VAT's all folks: How badly will be hit by tax hike?

CLAIMS and counterclaims about the impact of last week's 2.5 per cent increase in VAT may have left many consumers' heads spinning. According to Labour, it will cost the average family 7.50 a week, or 390 a year. Other bodies put it much lower at around 150, while the Taxpayer's Alliance goes higher still at more than 500.

Such exchanges are inevitable when rates change. When a 10 per cent VAT was first introduced in 1973 by a Conservative government, as the price for joining the common market, Labour leader Harold Wilson denounced it as "deplorable and inflationary", and warned that another Budget would soon be necessary.

Indeed, Labour delivered that next Budget after being returned to power. But it did not scrap the new VAT. Rather it extended it to a new range of goods including petrol, sweets, and crisps.

Today's Labour leader Ed Miliband branded the recent change the "wrong tax at the wrong time". He must be keeping his fingers crossed that, like Wilson, he gets to write the next Budget. But anyone hoping VAT will be cut should look to their history books.

In theory, the VAT hike will now add 20 per cent, rather than 17.5 per cent, to the price of most non-essentials, pushing up the bill for a new 20 jumper by 42p, a 500 flat-screen TV by 10.64, and a 13,000 new car by 276.59.

But theory and practice are not always the same thing when it comes to shopping psychology. Some shops have indicated they have no immediate plans to pass on the higher sales tax. John Lewis, Sainsbury's Home and Lifestyle, DFS and Staples are among the businesses which have pledged to absorb the cost for the time being. Others, such as M&S and Debenhams, have said they will be increasing prices, but only gradually.

Across the high street, other organisations, are believed to be using the VAT change to hike prices even higher, by as much as 5 per cent, which they can then blame on the government.

We don't yet know how these changes will impact shoppers' buying patterns. Not all goods attract VAT at 20 per cent, with some, such as energy, charged at 5 per cent. Other items are zero-rated, including food and children's clothing, effectively exempting them from the tax.

But this doesn't mean inflation will pass them by. Global food prices have hit record highs, with strong surges in demand for commodities, particularly wheat, sugar, milk and cotton. This will feed through to supermarket shelves and clothes retailers' rails.

So it may be a couple of months yet before we can see where prices will shake out. Only when they settle again, can we judge the impact on family budgets, spending power and the economic recovery.

It's a fair bet though, over time, that prices will climb. The question is by how much? And it is an important question. If significant inflation takes hold, then the Bank of England may feel forced to increase interest rates.In that case, the VAT increase will cost considerably more than a tenner on a telly. So it may pay to minimise the impact with small changes to your spending. We answer your questions about how to survive the tax hike.

What is VAT?

It is essentially a sales tax, which in 1973 replaced the UK's former purchase tax, which was charged at different rates on goods depending on their luxury status.

Is it added to everything I buy?

No. It is primarily designed to catch "luxury" items. Food, children's clothing, books and newspapers and similar items are exempt. However, the rules are complex.

How can food be complicated?

Well, the zero-rating applies, as a general rule, only to basic foodstuffs which are not further involved in complex processing. But knowing what is standard and what zero-rated is a minefield. For example ice-cream, and similar mixes are charged at 20 per cent. But frozen yoghurt, which can be thawed, is zero-rated. Cakes and biscuits are zero-rated, with the exception of luxury biscuits, including chocolate covered ones.

This led to the famous Jaffa Cake case, where the Revenue claimed that purchasers should pay standard VAT because it was a luxury biscuit, while the company, which won, claimed it was a cake. Cakes, no matter how luxurious, are standard rated. Similarly, 20 per cent VAT is always added to savoury snacks such as crisps and nuts.

While milk, tea, coffee and herbal drinks are zero-rated, full VAT is charged on orange juice, because it is a "processed" food. Similarly, health or medicinal foods are standard rated. That said, slimming replacement meals are exempt, provided they do not include confectionary.

What about eating out?

Restaurants and snack bars are obliged to add standard VAT to hot food and beverages. If buying a snack, therefore, a cold sandwich will be zero-rated, while a hot sandwich costs more because it is subject to VAT.

What about electronics?

Your computer services, broadband, and telecoms are all subject to standard VAT, so expect your next bills to be higher, costing about 10 a year more annually. Some companies are attempting to absorb the cost, but Apple said it would be upping prices immediately.

Mobile phone charges should similarly rise by around 8.48 annually, however, some companies have alerted customers of higher increases still. Text messages on the O2 network will rise from 10p to 12p, a 20 per cent increase, while texts with T-Mobile will rise from 10p to 11p.

Why has petrol gone up more than anything else?

Petrol has been hit by two duty rises, pushing the average price of a litre up 3.5p to around 1.27 per litre. Fuel duty rose by 0.76p per litre on January 1, with VAT climbing to 20 per cent three days later. The increase will hit rural communities and the haulage industry hardest. Prime Minister David Cameron has said he is looking at a fuel stabiliser which would cut the tax as prices rise.

Meanwhile, the only option for drivers is to change to a more fuel-efficient car, cut journeys or car share.

Has VAT on my heating oil risen?

No. VAT on domestic heating oil is charged at 5 per cent in line with gas and electricity. However, the cost of heating your home with oil has risen by around 70 per cent.

Suppliers have been accused of profiteering during the recent bitter spell, given that crude oil prices have risen by less than 20 per cent over the same period.

Gas and electricity companies have also been increasing their charges. To cut bills, consumers should shop around, improve insulation and use less.

Can I avoid VAT by paying "cash in hand"?

The higher rate of VAT will automatically add a fifth to the price of any job you are having done around the house. We already have a significant black economy, where tradesmen work for cash in hand to avoid incurring the cost for the householder.

But such activity is illegal and leaves you vulnerable to prosecution. Furthermore, if something goes wrong, you will have no comeback. Either way, it could prove an expensive mistake.

There are ways, though, to minimise the VAT bill. Tradesmen are only required to be VAT registered when their turnover reaches 70,000.

It is perfectly legitimate to employ someone who is not required to register for VAT, because he runs his business in a way which keeps his turnover down.

If you want a new kitchen, for example, you can order it yourself, and pay the VAT, but then use a non-registered jobbing labourer to fit it.

Are there any VAT concessions on building work?

There are a few. It is often possible to avoid the charge completely when a listed home is being upgraded. Improvements to a disabled person's home can also enjoy reductions.