The Office for Tax Simplification (‘OTS’) released their report Value added tax: routes to simplification on the 7th November 2017.
After taking some time to read through this report, I am pleased to report that there are many positive ideas coming out of this, along with one not so positive recommendation, which may have a significant impact on small businesses.
Although many may feel the best and most direct way to simplify the VAT system would be to get rid of it all together, I can definitively confirm that this was not one of the recommendations made by the OTS, and with VAT accounting for 22.5% of all revenue collected by HMRC, I would not suspect that this was ever considered to be an option.
The OTS made 23 recommendations in total, with 8 of these being core recommendations, which are the ones that I will concentrate on.
Starting with the one main negative recommendation, and the one most likely to impact on the most businesses:
Recommendation 1: The government should examine the current approach to the level and design of the VAT registration threshold, with a view to setting out a future direction of travel for the threshold, including consideration of the potential benefits of a smoothing mechanism.
In a nutshell, what is being said here is that the government should look at reducing the current VAT registration threshold, which currently stands at £85,000.
Although the report does suggest that consideration of upping the threshold should be made, when phrases such as the following are being used in the report about the existing threshold, to me this suggests that the underlying recommendation is for the threshold to be reduced:
‘Adversely impacts economic growth’
‘Creates economic distortions’
It is true that the UK currently has the highest VAT registration threshold in the EU, and one of the highest in the world. From analysis it is also true, that a disproportionate number of businesses are trading just below the VAT registration threshold.
However it is also true, that by going just £1 over the VAT registration threshold, this can result in over £14k of your turnover being due to HMRC as output VAT, so it is understandable why businesses make a concentrated effort to remain under the threshold.
With a budget later this month and rumblings already being made that the government will follow the recommendations of the OTS and review the existing threshold, with the likelihood being that the threshold will be reduced, it could be that many more businesses need to become VAT registered in the not so distant future.
For example, halving the current threshold down to £43,000 would see an extra 400,000 to 600,000 businesses registering for VAT.
This would add a huge administrative burden for many small businesses.
The report does suggest that a smoothing mechanism should be introduced, perhaps in the form of businesses not having to pay over the full amount of VAT due in the first three years of breaching the threshold. To me this doesn’t seem much like a simplification and is also unlikely to be acceptable to the existing EU legislation which governs our VAT system, at least until Brexit happens.
For small businesses, that’s the potentially bad news and something that they should be preparing for in the possibly not so distant future.
The other 7 core recommendations made are for me, much better news for businesses.
Recommendation 2: HMRC should maintain a programme for further improving the clarity of its guidance and its responsiveness for rulings in areas of uncertainty.
Speaking as someone whose job it is to review the guidance and try to obtain rulings from HMRC, this is great news.
The report states that HMRC’s published guidance is ‘frequently out of date’ and ‘difficult to search for’ and recommend an overhaul of this system. I would agree.
This should hopefully allow advice to be provided more efficiently and decisions about the VAT position of transactions to be concluded upon faster. Good news for businesses and good news for me!
Recommendation 3: HMRC should consider ways of reducing the uncertainty and administrative costs for business relating to potential penalties when inaccuracies are voluntarily disclosed.
Mistakes happen. Every now and then a business may make a mistake on their VAT return. Currently smaller mistakes can be corrected on the next VAT return, but you still need to disclose the error to HMRC and may face a penalty in relation to this, despite correcting the error and disclosing it.
In reality, penalties are rarely applied in these circumstances, but the possibility that they could be creates uncertainty. Anything to improve this existing system can only be a positive.
Recommendation 4: HM Treasury and HMRC should undertake a comprehensive review of the reduced rate, zero-rate and exemption schedules, working with the support of the OTS.
Currently the various different VAT rates creates anomalies such as the following:
Reading these examples, I don’t think anyone can deny that through a combination of the original legislation and then the subsequent case law, these anomalies have got pretty ridiculous.
Therefore any review and improvement of the existing position would be welcome.
Recommendation 5: The government should consider increasing the partial exemption de minimis limits in line with inflation, and explore alternative ways of removing the need for businesses incurring insignificant amounts of input tax to carry out partial exemption calculations.
Recommendation 6: HMRC should consider further ways to simplify partial exemption calculations and to improve the process of making and agreeing special method applications.
I think it is fair to say that most businesses who are affected by partial exemption, don’t like it.
Although the principles are sound in that you recover input VAT that relates to making taxable supplies, but can’t recover input VAT that relates to supplies that are exempt from VAT, the complicated calculations can create issues for businesses.
This is particularly true for small businesses that were not originally intended to be caught by partial exemption. The de minimis test does work for many businesses, with up to £7,500 of input VAT relating to exempt supplies possibly recoverable if the conditions are met, however this limit has not been increased since it was introduced in 1994.
Taking inflation into account the de minimis limit would now be £13,700, so the OTS’s recommendation to consider increasing the existing amount is positive for small businesses impacted by partial exemption.
The recommendation to consider ways to simplify the partial exemption calculations is positive in theory, but I am yet to be convinced that any of the possible options suggested to achieve this would actually result in simplification.
Recommendation 7: The government should consider whether capital goods scheme categories other than for land and property are needed, and review the land and property threshold.
Like the partial exemption de minimis limit, the capital goods scheme limit of £250,000 for land and property has not been increased since its introduction in 1990. During this time the value of land and property has increased dramatically and therefore many more transactions are falling within the capital goods scheme than was originally intended.
Therefore an increase in the threshold would appear to make sense and would take away the need for complicated calculations to be made by some businesses. I would however express caution in this as this limit is also applied in anti-avoidance legislation and therefore any rising of it would need to be carefully considered.
I much prefer one of the additional recommendations that suggests introducing a de minimis limit for adjustments, which could take away the need for many businesses to make the calculations on an annual basis when only minimal changes to usage have occurred.
The capital goods scheme also applies to computers, aircraft, ships and boats, although these are not often seen in practice, therefore the suggestion to look at removing these from the legislation, again appears to be a sensible move.
Recommendation 8: HMRC should review the current requirements for record keeping and the audit trail for options to tax, and the extent to which this might be handled on-line.
This is my favourite recommendation. The current system is simply not fit for purpose.
The option to tax department of HMRC are infamously slow at responding to correspondence and as a result this can create significant levels of uncertainty for businesses and in some extreme cases can hold up or even ruin property transactions whilst waiting for a response from HMRC on whether or not there is an option to tax.
The idea of moving this system online and potentially creating an online database resonates well with me and is something I would like to see introduced as soon as possible.
Many issues have been considered by the OTS, and it is now up to the government to decide on how to act on these. Whether this will be as soon as the budget next week remains to be seen, but should you have any concerns regarding any of the above or would like to discuss further, please do not hesitate to get in touch with me at email@example.com
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