Celebrating 50 years of Value Added Tax in the UK

VAT is the third-biggest source of government revenue in the UK, just after income tax and National Insurance contributions. Between 2021 and 2022, VAT provided the UK government with around £143 billion in revenue. 

VAT rates in the UK have fluctuated significantly in recent years, mostly in response to the COVID-19 pandemic, when the standard rate for hospitality, entertainment, and tourism-related services dropped to 5%. As of February 2023, the current VAT rates in the UK are as follows: 

• 20% standard rate
• 5% reduced rate on goods and services such as domestic gas and electricity, some types of medical equipment, and some types of social housing.
• A 0% rate for necessities like food, household water supplies, prescription pharmaceuticals, intra-community/international passenger transport, construction for private dwellings, and women’s sanitary products.

While the UK VAT rates still fall within the EU limitations on VAT rates, following Brexit, HMRC does not have to follow these limitations and may change so that they fall outside of those rules. This is a vital point to remember for any EU business that trades across borders to the UK.

VAT replaced Purchase Tax, which was a consumption tax based on the perceived luxuriousness of various goods. Purchase tax rates were much higher than VAT ones, ranging from 33% to 66%.

Introduced in 1940 to reduce the wastage of raw materials during WW2, Purchase Tax was exclusively levied on luxuries like private automobiles, jewellery, cosmetics, and wireless radios. Still, the exact definition of a “luxury item” was a regular point of contention in the House of Commons.

Following the UK's entry into the European Economic Community, VAT was introduced, and purchase tax was summarily abolished. 

If VAT did not have significant benefits for the government, businesses, and consumers alike, it’s unlikely that it would remain such a key component of the UK tax system for fifty years. VAT has multiple benefits as a form of indirect tax:

• VAT is a very economically efficient tax system, as it has its basis in the consumption of goods rather than rates of pay. Essentially, this means that VAT can raise governmental revenues by unnecessarily charging consumers. Individuals decide their rate of consumption, so they are not passively being taxed in a VAT system.
  
• VAT can be adjusted fairly easily. Rates can be raised or lowered, and different rates can be applied to goods without significant disruption to the overall economy.
  
• The burden of administration is placed primarily on businesses, which benefits the government and consumers. Arguably, businesses also benefit from this, as it increases their awareness of how taxation affects them — in this way, VAT is a fairly transparent system. 
  

The European Union recently released the VAT in the digital age proposal, which looks at how the EU VAT system can be updated to account for new technologies and new ways of working. But what does that mean for the future of VAT in the UK? How might things change?

The Making Tax Digital (MTD) scheme introduced in 2021 is a good indicator of how VAT might change in the next decade. MTD focuses on moving tax documentation online to increase the accuracy of VAT returns and the ease with which they’re created. Additionally, digitising documents benefits businesses and tax authorities by cutting down on physical paperwork and the need for storage space. 

Similar changes in future are likely, with technology and VAT intrinsically linked. Ideas like mandatory e-invoicing and the related concept of real-time reporting are becoming more common in European nations, and it’s possible that the United Kingdom may follow their lead.

While some argue against VAT, it’s unlikely that it will be replaced as the primary indirect tax option in the UK any time soon. It’s popular with the government for its relative simplicity and the amount of revenue it generates, and it’s popular with businesses, too: only 6% of UK companies would see it replaced.

The history of VAT is complex, but tackling VAT regulations as a business can be even more complicated. That’s where Avalara comes in: we provide tailored digital solutions to simplify tax compliance and help your business stay compliant.

Here are just a few of the ways we can help your business overcome even the biggest tax challenges:

• Avatax: Struggling to calculate multiple VAT rates while distance selling? The Avatax platform helps ensure fast, accurate tax calculations at checkout.
  
• Registration: Registering for VAT in another country can be complicated, and doing so multiple times as you expand is even tougher. Our digital solution helps streamline the process.
  
• Returns: Providing accurate VAT returns is crucial to compliance, but creating them can be time-consuming. Our Returns and Reporting tool helps you cut down on the time you spend creating VAT returns and helps ensure they’re error-free. 
  

If you’re interested in hearing more about VAT, why not attend the ICAEW VAT at 50 conferences on the 30th of March? 

At the conference, a huge range of experts will discuss vital VAT topics, such as the intersection of tax and technology or how businesses and governments can simplify the VAT system. As we mentioned above, our own VAT expert Alex Baulf will also be contributing during the all-day event. 

Finally, be sure to check out some of Avalara’s additional resources on VAT. We have various whitepapers and webinars that can help you become a VAT expert, including our new Guide to Cross-Border VAT.