VAT takes the biscuit (or is it a cake?)

If there’s one thing most people know about VAT it’s that Jaffa Cakes are cakes, not biscuits. Not everyone is sure why this matters – of course its because “biscuits wholly or partly covered in chocolate” are an exception to the general zero rate for food. The Office of Tax Simplification report on simplifying VAT (published on 7 November) gives a more colourful example of the same principle, that a gingerbread man with chocolate eyes is zero rated (they are really chocolate chips) but if he has chocolate trousers he is standard rated! There are further anomalies in many, many areas of VAT both around rates and exemptions.

The report suggests that these can only be addressed in the medium to long term, citing the constraints of EU law. However, this is to overlook the fact that many (if not most) of the UK’s zero rates have their roots in the UK’s Purchase Tax and in HMRC’s custom and practice.

It’s fair to say that the current EU legislative framework does place some constraints on the application of the reduced rate and also that where the UK’s zero rate is as a result of a derogation (exception) from the core framework it’s a one-way street – its scope cannot be extended and once given up cannot be reintroduced. However the current EU regime permits member states to apply a reduced rate to a wide range of supplies including many currently zero rated by the UK, such as food.

Furthermore, the EU’s VAT Action Plan published in April 2016 and its follow up in October 2017, proposed giving greater freedom to EU member states around rates. Legislative proposals are to be expected in 2017. So long as the UK remains in the Single Market this remains relevant to us. Two options are being considered:

1.       A more regular review of the list of permitted reduced rate items and extension of derogations to all EU member states to allow a level playing field together with a maintenance of the minimum 15% standard rate.
2.       Allowing member states complete freedom as to the scope, level and number of reduced rates, with overriding controls on distortion of competition.

Regardless of the developments at EU level, the UK could modernise the taxation of food which is most definitely the area of greatest complexity. It could, for example, eliminate many of the anomalies particularly in the area of snacks, confectionery and beverages where some healthy items such as nuts,  healthy beverages (fruit / vegetable smoothies), muesli bars are standard rated and other less healthy / unhealthy items are zero rated. It could also apply a reduced rate of VAT to catering currently taxed at the standard rate. The modern lifestyle means that eating out / hot takeaway food is seen less as a service and more as a substitute to home cooking. Many other EU member states apply a reduced rate to such supplies.

I understand that any wholesale review of rates will have “winners” and “losers”. But the current complex regime serves no-one (except perhaps VAT advisers!). Retailers face potentially significant VAT bills from making the wrong call on a product’s VAT liability which can turn on a subjective interpretation of matters such as the “potatoness”  of a product. Decisions on the design of food products can be driven by VAT rather than nutritional factors.

This is one of a series of articles on the OTS report. We have focussed mainly on food – other areas have been / will be covered in other articles. See also our earlier post which outlines the main OTS recommendations.

Read more about the OTS study here.