smoothing’ mechanism to avoid the “cliff-edge” effect hitting businesses at whatever level the threshold is set.
At the same time, the OTS report recommends that the UK tax authority, HMRC, needs to improve the clarity of its guidance and how it handles rulings in cases of uncertainty. This is alongside suggestions that the UK authorities should review the reduced rate, zero rate and exemption schedules and look for ways to simplify this system.
“The review stopped short of making firm recommendations to address this, but options include dramatically increasing the threshold to take more businesses out of the VAT net,” David McDonnell, VAT director at MHA MacIntyre Hudson, said. “This obviously reduces Treasury revenues, so much more likely is a dramatic reduction in the threshold, bringing it in line with the EU norm, tipping more businesses over the VAT cliff edge and generating more money for Treasury coffers.”
Alan McLintock, chair of the indirect taxes sub-committee at the Chartered Institute of Taxation, said his organisation strongly supports making the rules on VAT “less complex and easier to apply, in the expectation that it should lead to less uncertainty among business, and fewer disputes with HMRC”.
Higher or lower?
Ahead of the autumn budget next week, Chancellor Philip Hammond has considered the OTS recommendations and there is speculation that the UK government might adopt a new threshold for VAT. Whatever decision is reached, any policy shift will have major implications for HMRC.
Cutting the VAT threshold to £43,000 would help minimise the distortions of the “cliff-edge” and increase tax revenue by £1 billion to £2 billion a year, the OTS report claimed. It would expand the number of registered businesses and may help address the disparity between the UK’s VAT system and other EU member states.
However, the problem with a lower threshold is that it would increase the compliance burden placed on small to medium-sized businesses. It might not dramatically reduce the competitive distortions of the “cliff-edge”, in other words. It’s also possible that the influx of newly registered companies might also raise the administrative costs for HMRC at a time when it appears to be cutting staff.
On the other hand, if the UK were to adopt a similar model as Singapore, where the threshold for VAT is £500,000, this could reduce competitive distortions between registered and deregistered businesses. It would alleviate the compliance burden too. But it would mean a big drop in tax revenue
McLintock believes that future examinations of the VAT threshold will have to manage a trade-off between business growth and business activity. “Much will depend on how any change to the threshold is implemented,” he said.
Alternatively, the ‘smoothing’ mechanism is another possibility for a change in the VAT threshold. This mechanism would allow companies, which make more than £85,000 a year, to retain some of the revenue collected. There are different ways this could be achieved, whether it focuses on, for example, the cash impact of registration or the administrative burden. One possibility is a time-limited cut to VAT for newly-registered companies.
Any such mechanism may require a tiered system of registration, which could potentially make the existing system more complicated. On the other hand, the OTS argues that the benefits of a ‘smoothing’ mechanism could include higher productivity.
“Developing a workable mechanism that balances the risk of fraud, revenue loss and potential complexity against the benefits of smoothing entry to the VAT system and reducing business burdens is challenging, but the OTS considers there is merit in examining this for the future,” the report said.
“It’s difficult to see how these options would achieve anything other than add further layers of complexity and confusion, flying in the face of the stated aim to simplify taxes across the board,” McDonnell said.
“Raising the threshold to such a high level would cut the funds available for public services by between £3 billion and £6 billion a year. It would also have potential behavioural consequences,” the report said. “For example, the presence of many more unregistered businesses in the marketplace could well encourage some of them to operate in the hidden economy, reducing their compliance with – and payment of – other taxes.”
Challenges for business
Because the Brexit deal is still being negotiated, the OTS report makes it clear that it cannot base its recommendations on the final plan, but the relevance of VAT policy cannot be overstated. What the final deal will look like is a matter of speculation right now, but this throws up more concerns for business.
“At a time when businesses would normally have a clearly defined plan for the year ahead, businesses across Europe are faced with major confusion in the form of Brexit,” Kid Misso, senior director at Solution Consulting, said.
This is why companies have to consider the worst-case scenarios as their planning. Richard Asquith, VP Global Indirect Tax at Avalara, told International Tax Review that the major risk for business “is the imposition of import VAT on goods coming into the UK from the EU27”.
Avalara’s Brexit Survey found that one in three of the firms surveyed see themselves scaling back operations post-Brexit, 75% believe that the exit will cost them more in VAT and customs duties, while 92% of firms fear that the withdrawal will increase the complexity of compliance. This is why VAT policy is so important to what the transition will mean for the UK economy.
“Many companies are already looking at removing the UK from their international supply chains for goods,” Asquith said. “So less trade. But I am not sure it will mean stopping – they UK, after all, is the world’s sixth largest economy.”
In the challenging pre-Brexit environment, the government’s position on VAT is unpredictable, but they may decide to keep the status quo, for now at least, according to some tax professionals. However, the OTS report has raised the issue and it is now firmly on the agenda. The upcoming UK budget statement on November 22 may see the chancellor act quickly to shake things up – or not.
The above article was published on www.internationaltaxreview.com on November 16 2017 and has been republished with the approval of the Publisher.