VAT Rate Cut – Stimulus or suppressor?

As speculation increases that Chancellor Rishi Sunak will look to a reduction in the VAT rate as part of the UK Government’s economic stimulus measures, it is worth considering the potential impact on the economy and on business of a rate change. 

The Economic position 

Using a VAT rate cut as an economic stimulus is not a new idea. Already, the German government has announced a 5% reduction in the VAT rate for the last 6 months of the year. During the financial crash in 2008, the UK VAT rate was cut from 17.5% to 15% for thirteen months. In Scotland, a VAT rate cut is listed as one of the ten principles that should underpin the UK’s fiscal stimulus approach. 

Before Alistair Darling applied the rate change virtually overnight, the argument against a rate change was that it would take several months for businesses to prepare. Whilst the rate changes in 2008 (to 15%), 2010 (to 17.5%) and 2011 (to 20%) were not without some difficulties, businesses were generally able to make the necessary changes quickly and easily. 

The position in 2020 is perhaps more complex than that facing Alistair Darling in 2008; however, the options open to Rishi Sunak are more varied.  Rather than a simple rate change across the board; the options most frequently reported are: 

• a reduction in the standard rate of VAT to 15% across the board; 
• reducing the VAT rate to target activities that require particular stimulus; 
• applying a lower VAT rate to the hospitality and tourism sector. 

However, suggesting a blanket or targeted VAT rate reduction now at the time when the retail lockdown is being lifted may have a counterproductive result. Who’s going to rush out and purchase a new car or flat screen TV today if the press is reporting that the VAT rate will be lower next month?   

Any general reduction in the standard rate is likely to be for a very limited period, in order to encourage consumers into discretionary spending in the knowledge that prices will soon rise. However, does a VAT rate reduction result in lower prices for consumers? There is strong evidence that many retailers retained, rather than passed on, the VAT cut in 2008. As recently as last month, those downloading e-books to their Kindle after the introduction of zero rate on e-publications saw little sign that prices had reduced. Recent research shows that only about half of any VAT cut is passed on to consumers, whereas rate increases are passed on immediately. 

Assuming that the reduction is passed on, what evidence is there that £25 off a £600 flat screen TV will encourage more spending? On its own, the VAT cut is unlikely to trigger significant increased consumer spending. However, the difference between 2008 and 2020 is that consumers appear desperate to get back to the shops. Coupled with advertising and deals from retailers, I consider that the VAT cut will help boost discretionary consumer spending and help the economic recovery. 

Targeted reductions may be more politically acceptable; however, if the history of VAT in the UK has taught us anything, it is that the more targeted you try and make measures, the more complex and potentially open to abuse the VAT system becomes. 

Of the options suggested, the one long overdue in the UK is the reduced rate for the hospitality and tourism sector.  Other than travel and the admission to cultural events, the UK has been reluctant to embrace reduced rates to the extent seen elsewhere in Europe where average rates are 25-50% lower than the UK VAT rates applied to: 

• restaurant and catering services; 
• hotel accommodation; 
• admission to amusement parks; 
• admission to sporting events. 

There is certainly plenty for the Chancellor to consider and, if he were to choose one measure, our beleaguered hospitality and tourism sectors would be a welcome place to start.  

Practical considerations 

Although changes to the VAT rate is not a certainty, we would recommend that businesses consider the impact of a reduction on their VAT reporting processes. In particular, applying the experiences of 2008, we would advise businesses to consider the following issues if there is a temporary reduction in VAT rates: 

• Are your systems set-up to cope with more than one standard rate of VAT during any transition period? 
• How easy is it to change the VAT rate on your systems?   
• If targeted reductions are made, do you have sufficient knowledge to allow relevant products to be amended? 
• If you cannot recover all of the VAT you incur, can you get your suppliers to invoice after the rate change? Before rates then go back up, would you be prepared for them to invoice in advance? 
• If you quote prices inclusive of VAT, how will this affect your pricing and margins?   
• Do your contracts allow for adjustments to reflect VAT rate changes? 
• If your customers cannot recover VAT, will they be looking to defer purchases they were due to make from you, or at least ask you to hold off invoicing for these? How will this affect cashflow? 
• Are you getting the “tax point” right on your sales, so that the correct rate of VAT is applied?  In particular, for “continuous supply” services, how do you treat supplies that span the rate change? 

How can AAB help? 

Our Indirect Tax team has experience of previous VAT rate changes and the issues experienced by businesses. Our team will be able to support you the practical aspects of a rate change. 

If, as rumoured, the Chancellor does cut the VAT rate, considering the above practical issues is a good starting point. However, if you require further information or support, please contact Alistair Duncan, Indirect Tax Director, or your usual AAB contact. 

If you have any queries please do not hesitate to contact, Alistair Duncan, Director and Head of Indirect Tax, or your usual AAB contact.