The way VAT, Customs and Excise duties operate in the UK may change after Brexit. The scale of change will depend upon the outcome of the UK- EU negotiations and whether a transition period is secured.
Value Added Tax (VAT) is a tax on consumer expenditure which is collected on imports and business transactions. Generally, it is levied on goods and services at each stage in the supply chain (output tax) with, typically, a business receiving a credit (input tax) for the VAT charged to it.
The UK was obliged to introduce VAT when it joined the European Economic Community (EEC) in 1973. VAT broadly replaced a purchase tax on luxury goods. The six original members of the EEC had introduced VAT to reduce the distortion of export refunds, which gave member states a potential competitive advantage over one another.
The UK VAT system operates within parameters set by EU VAT directives, a system that only applies to EU member states. Typically EU VAT directives do not apply to members of the European Economic Area (EEA).
When the UK leaves the EU, the presumption is that it will also leave the EU VAT area.
In theory the UK could abolish VAT after Brexit, but in practice it is very unlikely. VAT is a major revenue raiser, forecast to raise approximately £125bn in 2017-18, which amounts to 18% of tax receipts.
The Government’s technical guidance on VAT for businesses in the event of no Brexit deal, published 23 August 2018, indicated that the Government expects that the UK will continue to have a VAT system and believes that the revenue that VAT provides is vital for funding public services.
Additionally, VAT is the IMF’s “tax of choice” and over 160 countries have now introduced it - it accounts for 20% of tax revenue globally. The UK has been party to the internationally agreed standards of the OECD International VAT/GST guidelines and is unlikely to reject this approach.
The UK could, depending on the terms of the final agreement, gain more flexibility on the structure of VAT after Brexit.
The current constraints include:
- The UK can maintain its existing zero rates on items such as food, children’s clothes and shoes, and books, agreed as part of its original accession deal to the EEC. But it cannot create new zero-rated items and if it moves an item out of the zero rate band it cannot move it back.
- There is a prescribed list of goods and services that EU member states can subject to a reduced rate of VAT. This is set at a minimum of 5% with only two reduced rates allowed.
- The minimum standard rate of VAT is set at 15%. There is currently no maximum, but the European Parliament has passed an amendment proposing a cap at 25% (the current highest rate being 27%). The current UK standard rate is 20%.
- Member states cannot levy a rate of VAT that is higher than the standard rate - so the UK cannot, for example, have a luxury goods rate.
The EU has become increasingly concerned that intra-EU trade has become a major source of fraud and it plans to move to a single EU VAT area which would see a fundamental shift in the way VAT is accounted for. Measures have recently been agreed to reform the VAT system,including proposals for more flexible VAT rates. It remains to be seen to what extent the UK will adopt these measures.
The potential flexibility created by Brexit means UK ministers may come under more pressure to lower VAT rates or remove and reform exemptions and reduced rates. This could lead to further complexity and is likely to be politically challenging.
But this flexibility could open the way to more radical reform like a lower standard rate of VAT on everything. For example, the Goods and Services Taxes of New Zealand and Australia apply a single rate of 15% and 10% respectively, with far fewer exceptions. But there would be many potential winners and losers from such reform.
The UK already has a comparatively high registration threshold for VAT at £85,000, which has been fixed until April 2022 whilst the Government consults on the recommendations from the Office of Tax Simplification.
VAT law is interpreted, ultimately, by the Court of Justice of the European Union which is binding on the UK. Post-Brexit, this is likely to change (depending on the deal) and the UK’s courts will need to take account of the CJEU’s decisions. How this will affect the interpretation and direction of the UK’s case law remains to be seen, especially when dealing with general VAT principles that have evolved over several decades.
The big change after Brexit will be how VAT is charged on trade with the remaining EU 27member states. The scale of change will be contingent on the final negotiated outcome.
At the moment, VAT is generally not charged on the supply of goods between businesses from another European country by the supplier. Instead, a business recipient is generally required to charge itself VAT, known as acquisition VAT, which is typically an accounting transaction on the VAT return. There are different rules for private customers and other exceptions. For services, the ‘place of supply’ rules determine the country in which VAT is charged and accounted for.
How will VAT on cross-border goods change?
If the UK leaves the EU VAT area it will become a 3rd country and supplies of goods crossing international borders will become imports and exports; attracting import VAT and customs/excise duties.
The payment of VAT at the border will have potential cash flow consequences which the UK Government proposes to mitigate, in a ‘no-deal’ scenario, through the introduction of postponed accounting for import VAT. This would shift the VAT accounting and payment away from the border to the VAT return. Postponed accounting would also apply to rest of the world imports, not just those from EU countries. HMRC have not yet confirmed if postponed accounting will be available in scenarios other than a ‘no deal’.
Some businesses will also have to make import-export declarations for the first time – a change that may affect between 145,000 and 250,000 businesses who conduct their trade solely between the UK and EU27. A further 73,000 businesses, who trade with both EU and non-EU countries, will now have to make declarations for their UK-EU trade in addition to their non-EU trade. See government issued advice for more details.
EU Member States will require VAT to be paid on importation unless they introduce a deferral mechanism. UK businesses exporting to the EU may need to engage VAT representatives in different countries to comply with EU VAT obligations. Businesses wishing to claim a refund of overseas VAT will no longer have access to the EU VAT Refund Portal, and are likely to face longer waiting periods to be refunded according to Daniel Lyons of Deloitte.
Individuals and overseas businesses will also be affected as the rules for parcels entering the UK will change. The UK Government has indicated in its technical guidance that Low Value Consignment Relief – for parcels valued as £15 or less – will be scrapped on parcels arriving from the EU.
How will VAT on services change?
There has been little detail from the government about how services will be dealt with. The EU VAT rules governing services depend upon the nature of the service provided, who receives the service and the location of the service. Certain rules regarding the export of financial services are under consideration.
UK suppliers of digital services to EU non-business consumers using the EU’s online Mini One-Stop Shop (MOSS) scheme will have to change to the ‘non-Union’ scheme to account for their sales. The MOSS allows non-established service suppliers to file a single VAT return – documenting their sales by Member State of consumption – in only one Member State. This return is then distributed to the relevant Member States so VAT can be levied accordingly. Businesses established in non-EU countries who use the UK for their MOSS VAT return will have to move their MOSS identification to an EU27 Member State to continue using the non-Union MOSS scheme.
What about other indirect taxes?
Customs duty could be greatly impacted. The Taxation (Cross-Border Trade) Act 2018 provides a framework to impose and regulate a UK customs duty regime on the trade of goods, and amend current UK Vat and Excise duty laws, once the UK has left the EU. The CIOT, ICAEW and ICAS have produced a factsheet on the Act here, while the CIOT runs a dedicated Brexit portal.
As well as rates of customs duty, non-tariff barriers such as quotas and rules of origin along with import and export processes and declarations are likely to have a large impact on business if the UK leaves the EU’s customs union.
The EU introduced minimum duty rates on alcohol, tobacco and energy as part of the Single Market in 1993. It also imposed some restrictions on the structure of taxes. The UK may seek to make changes after Brexit to the structure of taxes but this will depend upon the negotiated outcome.
One further consequence of Brexit could be the reintroduction of duty free sales for travel to and from the EU27 member states.
Direct taxes are a matter for member states. The UK has in the past used its veto on tax policy - which still requires unanimity - to prevent any EU incursion into direct tax policy. But it is not just the UK that has concerns about EU action on direct taxes: recent discussions on an EU wide Digital Services Tax failed to make progress after a number of members states raised objections at the December ECOFIN.
However, the European Commission has become increasingly active in recent years, where it thinks member states are using favourable tax regimes as a form of state aid. The Benelux countries and Ireland in particular have been in the firing line. The EU is concerned that Brexit may trigger more aggressive tax competition from the UK. EU Commission slides on a "level playing field" set out some of the provisions it might seek to add to an EU-UK agreement, which would prevent the UK from undercutting the EU on direct taxation. After Brexit, the EU27 may be more likely to proceed with tax harmonisation measures, target tax avoidance in UK Overseas Territories and, once the UK has fully left, it will cease to benefit from some of the limited direct tax measures that have been agreed.
Institute for Government would like to thank Angela Fearnside and Ruth Mace at the Chartered Institute for taxation for their help with this Brexit explained.