Taxing Terms: Value Added Tax

October 10, 2016 by in category Blog tagged as , , , , , , , , with 0 and 47

How Value Added Tax works

Value Added Tax image by Raw Pixel.

Value Added Tax could be seen as the Marmite of indirect taxation, more so given how our economy is service-led. We see it on our consumer goods, in our restaurants, and on our fuel bills. In some cases, it has been used to shift the taxation burden from direct to indirect forms. Image by RawPixel.com (via Shutterstock).

Love it or hate it, VAT is the most reviled and revered form of taxation. Some critics think it is an unfair form of taxation, as the tax burden is shifted towards people on low incomes. Value Added Tax was launched in 1973 by Chancellor Anthony Barber, as a replacement for Purchase Tax. Its immediate predecessor was introduced in 1940 by Chancellor Kingsley Wood. With materials being scarce in the Second World War, and rationing, it was levied on luxury goods. This to dissuade conspicuous consumption during the war years.

Purchase Tax rates began at 33.3% before peaking at 100%. By 1946, it returned to its original figure. With the end of rationing, and the rise of shopping as a leisure activity, high purchase tax rates were counterproductive. Even with the end of Retail Price Maintenance in 1964. Where Purchase Tax varied from Value Added Tax was due to the former being applied at the factory gate. VAT is added on top of the pre-tax retail price.

VAT was launched as part of the UK’s conditions for EEC membership. It replaced Purchase Tax on the 01 April 1973.

Value Added Tax

VAT, or Value Added Tax to give its Sunday name, is what’s known as an indirect tax. The consumer sees VAT as a tax on consumption. In recent years, cuts in direct taxation (Income Tax) have been offset by gradual rises in VAT. Therefore, persons on a low income (who do not earn enough to pay Income Tax) pay most of their taxes through indirect forms.

In 1973, VAT was 10%, before the standard rate was cut to 8% the following year. A further 12.5% rate on luxuries was introduced. This was short lived. In 1979, during Geoffrey Howe’s first budget, Value Added Tax went up to 15% for all purchases. Furthermore, the top rate of Income Tax was cut from 80% to 60%. From the 18 June 1979 to 19 March 1991, Value Added Tax remained the same rate. Norman Lamont’s budget saw VAT rise to 17.5% with the addition of an 8% rate for energy bills. The 8% rate was cut to 5% in Gordon Brown’s November 1997 budget.

After a temporary cut in VAT to 15% in 2008 (and the return of the 17.5% rate in January 2010), George Osborne increased the standard rate of VAT to 20%. This, in October 2016, is the present-day rate.

How VAT is levied

Any business that sells taxable goods and services that equals or exceeds a given taxable turnover threshold has to register for VAT. Since 2015, the Value Added Tax threshold has stood at £82,000 per annum. All registered businesses have to charge VAT on the full sale price of their products or services. Unless the item is exempt from or outside the system. VAT returns have to be filed with the HMRC every quarter.

Registered businesses have to pay over to HM Revenue and Customs the VAT they have charged on their goods and services. This is known as output tax. They may offset this with the Value Added Tax they have incurred on the products and services they have purchased. This is known as input tax.

For businesses with an annual turnover below £150,000, the HMRC has a separate scheme known as the Flat Rate Scheme. They pay a fixed percentage of their turnover every quarter. This was launched to cut red tape for small businesses.

If you run a VAT exempt business, you probably don’t need to register for Value Added Tax with the HMRC. Should the business sell a mix of products and services that are exempt from VAT, or liable for VAT, they can only claim for the latter. On the other hand, some businesses like superstores and bookshops may reclaim VAT on all purchases.

In Brief

  • Launched in April 1973 as a condition of joining the European Economic Community in January 1973;
  • Replaced Purchase Tax, launched in 1940 at the height of the Second World War;
  • Value Added Tax has three basic rates: Standard (20%); Reduced (5%); and Zero (0%);
  • The taxable turnover threshold is £82,000 per annum;
  • Returns are filed every three months.

References

Appendices

Figure 1: Purchase Tax, VAT’s predecessor

From: To: Purchase Tax Rate Chancellor of the Exchequer
21 October 1940 April 1942 33.3% Sir Kingsley Wood
April 1942 April 1943 66.6% Sir Kingsley Wood
April 1943 April 1946 100% Sir Kingsley Wood
April 1946 April 1973 33.3% Hugh Dalton

Figure 2: VAT rates since 1973

From: To: Standard Rate Higher Rate Chancellor of the Exchequer
03 April 1973 July 1974 10% None. Anthony Barber
July 1974 November 1974 8% 12.5% Denis Healey
November 1974 17 June 1979 8% 25% Denis Healey
18 June 1979 18 March 1991 15% Abolished. Geoffrey Howe
19 March 1991 30 November 2008 17.5% None. Norman Lamont
01 December 2008  31 December 2009 15% None. Alistair Darling
01 January 2010 31 December 2010 17.5% None. Alistair Darling
01 January 2011 To date 20% None. George Osborne

Figure 3: Lesser rates and exemptions

VAT Rate Examples of items affected Comments
8%
  • Utility bills.
First VAT rate for utility bills, from April 1994 to November 1997. Was originally going to rise to 17.5% in 1995, but a lost Commons vote put paid to the proposal.
5%
  • Utility bills;
  • Feminine hygiene products;
  • Residential energy, insulation, and renovations.
Present-day VAT rate for utility bills since 1997. Also reduced rate for some essential items.
0%
  • Public transport fares;
  • Books and periodicals;
  • Children’s clothing;
  • New build properties.
Comes under ‘life necessities’.

Peach Wilkinson Accountants, 10 October 2016.

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