Oh, VAT on earth does all of this mean?

Published on Sunday 23 November 2008 20:56

IT was first imposed in 1950s France by an economist who envisaged a simple system of taxation. Since then, Value Added Tax, or Vat, has become Europe's biggest invisible export, and is now an in-credibly complex integral part of the economies of about 180 countries.

A tax on goods at the point of sale, it does not affect the cost of manufacture or distribution, regardless of how many times the goods change hands before final point of sale. The payment is always a percentage of the final cost. It is charged to a buyer by a Vat-register-ed seller. It is reclaimed by a Vat-registered buyer after goods and services are bought.

It is a hugely political tool whose misuse can crush a government.

Mindful of this, the United States is the only major economy which has not yet imposed the system. Presidential candidates who suggest it tend to lose their bid for the White House.

However, it is a prerequisite for membership of the European Union. Currently, the minimum standard rate of Vat throughout the EU is 15 per cent, although reduced rates of Vat, as low as 0 per cent, can apply. The maximum rate is 25 per cent.

When the UK joined up, in 1973, it replaced its existing Purchase Tax and Selective Employment Tax with Vat. In 1979, it had a zero rate, a basic rate of 12.5 per cent charged on "luxury" items, and a reduced rate of 8 per cent on most other goods and services.

When the Conservatives came to power that year, Geoffrey Howe, the Chancellor, increased both of these to a single rate of 15 per cent, to partially offset the impact of large cuts to basic and higher rates of Income Tax.

This was portrayed as a deliberate move aimed at shifting the burden of taxation from earnings to consumption. It remained at 15 per cent until 1991, when the then Chancellor Norman Lamont raised it to 17.5 per cent.

The increase was intended to provide revenue for the Community Charge Reduction Scheme, aimed at assisting local authorities suffering from the fall-out of massive levels of defaulting on the poll tax.

Over the past ten years, European economies have been losing manufacturing output to emerging markets with more business-friendly tax regimes, which made it more expensive to produce in the European Union.

In response, governments looked to ease their corporate tax rates – but had to find a way to offset this. The obvious option was to increase Vat, thus passing the tax burden on to the consumer.

France spoke about a five per cent rise – regardless of the fact it was in an election. The Netherlands declared a one per cent rise to 20 per cent from the start of 2009.

However, inflation re-emerged and threw a spanner in the works. France quickly backed down and Holland shelved its plans.

Rocketing oil and basic food prices caused havoc in the latter stages of 2007 and spilled into 2008 – along with one of the worst financial crises the world has seen. Central banks have been slashing interest rates in a bid to bring inflation back down but the situation means Vat increases are, on the face of it, unlikely. Indeed, it appears that Alistair Darling, the Chancellor, is looking at going the other way.

Although raising taxes in a recession might seem a non-starter, the two most recent UK Vat hikes came in troubled economic times.

On 15 October, the Minister of Finance of Ireland announced a 0.5 per cent increase in its standard VAT rate. Ireland was one of the first economies to go into recession in this economic cycle.

Commentators have said that its Vat increase may now relaunch the trend for the rest of Europe.

15 things you probably didn't know about VAT

1

Biscuits and cakes are considered a necessity by UK law and are zero VAT-rated. However, chocolate-covered biscuits are a luxury and so subject to VAT. McVities and HM Customs & Excise argued over whether the Jaffa Cake was a cake or a chocolate biscuit. McVities baked a 12-inch Jaffa Cake which convinced a tribunal of its cake status.

2

UK opticians have fought a long battle with customs over VAT. Many were furious when it was announced that, as of 1 June, 2001, all agreed methods of calculating VAT on spectacle dispensing in the UK were to be terminated and spectacle sales would attract the full rate of 17.5 per cent. They said it effectively meant an increase in price of about 10 per cent for every pair of spectacles dispensed in the UK.

3

Fruit and vegetables are zero-rated. Cold gazpacho soup in a carton is zero-rated. However, a smoothie is subject to VAT – this is because it is classed as a beverage, despite being made of fruit.

4

Maurice Laure, joint director of the French tax authority, the Direction Generale des Impots, was the first to introduce VAT.

It was effective from 10 April, 1954 for large businesses, and it was extended over time to all business sectors.

5

HM Revenue & Customs once tried to tax sausage casings. It argued that, as sausage casings were made of collagen, they were not a food and therefore should be subject to VAT. However, a tribunal found differently.

6

European legislation dictates that, once an item moves from zero to a positive tax rate, it cannot go back. The list of taxable items has extended gradually over the years, leading some to label VAT a "stealth tax".

7

Standard VAT rate applied in EU member states as at 1 July, 2008: Sweden and Denmark, 25 per cent; Finland and Poland, 22 per cent; Belgium and Ireland, 21 per cent; Austria, Bulgaria, Hungary, Italy, Portugal and Slovenia, 20 per cent; France 19.6 per cent; Czech Republic, Germany, Greece, Netherlands, Romania and Slovakia , 19 per cent; Estonia, Latvia, Lithuania and Malta, 18 per cent; the UK 17.5 per cent; Spain 16 per cent; Cyprus and Luxembourg, 15 per cent.

8

Children's clothes and shoes do not attract VAT – a concession exploited by small-sized adults able to get their wardrobes from the children's departments.

9

One of the first cases challenging VAT was brought to the tribunal in 1974 by the Blackpool Leisure Beach Company. It argued that its Big Dipper ride was a form of transport and so should be VAT-free. To much surprise, the VAT tribunal agreed – only for the decision to be overturned later.

10

In France, VAT at a standard rate of 19.6 per cent is the most important source of state finance, accounting for approximately 45 per cent of state revenues.

11

When VAT celebrated its 30th birthday, on April Fool's Day 2003, it had collected a total of more than 828 billion for the UK Treasury.

12

The packaging of foodstuffs can have consequences – sweetened dried fruit, if sold as confectionery, is standard-rated, but if it is labelled as suitable for home cooking too, it can be sold VAT-free.

13

If you order a milkshake with your McDonalds meal, you get it VAT-free if you take it away. However, if you choose to eat in, or if you order a Coke, the VAT system gets a cut.

14

Crisps on their own are standard-rated. But if they require further preparation before consumption they are zero-rated. United Biscuits claimed its McCoys Dips, when sold together with crisps, should be zero-rated as further preparation was required. Procter & Gamble did the same with its Pringles Dippers two years before. United lost; P&G won.

15

The average annual "score" over the 1990s in High Court VAT rulings was ten to HM Revenue & Customs and six to the taxpayer. Most cases involve small businesses meeting the demands of Customs.