British departure just got even more complicatedby Leopold Traugott / April 23, 2018 / Leave a comment
As Brexit negotiations proceed, it is ever more apparent how many issues they touch upon. But after the joys of learning about the intricacies of trade rules and the passporting of financial services, this explainer deals with a topic which concerns all of us—Value Added Tax. We all pay it, but no one (yet) knows for certain how the UK’s decision to leave the European Union will ultimately impact it. As with most Brexit issues, the answer isn’t clear-cut. Different solutions are possible, each representing their own trade-offs. One thing’s certain—VAT makes exit even more complicated than it otherwise would be.
The UK, like all other EU member states, is currently part of the bloc’s common VAT area designed to facilitate trade between its members. Joining this area was not an option, but a precondition for being allowed to join the EU. This was actually the reason the UK introduced VAT in the first place.
While the EU does not prescribe a fixed standard VAT rate—it varies from 17 per cent in Luxembourg to 27 per cent in Hungary—it sets certain guidelines. There is a minimum standard VAT rate of 15 per cent, and a maximum of two reduced minimum rates of at least 5 per cent that may be applied to a limited set of goods and services. The UK has additional derogations in place allowing it to zero-rate certain products.
As the UK withdraws from the EU and its institutions, its membership of the EU VAT area is up for debate. Should the UK leave it—which treaty law suggests would happen automatically—this would have a range of implications. It would change the way British businesses trade with Europe, but provide greater flexibility for government to alter how the tax operates in the UK. There is already a domestic debate on the vices and virtues of the UK’s current VAT regime, with the government consulting on potential changes it could make to the system within the confines of existing EU law. Meanwhile, the House of Commons’ Treasury Committee under Nicky Morgan is conducting a wider inquiry on the future of VAT in the UK post-Brexit.
EU rules on VAT currently restrict the UK’s ability to offer reduced rates for certain goods and supplies—popular calls for zero-rates or reductions on domestic fuel, children’s car seats and tampons are the most prominent examples of changes possible outside the EU VAT area. Some of these restrictions may disappear soon even within the common VAT area, as the EU is overhauling its rules to grant member states greater flexibility in setting reduced and zero rates in the future. But, outside the EU VAT area, the UK would be free immediately to introduce new VAT bands and zero-rate a larger number of products. This could be used to benefit certain groups but also lead to special pleading from certain industry sectors in search of tax breaks.
Should the UK leave the EU VAT area, this could also add new spice to the devolution debate. The Reform Scotland think tank is already proposing the devolution of VAT-setting powers to Holyrood post-Brexit. Under current EU law, which stipulates that each member state must have universal VAT rates throughout its territory, this would be impossible. Whether the UK government would actually consider this is of course another question.
Meanwhile, British businesses fear that leaving the EU VAT area would weigh heavily on EU-UK trade. No VAT is currently levied on trade within the area: it is only charged when a good is sold to the final customer. If the UK were to leave the EU VAT regime with no other agreement in place, companies could suddenly be required to pay VAT upfront on goods imported from the EU (and vice versa). For around 130,000 British companies, mostly small and medium-sized enterprises, this would be the first time they pay upfront import VAT.
This change would create both cash flow and time burdens, which would be particularly costly for small businesses. It would force HMRC to increase its staff and resources even further. Goods would be held at the border until VAT was paid. This could also mean increased operations on the island of Ireland, putting further at risk the goal of preventing a hard border.
British companies trading across the EU in services would be hit as well. They would need to become VAT-registered in each member state where they operate. At present, being registered in one member state is sufficient to trade in all.
Businesses are already out and about looking for ways to reduce the potential damage. Should the UK leave the EU’s VAT area, the British Retail Consortium, a trade association, has floated the idea of a government-run deferment scheme on import VAT to alleviate cash flow concerns. The decision to launch such a scheme could be taken unilaterally by the British government. Other EU member states, such as Spain, already operate similar schemes for third country imports. It may, however, fall foul of the World Trade Organisation’s Most Favoured Nation rules, which would consequently force the UK to offer companies the same deferment rights on their imports from non-EU countries.
Further ideas to mitigate the consequences of leaving the EU VAT area include increased use of self-assessment for companies, a practice currently encouraged for bigger companies within the EU.
Meanwhile, a cooperation agreement recently signed between Norway and the EU could serve as a model for alleviating some of the problems arising from leaving the common VAT area. It ensures continued close cooperation on combatting VAT fraud and on the recovery of VAT claims.
Upcoming reforms of the EU VAT area itself will remain important. Should the European Commission’s proposal to move from an origin- to a destination-based VAT be implemented, this may even force traders within the area to pay VAT upfront. The comparative costs of leaving would be lower.
It is not entirely clear yet whether, or on what terms, the EU would allow the UK to remain in the common VAT area post-Brexit. The EU’s “backstop” proposal for a common regulatory area on the island of Ireland includes the continued application of parts of EU VAT law for Northern Ireland. Some experts see this as an indication that the EU may be willing to offer the same for the whole of the UK.
So far, the British government hasn’t decided what solution it seeks. While the current draft of the Taxation and Cross Border Bill indirectly suggests leaving the EU VAT regime, a recent report by the House of Common’s EU scrutiny committee assumes the opposite, expecting the Treasury to push for the UK to remain within, or at least closely aligned.
Much lobbying will be done on this issue over the upcoming months. If the UK decides to leave the EU VAT area and take powers back home, these lobby efforts will intensify even further.