VAT or Value Added Tax is a form of consumption tax which is an increasingly prevalent source of revenue for governments across the globe. Over 175 countries currently have implemented VAT or its equivalent GST (Goods and Sales Tax).
In the UK, VAT is the one tax that is suffered by every single person in the country. Unlike some other taxes, it is a relative newcomer. For instance, taxes on income and business profits date back to 1799; inheritance tax (in the guise of its forerunner, Death Duty) to 1796 and stamp duty all the way back to 1694. Even Johnny-come-lately taxes like National Insurance predate WW1. VAT, however, only dates to the 1950s.
So when, and how, did it come about?
A brief history of VAT
A system of VAT was initially conceived by the Germans in the aftermath of WW1 but was first implemented by the French in 1954 in its then-African colony of the Ivory Coast. It was so successful that it was rolled out to France-proper in 1958.
By that stage, the other five members of the EEC (Germany, Italy and the Benelux countries) were operating variations of sales taxes and which were cascade taxes in nature. Cascade taxes are those applied at every stage in the supply chain, without any deduction for the tax paid at earlier stages. Any supply chain longer than two participants means that the real amount of tax included in the final price of a particular product is obscured and impossible to determine. Why was this bad? Firstly, there was always the risk that EEC countries would – deliberately or accidentally – subsidise exports by overestimating the taxes refundable on exportation. Secondly, it created an artificial incentive for vertical integration, thus reducing the tax-take in the intermediary stages. Finally, vertical integration can lead to monopolisation of the markets, so was anti-competitive.
VAT schemes, on the other hand, solve all three of those problems. The deductibility of tax paid at each level of the supply process means that the actual amount of tax paid (only on final sale) is known; nothing is gained tax-wise from vertical integration and therefore monopolies are avoided and competition protected.
This led to the EEC First Directive in the late-1960s which replaced the existing multi-level sales taxes operated by the other member states with the VAT system operated by the French. Henceforth, every new member would be compelled to follow suit.
The UK’s experience
The UK had been operating its own consumption tax since 1940. Rather than going down the route of the sales taxes preferred by the other EEC members, the UK adopted a purchase tax, applied at the point of manufacture, not sale. The reason for this was to avoid wasting precious resources at a time of conflict (WWII) and the tax was levied at different rates depending on the individual goods’ “luxuriousness”. As WWII progressed, the main rate increased, peaking at 100% in 1943, before falling to 33⅓% immediately after the war. By 1973, the rate of Purchase Tax in the UK was 25%. Purchase Tax was abolished upon the UK’s accession to the EEC on 1st January 1973 and replaced by VAT, which was initially set at 10%.
Because prices already bore some element of consumption tax, the move to VAT was not as big a shock as it was perhaps for countries like Spain: when they acceded to the EU in 1986, VAT resulted in an immediate price hike on Day 1, as they had not previously had a consumption tax in any form whatsoever.
So, what is VAT?
VAT is a general tax which applies in principle to all commercial activities involving the production and distribution of goods and provision of services. It’s a consumption tax because it is borne ultimately by the consumer. It is not a charge on business. Because it is charged as a % of price and collected fractionally, the tax burden is visible at each stage of production. Because it is not paid by the buyer to the government directly, but is routed via the seller, it is an indirect tax.
Is it a good tax?
That is a matter for conjecture! It’s certainly important to UK government finances, as it is the second largest revenue generator for the Treasury, after Income Tax, representing around 21% of government receipts.
As a tax it is efficient, being relatively simple to administer. Because it’s based on consumption, rather than income or profit, it’s relatively stable as a revenue base, which is why it tends to work very well in those countries with less stable economies, and why it is so prevalent throughout the world.
VAT is egalitarian, in that it affects most business sectors and is “suffered” by every single person in the country to one degree or another. Its egalitarianism is also its major weakness; because it is levied on everyday purchases, like adult clothing, fuel, domestic heating costs and snack foods, it absorbs a greater proportion of the disposable income of the poor (around 11% according to the Office for National Statistics) than the rich (around 5%) and is therefore seen by some as being regressive in nature
What is certain, however, is that the impact of VAT on the poorer sections of the economy could have been much worse, had the Heath Government not negotiated the zero-rating of certain essential supplies like:
- Basic foodstuffs
- Medicines
- Household water supplies
- Sewerage supplies
- Books, newspapers and periodicals
- Passenger transport by bus, boat, train and plane
- Children’s clothing
A lot of the above goods and services are subject to VAT elsewhere in the EU, albeit at reduced rates. The UK also has the most generous registration threshold for VAT in the EU at £ £90,000, increased from £85,000 in the Spring Budget 2024 as a measure to assist smaller business. It permits some goods and services to be secured VAT-free.
VAT Rates on Goods
- Standard Rate (20%): Applies to most goods and services, including electronics, clothing (except for children), and alcohol.
- Reduced Rate (5%): Applies to specific items, such as children's car seats, sanitary products, and energy-saving materials.
- Zero Rate (0%): Applies to essential items, including most food, books, and children's clothing.
- Exempt: Some items are not subject to VAT, such as insurance, finance, and property transactions
The future of VAT in the UK
In the aftermath of Brexit there was a faint hope by some that VAT, being a European Economic Commission construct, might have been dispensed with. However, as it generates such a large proportion of Treasury income, it is obviously here to stay.
As with other areas of taxation, the future of VAT in the UK is focussed on full digitisation. In line with Making Tax Digital, the government’s initiative for tax records to be managed digitally and submitted to HMRC via compatible software, the aim is to have real-time VAT reporting by 2030. As part of this, there are plans to mandate electronic invoicing for all VAT-registered businesses by 2029. All these measures are intended to increase efficiency and reduce fraud.
Another possible change to look out for is Green Taxation – introducing reduced VAT rates for green energy products to meet environmental targets.
The information provided in this blog is for general informational purposes only and should not be considered professional advice. As far as we are aware, the content is accurate at time of publication. Torgersens assumes no responsibility for errors or omissions in the content or for any actions taken based on the information provided.
.jpg)
.jpg)
