With marshmallows and VAT, size matters — Wacky Tax Wednesday

It’s become an annual tradition in our household to binge “The Great British Baking Show” over the holidays. Maybe that’s why funny, food-centric British tax laws are on my mind.

How does the UK tax food?

Instead of a sales tax, the United Kingdom imposes a value-added tax (VAT) on most products and services.

There are three VAT rates in the U.K.:

  • Standard rate (20%)
  • Reduced rate (5%)
  • Zero rate (0%)

The zero rate applies to most food for human consumption — what we in the States might call food ingredients or food for home consumption. Examples of zero-rated foods include raw meat and fish, fruit and vegetables, and cereals and nuts.

However, some food is subject to the standard rate of 20%. Examples of standard-rated foods include ice cream, potato chips, and some confectionery. Catering, restaurant, and takeaway food is also taxed at the standard rate.

HM Revenue Customs (HMRC) does its best to provide clear guidance for businesses along with numerous examples of standard-rated and zero-rated foods, but it isn’t easy. There are just too many nuances to include every possibility, so questions and controversies sometimes arise.

For example, if you had to guess, would you say a marshmallow is subject to the standard rate or the zero rate? What about an oversized marshmallow sold to be skewered and roasted over a fire?

Mega marshmallows = mega tax bill

According to the HMRC, “standard-rated confectionery includes chocolates, sweets and candies, chocolate biscuits and any other ‘items of sweetened prepared food which is normally eaten with the fingers.’” The tax agency’s online guidance gives “marshmallow” as an example of standard-rated confectionery.

However, HMRC also notes that a product sold for use as an ingredient in home cooking or baking can, in some circumstances, be zero-rated.

So, what’s a business in the marshmallow industry to do?

One “wholesaler of American sweets and treats” decided its Mega Marshmallows were zero-rated. HMRC disagreed. In August 2019, HMRC assessed the business £472,928 in value-added tax on supplies of Mega Marshmallows for the periods between June 2015 and June 2019.

The company appealed, as companies often do, and in September 2022, the First-Tier Tribunal issued a nine-page ruling. This wasn’t an open-and-shut case.

The ruling lists a number of factors suggesting the product should be categorized as standard-rated confectionery, including:

  • The product can be eaten as a snack from the bag
  • The packaging identifies the product as a product which may be consumed as a snack
  • The product’s generally eaten with the fingers, either without roasting or once roasted and allowed to cool down

Yet the ruling also lists factors suggesting the product “is not properly characterised as confectionery,” including:

  • Items intended to be subject to a further cooking process would not be expected to fall within the term confectionery
  • The packaging holds it out as primarily intended to be roasted and it’s typically displayed in the barbecue section of retail stores
  • As a seasonal product, the product is enjoyed more in the summer months than regular marshmallow products, demonstrating that customers do tend to roast the product

The tribunal took these and other factors — including where the product is placed in supermarket aisles — into account. And in the end, it decided that the product must be zero-rated.

Size matters, at least when it comes to taxing marshmallows in the U.K. Like their outsized counterparts, mini marshmallows “held out for sale as a baking product” also tend to be zero-rated. However, regular-sized marshmallows and those “held out for snacking” are generally subject to the standard (20%) rate.

The tax man can catch the gingerbread man

Like marshmallows, different types of gingerbread can also be taxed differently in the U.K.. To wit:

  • The zero rate applies to slab gingerbread
  • The standard rate applies to gingerbread men decorated with chocolate “unless this amounts to no more than a couple of dots for eyes”

According to HMRC, most traditional bakery products (e.g., bread, biscuits and cakes) are zero-rated. That explains why slab gingerbread, which tends to be breadlike or cakelike, qualifies for the zero rate.

HMRC goes on to note that the following confectionery is standard-rated:

  • Biscuits wholly or partly covered in chocolate (or products similar in taste/appearance)
  • Sweetened prepared food, other than cakes and non-chocolate biscuits, that’s normally eaten with the fingers

A line has to be drawn somewhere, I suppose. But one wonders whether the standard rate applies only to chocolate-decorated gingerbread men or to all chocolate-decorated gingerbread people (or animals or shapes, for that matter). Also, what if the gingerbread people have chocolate bits for eyes plus a few chocolate buttons and trimmings? Is that enough to tip the scale toward taxation?

Bizarre anomalies with VAT on food and drink

The absurdity of such distinctions is frequently highlighted by economists and politicians interested in simplifying the VAT system. After trotting out the gingerbread example and “other bizarre anomalies with VAT on food and drink,” Anthony Browne, member of Parliament (MP) for South Cambridgeshire, quipped, “How we have all laughed over the years at the crazy VAT system on food.”

Such bizarre anomalies may be entertaining for the casual bystander. I get a kick out of them, and they can be a fun bit of trivia or conversation fodder at holiday parties. But, they can be a source of tax compliance pain for businesses.

Automating tax compliance can help eliminate the pain.

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