This year marks 50 years of VAT in the United Kingdom. Although the VAT implementation date (April 1, 1973) coincided with All Fools’ Day, the Chancellor of the Exchequer at the time, Sir Anthony Barber, was rather serious when he made a bold statement that “VAT will be a simple tax on the supply of goods and services”. Despite the initial intention to keep the VAT system “simple”, it soon became clear that a simple tax might not be well suited to handle complex dealings in the increasingly digitalised and interconnected economy. As the tax was catching up with new business models and commercial practices, the regulatory framework was growing in size and complexity. Nearly 30 years after the introduction of the U.K. VAT system, Lord Justice Sedley summarised it as follows: “Beyond the everyday world … lies the world of VAT; a kind of fiscal theme park in which factual and legal realities are suspended or inverted”.
As we celebrate 50 years of VAT in the U.K., it’s worth reflecting on some of the most memorable developments in the history of the tax. There is no better source of VAT idiosyncrasies than the VAT rate system as interpreted in numerous court judgments and rulings. Just like many other countries, the U.K. applies a standard VAT rate (20%) and two reduced rates (5% and 0%) to make basic necessities such as food more affordable for low-income people. However, the way the reduced rates are administered and interpreted feels more like a walk in a “fiscal theme park” than a logically designed system guided by sound principles.
U.K. VAT intricacies
Under U.K. law, VAT on cakes and biscuits is 0%. However, if a biscuit is partly or wholly covered in chocolate, it must be taxed at the standard rate. This weird rule led to a high-profile dispute between the U.K. tax administration (HMRC) and McVitie’s about the classification of Jaffa cakes (spongy cookies layered with jam and coated with chocolate) that McVitie’s manufactured. HMRC unsuccessfully argued that in spite of its name, Jaffa cakes were actually biscuits, and because they were partially covered in chocolate, they should be subject to VAT.
Another weird U.K. VAT rule says that potato crisps are subject to 20% VAT, but maize- and corn-based snacks attract no VAT at all. Procter & Gamble lost an appeal against HMRC when it tried to classify its Pringles crisps as a maize-based product because the Court of Appeal ruled that the potato flour was Pringles’ largest single ingredient. It didn’t matter that the potato content was less than 50%.
Even the size of a product may be crucial for the tax-rate determination. Last year the First-tier Tribunal concluded in an eight-page ruling that oversized marshmallows should be VAT-free, although normal marshmallows are subject to a 20% VAT. The fact that oversized marshmallows were particularly suitable for roasting justified this different treatment. Another court case considered whether protein-rich flapjacks could be treated as cakes and therefore zero rated for VAT purposes, or were a confectionery item and therefore subject to 20% VAT. The court ruled that the flapjacks under consideration were not cakes because they were not baked and contained significant amounts of protein.
Flapjacks are a very tricky product when it comes to VAT rates. In its detailed guidance entitled, “The bounds of confectionery, sweets, chocolates, chocolate biscuits, cakes and biscuits: The borderline between confectionery and cakes,” HMRC investigates flapjacks versus other food categories and observes:
It is our policy that there is a difference between flapjacks and cereal bars. This policy development arose because, at the inception of VAT, flapjacks were widely accepted as cakes, and cereal bars were not widely available, if at all… It is difficult to draw a borderline between the two products, as flapjacks could easily be viewed as cereal bars. However, the above policy is, we believe, fair and reasonable.
Fair? Reasonable? The tax treatment of food can be hard to swallow. But nonsensical VAT rules apply not only to food. If you are planning to sell fur items, HMRC has prepared a flowchart that will help you identify which tax rate to apply. Once you answer ten questions, you will know that if your item is made from goatskin, no VAT will apply. However, if the goatskin originates from Mongolia, Yemen or Tibet, you must charge 20% VAT. I doubt whether Mongolian goats are aware of their special status under the U.K. VAT law.
Elsewhere in Europe
The U.K. is not the only country where the VAT rate system defies common sense and is sometimes immune to any logical explanation. E.U. countries have equally bizarre regulations and case law. In Germany, guinea pigs are taxed at 19% but rabbits benefit from a reduced rate (7%). And in the famous “Subway” case, the Irish Supreme Court ruled that the bread used by the restaurant chain Subway wasn’t actually bread and didn’t qualify for the VAT zero rate that generally applies to bread. According to the Court, the key factor that determines whether bread is bread for VAT purposes was the sugar content. And that was too high in Subway’s bread.
Outlook
VAT was heralded as a “simple tax” when introduced on the All Fools’ Day in 1973, but has proved to be anything but. While VAT has adapted to changing economic conditions, it has also given rise to disputes over marshmallows, spongy cakes and flapjacks. While we all agree that it does not make much sense for courts and tax officials to spend time and taxpayer money discussing how to eat cakes or roast marshmallows, there isn’t any indication that rate-related nonsense will stop anytime soon. As the U.K. VAT enters its second half-century, its idiosyncrasies and weirdness will continue to entertain us.
The opinions expressed in this article are those of the author and do not necessarily reflect the views of any organisations with which the author is affiliated.
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