VAT Rates—How Important Are They?

There are currently strong calls in the U.K. for a reduction in the rate of value-added tax (VAT) applied to utility costs, despite such a request being voted down by the government. Inflation has just hit 5.4% and there is strong growth in the overall cost of living, so it makes sense in theory to counter some of the impact by lowering the tax on relevant costs. While it would not be a huge change, downwards to zero from the existing 5%, there would be some impact.

Whether this specific rate decrease assists the right group of people, however, is a debatable point, and there have recently been strong arguments put forward for the rate to stay at 5%. It is probably for this reason though—the strong arguments between political and economic benefits—that VAT rates in general have remained relatively static. However, recent changes by the EU, and the U.K.’s exit from the EU, have opened a door, and we may now see significant change happen in the near future.

History of VAT Rates

The EU’s VAT legislation (this is relevant to the U.K., as until last year those rules applied, and there has been little change since) was written with prescriptive rules setting out the rates that member states could apply and the supplies for which they could be used. For example, the standard rate of VAT could be no lower than 15% while reduced rates must be at least 5%. There were some exceptions that allowed for specific rates of VAT to be carried forward when countries joined the EU: The U.K. having zero rating provisions whilst most of the EU does not is such an example.

For many EU governments, these rules were convenient to help manage requests to change rates. It was easy to put the blame at the EU’s door, citing the restrictive VAT laws set by the EU as a reason to not do anything. This was an argument flipped around in the U.K. during the Brexit referendum, with the Leave campaign stating they would reduce VAT on tampons and utilities if the U.K. left as the power to do so would then be available. We will come back to this.

New EU Rules

There have been some updates to the EU law on VAT rates in the recent past. One example was the unilateral move by many member states to apply reduced rates of VAT to online versions of printed matter (i.e., digital newspapers). This was done to mitigate the different rates applied to physical and online copies of, in effect, the same products. With so many countries changing their rules without permission from the EU, the VAT Directive was amended. This change was made, in effect, as a result of external pressure for the rules to reflect modern supply chains and methods of consumption.

Further steps have now been taken, and in December 2021, draft legislation was presented to the EU Parliament to allow member states greater scope to set their own VAT rates. The list of supplies to which a reduced rate can be applied is to be increased, and member states will also be allowed to make some supplies subject to the zero rate. This should give countries the flexibility to set rates in line with their local objectives—but also prevent accusations of the EU blocking such changes.

Helping the Environment

The new rules set out above should come into effect from the end of March 2022 for member states. This immediate change will see added to the list of supplies which can benefit from reduced rates those that protect public health, that are good for the environment, and that support digital transition.

Over time, however, there will be further changes to ensure that reduced rates (including 0% rates) cannot be applied to supplies which are deemed detrimental to the environment and the EU’s climate change objectives. The hope is that this nudges consumption towards items that are better in these areas, on the basis that they should be cheaper compared to more environmentally damaging products.

This is an interesting development and approach to take when considered in light of Greenspace (UKUT 0290), a recent U.K. Upper Tribunal case. Here the taxpayer had installed roof panels where the top was aluminum, but the underside insulated material. The panels were installed in conservatories to help better manage the temperature within. Greenspace had accounted for VAT at the reduced 5% rate, on the basis that there was a qualifying installation of energy saving materials. However, the U.K. tax authority, HM Revenue & Customs (HMRC) argued that instead a supply of installing a roof had taken place and hence VAT at 20% was due. HMRC won its argument and the taxpayer has been left with a 2.5 million pound ($3.34 million) bill as a result.

It must be noted that the U.K. government had previously tried to allow for the application of this law to be wide ranging, but rulings from the Court of Justice of the European Union had forced the government to narrow the approach. That said, given the case was heard after the U.K. had agreed to leave the EU it is surprising that HMRC was not instructed by the government to “drop” the matter on the basis that the insulation was a good environmental step. This is especially the case given it was acknowledged by HMRC and the court that had Greenspace installed just the insulation into the existing roof, the 5% rate would have applied.

What Will the Future Bring?

With the U.K. now having left the EU, it is free to set its own VAT rates as it chooses. This means that, if so desired, VAT could be cut on supplies of domestic fuel—there would be a cost to the Treasury of approximately 1.7 billion pounds, while each U.K. household would enjoy a 90-pound saving (if passed on). The government could also widen the scope of the reduced rate for energy saving products and services, to encourage their consumption. These actions would also help a pro-Brexit government demonstrate some tangible benefits, albeit slightly diminished in light of the EU’s recent steps.

The risk, however, is that once a change to the VAT rate for a particular supply is made, it potentially leaves a government open to persistent lobbying by many groups for rates on other supplies to be changed. Resisting such calls may become more difficult as time passes, and for both the U.K. and EU member states, it will no longer be possible to blame the EU.

It is clear that some rate changes would be beneficial in trying to encourage behavioral changes and help achieve policy objectives, with the environment being a clear example. However, it is also to be expected that reducing any rate will be fiercely rebuffed due to the cost and in some cases, blunt policy objectives. VAT on utilities is a good example of this, in that—while a reduction would be politically beneficial—it does not result in a targeted uplift (i.e. everyone, poor and rich, benefits) and also costs a significant amount.

Changes to VAT rates also bring complications to businesses, especially when trading across multiple territories. Countries that have the ability to set their own rates across many more supplies will only add to the burden of trying to apply the right VAT rate to a supply. That inevitably leads to higher costs, which nearly always are passed to the consumer.

It is almost certain that there will be some changes as countries embrace the possibility of enjoying this new opportunity. Businesses will need to stay abreast of this to ensure they know what the right rate is and have processes in place to apply that. As for the impact on national treasuries and consumers, we will have to wait and see.

This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Rob Janering is a VAT Partner at Crowe.

The author may be contacted at: rob.janering@crowe.co.uk