Value Added Tax: Routes to Simplification

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Written by Nigel Mellor, Senior Policy Adviser, the Office of Tax Simplification 

On 7 November 2017, the Office of Tax Simplification (OTS) laid before Parliament its report entitled Value Added Tax: routes to simplification. The OTS is a small team of independent, expert advisers who undertake detailed research into tax complexity issues typically on behalf of Ministers but it can undertake reviews at its own instigation. The parties consulted for the report included professional bodies, trade associations and micro-businesses through to global corporations. In addition, the team worked closely with HM Treasury and HM Revenue and Customs. Once a report has been finalised, the OTS then lays it before Parliament and typically the Chancellor gives a formal response to any recommendations which have been made.

The 80-page report contains 23 recommendations of which 8 are described as being core recommendations and 15 are categorised as additional recommendations. In essence, the report can be broken down into three main areas; namely,

  • The issues and impacts involved if the registration threshold were either higher or lower than it is at present;
  • Administrative changes which could help businesses, advisers and HMRC better achieve their common aim of easing friction points in the system;
  • The extent to which the definitions of the type of supply which are currently relieved from VAT create complexity for businesses and administration.

 

Registration threshold issues

The UK’s £85,000 VAT registration is often seen as being a tax simplification measure as many small businesses can comfortably operate below this level without needing to register for VAT. The report points out the current threshold is the highest in the EU and the OCED and at present, the average threshold in the EU is around £20,000. The report also highlights the fact that based on submissions received and academic analysis of HMRC data, the threshold is clearly having a distortive impact on business growth. This is considered to be because businesses are deliberately limiting their expansion, for example, by not taking on an extra employee, an extra contract, or closing their doors for a period to keep their turnover below the threshold. The distortions which this creates can clearly be seen in the graph below.

The OTS has therefore recommended that the government should examine the current approach to the level and design of the VAT registration threshold, including consideration of the potential benefits of introducing a smoothing mechanism.

Numbers of entities by turnover band around the registration threshold

Source: HMRC data from 2014/15, when the threshold was £81,000

 

Administration including guidance, rulings, penalties and appeals

The OTS in earlier reviews has highlighted feedback which it has received that practical issues are often the most important to users of the tax system and many contributors identified where improvements could make life easier for businesses.

A range of concerns were expressed to us about the benefit which is obtained from certainty when decisions need to be made about the VAT treatment of goods and services they supply and/or when dealing with one off events such as a complex restructuring. Concerns were also raised with us about the quality of the guidance produced by HMRC, problems relating to penalties (particularly where a business had made a voluntary disclosure), and issues relating to appeals. The OTS has made a number of recommendations in this area so as to try and address some of these concerns.

 

Multiple rates

Goods and services supplied in the UK are by default subject to VAT at the standard rate. There are various exceptions under which the goods or services may be subject to a reduced rate, zero-rated or exempt from VAT. As most readers will be aware, these boundaries can create absurdities and the different treatments can cause complexity and be administratively burdensome. This complexity has arisen over many years and on occasion the treatment has links to how goods were classified for purchase tax.

The OTS recommended that rather than trying to address these complexities in a piecemeal fashion, the time is now right for HM Treasury and HMRC to undertake a comprehensive review of the reduced rate, zero-rate and exemption schedules, working with the support of the OTS.

 

Partial exemption

During the course of the review, it became apparent that many more businesses are now captured by the partial exemption regime than would have been the case when the tax was introduced over 40 years ago. There are many reasons why this has happened including the fact that there is now more diversification by businesses but a contributing factor is that the de minimis limits which are designed to keep smaller businesses out of partial exemption have not been increased for decades. Similarly, many larger businesses expressed concern that when they need to negotiate or renew a partial exemption special method, the process was frequently taking years to obtain approval.

As a way of resolving these issues, the OTS recommended that the government should both increase the de minimis limits and explore alternative ways for businesses incurring insignificant amounts of input tax to be relieved from carrying out partial exemption calculations.

 

Capital Goods Scheme

The Capital Goods Scheme (CGS) requires businesses to consider each year after the purchase or first use of the asset whether the use of the asset has changed. The rules around the necessary adjustments can be quiet complex. The scheme currently captures land and building works in excess of £250,000 as well as computers, aircraft and yachts costing more than £50,000. There are several issues with caused by the complexities of the scheme but the most important is that the threshold for scheme adjustments relating to land and property have not increased since 1990 despite a huge increase in property values. The OTS have recommended that the land and property threshold should be increased and it has also questioned whether the other categories are still needed.

 

Option to tax

The option to tax allows businesses to charge VAT on certain land a property transactions which would otherwise be exempt and this enables a recovery of input VAT on costs associated with that supply. The OTS explored a number of potential changes in relation to this area and it has recommended that HMRC should consider how the record keeping and audit trails for options could be improved for example by handling options to tax on-line.

 

In addition to the core recommendations which have been outlined above, the report has made a number of additional recommendations. These recommendations are explained in more detail in the report and a pdf can be downloaded from the OTS section on the gov.uk website. This can be found at: https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/657215/Value_added_tax_routes_to_simplification_print.pdf

 

 

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