VAT rate cut

The Chancellor announced that from 1 December 2008 the standard rate of VAT would fall from 17.5% to 15%. This is the maximum reduction he was allowed to make under European regulations. The UK will now have the lowest standard VAT rate of any major country in the European Union. Germany, for example has a standard VAT rate of 19% and France 19.6%. Ireland recently announced an increase of rates to 21.5%.

The UK reduction is temporary and will be reversed from 1 January 2010. The rate will then increase back up to 17.5% but, at the moment, no further. Legislation is to be announced on 25 November to counter possible tax planning schemes enabling consumers to benefit from the reduced rates on services and goods provided after the increase in rate.

There have been no changes to products and services which currently benefit from reduced and zero-rates of VAT such as food and domestic fuel.

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Effect on consumers and exempt businesses
Effect on businesses
What does a business have to do?

Effect on consumers and exempt businesses

The reduction in the rate is good news for consumers provided retailers pass on the reduced tax rates. It may be possible for consumers also to benefit from the reduced rate even if they have already paid for but not yet received the goods or services. Many items which we all buy are, however, unaffected by the changes.

Business sectors that are unable to recover VAT on the services they receive such as financial services, education and health, will also be major beneficiaries. They too may be able to ask for a refund of VAT already paid on services such as rent which they have paid for periods which span 1 December. Credits for these services must be made by 14 January 2009. Exempt businesses should consider deferring expenditure until 1 December to take advantage of the reduced rates, this would include delaying the payment of services bought in from overseas.

Effect on businesses

The impact of the changes on most businesses will be mixed. There will be the general benefits obtained from the stimulus provided to the economy. Certain sectors will be immediately affected. These include financial services and insurance. They are unable to recover all of the VAT that they incur. A reduction of the VAT charged to them will have beneficial impact on cashflow, as well as providing an overall reduction in costs.

Most businesses, however, are net VAT payers and account for more VAT than they recover on their costs. The VAT that they collect forms a major part of their cashflow. Management of cash is crucial to their survival and wellbeing. Under the UK VAT regime businesses typically pay over the VAT that they collect from their clients on quarterly returns due 30 days after the end of the accounting period. This means provided that debts are collected reasonably promptly the charging of VAT has a positive impact on cashflow. The impact of the lower rate may be to increase pressure on company finances at a difficult time.

Many businesses may also face significant costs in amending their accounting systems to reflect the rate changes, not once but twice in a 13 month period. In fact, the amendments required to systems, pricing and treatment of invoices and credit notes and other documentation is likely to be very onerous on most if not all businesses.

There are number of other implications from the change:

• Importers of goods will face a significant reduction in the VAT charged on goods brought into the UK. Therefore, it is time to review the level of deferment guarantees provided to HMRC
• Businesses are less exposed in the event of bad debts. Should businesses want to claim VAT relief on their debts they will need to be able to identify debts arising pre and post 1 December
• Contracts that are agreed prior to 1 December are adjusted automatically to reflect the change
• Fuel scale charges may require amendment
• Direct sales companies that are affected by special valuation regulations on sales made to their distributors, may need to amend the rate of tax paid.

What does a business have to do?

The change in rate is being introduced from 1 December, just 6 days' time after the announcement. This does not allow much time to amend accounting systems. Many businesses may not be able to comply fully in time to prepare their next VAT returns due, for example on 31 January. It is possible to obtain permission from HMRC for returns to be estimated pending the introduction of the system amendments. This should be considered and done in advance of the submission date.

Businesses will need to consider how they treat services or goods supplied which span the rate change. The rate of VAT chargeable is determined principally by the taxpoint. This is the date on which the tax is accounted. If the taxpoint falls after 1 December the 15% rate will apply irrespective of when the work was done or the goods ordered. It can be created either when an item is delivered or a service is performed, paid for or invoiced. One provision allows the invoice date to be the taxpoint if it is issued within 14 days of delivery. For goods delivered after 18 November it maybe possible to defer the taxpoint until after 1 December and account for VAT at the lower rate. Care needs to be taken if goods are delivered in November but are not invoiced within 14 days.

However, there may be circumstances where taxpoints are created prior to 1 December where businesses can still account for VAT at the lower rate and pass on the saving to their clients or customers. Examples include:

• Services such as rent and software maintenance contracts that are usually invoiced for periods in advance. Where previously issued invoices cover periods that span 1 December the invoices can be credited and replaced with a new ones which charge the post 1 December period at the reduced rate
• Goods that have been paid for and invoiced prior to 1 December but not yet delivered. Existing invoices can be credited and reissued at the lower rates
• Advance payments or deposits paid but services, such as Christmas lunches, delivered after 1 December

Businesses are under no obligation to issue these credit notes. However, if they choose to do so this they must issue the credit note within 45 days of the change of rate ie by 14 January 2009.

Businesses that receive monthly payments such as those involved in leasing may choose to issue one annual invoice instead of twelve. Tax is payable and recoverable as and when each payment is made. These businesses will need to reissue invoices and amend payment arrangements covering the post 1 December period. Clients will only be able to recover VAT on the payments if they possess valid amended invoices.

In general any business issuing credit notes or giving discounts such as volume discounts that relate to supplies that predate the rate change will need to consider whether to agree the VAT is not adjusted.