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ICAEW REPRESENTATION 79/17 TAX REPRESENTATION

OFFICE OF TAX SIMPLIFICATION REVIEW OF VALUE ADDED TAX ICAEW welcomes the opportunity to comment on the Review of Value Added Tax call for evidence published by The Office of Tax Simplification on 28 February 2017. This response of 20 July 2017 has been prepared on behalf of ICAEW by the Tax Faculty. Internationally recognised as a source of expertise, the Faculty is a leading authority on taxation. It is responsible for making submissions to tax authorities on behalf of ICAEW and does this with support from over 130 volunteers, many of whom are well-known names in the tax world. Appendix 2 sets out the ICAEW Tax Faculty’s Ten Tenets for a Better Tax System, by which we benchmark proposals for changes to the tax system. We should be happy to discuss any aspect of our comments and to take part in all further consultations on this area. On 17 May 2017, ICAEW hosted a webinar presented by Nigel Mellor and Paul Morton of the OTS to our members. On 5 July 2017 we invited representatives from the OTS to attend our VAT and Duties SubCommittee meeting, in which we were able to put forward some key comments and concerns and discuss aspects of the call for evidence.

Contents Paragraphs Major points Simplifying the tax system in the run up to MTD and Brexit VAT registration limit Summary of other key points on the specific questions raised

1–3 4–5 6 – 17 18 – 122

Responses to specific questions Solving the VAT cliff edge problem

Appendix 1

Ten Tenets for a Better Tax System

Appendix 2

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ICAEW tax representation 79/17: Office of Tax Simplificatio n review of Value Added Tax

MAJOR POINTS Simplifying the VAT system in the run up to MTD and Brexit 1. This is a good time to be looking at VAT simplification with:  Brexit under negotiation, and  Making Tax Digital being planned. 2. However, it is arguable that to make further VAT changes now would be more difficult because of the above, than they would be at a time when other significant changes were not also being made, even if the changes were aimed at simplifying the tax. 3. Given the above we are very concerned that there is not enough time to consider VAT simplification measures properly before the introduction of MTD for VAT. Software developers will also need time to implement changes. We therefore caution against making major changes to the VAT rules in this period. VAT registration limit 4. VAT was introduced in 1973 as a ‘simple tax’. The original VAT registration threshold was £5,000 which, if indexed at RPI since then, would result in a VAT threshold of about £50,000. However, since its introduction, VAT has become vastly more complicated to administer (even if the actual return is relatively simple) and is a significant burden that falls disproportionately on smaller businesses. In the 1990s the Government sought to address this problem of increased complexity and burdens by raising the VAT limit materially, thus lifting more smaller businesses out of the VAT system. The VAT registration threshold is in practice a major simplification measure for smaller businesses and we believe it should be retained at its current level or consideration be given to increasing it further, perhaps with measures to ease businesses into the VAT to avoid the ‘cliff edge’ effect – see below and Appendix 1. 5. In the poll we did during the OTS webinar on 17 May 2017, viewers voted for keeping the registration threshold where it is or increasing it. While not a statistically valid response, it does support the conclusion that people see potential problems if the threshold is reduced. Summary of other key points on the specific questions raised Multiple rates 6. As a general principle, complications arise when the VAT liability of a supply can be changed by the nature or status of the customer. In many cases, the difficulties could be overcome by allowing the customer to recover VAT charged to it. Other examples of areas where the VAT liability of a product is unnecessarily complex in itself are food, printed matter, financial services and children’s clothing. Consideration should be given to a significant simplification of the legislation in these areas 7. To a large extent many of the “boundary” difficulties will remain so long as different VAT liabilities remain a feature of the system. To take the case of food, there are many products available in the UK today that were not available when VAT was introduced in 1973. It may be possible to allow the definitions of particular products to be agreed with trade associations covering those particular products. Partial exemption 8. Partial exemption can arise in almost any business and the abolition of exempt supplies would be a major step on the road to VAT simplification. Consideration should be given to reintroducing the disregard for the sale of a habitually occupied property. It is questionable whether a partial exemption method should require approval and we believe this could be left to the business to determine. 3


Option to tax 9. There are possible merits in which all property is taxable unless an election to opt out is exercised, but such a system also has a number of difficulties. HMRC should consider introducing an electronic system to notify options to tax, with instant acknowledgements being automatically sent. Capital goods scheme 10. Consideration should be given to removing this scheme or limiting it to property purchases only. Consideration should also be given to increasing the thresholds and basing them on the value to the VAT incurred rather than the purchase price. Flat Rate Accounting Schemes 11. If the general VAT system could be simplified, then some special schemes are likely to become obsolete and could be withdrawn. MTD is also likely to reduce the need for some schemes, in particular the annual accounting scheme and the flat rate scheme. Retail schemes 12. We believe that although modern accounting software has been widely adopted, there are still many small businesses that do not have access to this. We do not see any advantage in asking businesses to send information directly from the till to HMRC and do not see how it could be regarded as a simplification. Tour Operators margin scheme 13. The use of the scheme could be limited to those businesses that are classified as tour operators. It may also be worth considering the use of TOMS on an optional basis. Annual Accounting Scheme 14. Consideration should be given to discontinuing the annual accounting scheme when MTD is introduced for VAT. VAT administration 15. VAT guidance often lacks sufficient detail to enable businesses to rely upon it, or to find the answer to specific queries. This results in resource intensive and potentially unnecessary enquiries to HMRC. VAT penalties 16. Penalties can be disproportionate, for example a default surcharge applying to a large payment that was made only a few days late. If a VAT return has been used to correct an error that was not deliberate, it should be automatically treated as having been voluntarily disclosed. Formal ruling system 17. Transfer of a business as a going concern is the area where rulings are probably most required.

RESPONSES TO SPECIFIC QUESTIONS 1: Identifying the implications of the level of the registration threshold 1.1. Why are businesses below the VAT threshold registering – how does that 44% break down? 18. VAT registration increases administrative requirements, exposes a business to an additional raft of potential penalties for non-compliance and can adversely affect profits if the business is unable to increase its prices to include the additional 20% price increase for VAT. These consequences must be considered where a small business decides to register below the VAT threshold. 4


19. The most common reasons for registering voluntarily for VAT are:     

To reclaim VAT on inputs, particularly where all the business’ customers are mainly VAT registered anyway and able to recover VAT incurred, or where the supplier’s products are zero-rated To give the impression of being a larger and more substantial business Because the business is growing, it is easier to register voluntarily than to keep reassessing whether turnover has exceeded the limit Prior to the introduction of the limited cost trader classification, some businesses gained a small financial advantage by registering under the flat rate scheme Some businesses within the EU require UK businesses to be VAT registered before they will trade with them.

20. Registration also carries with it the need to keep accounting records more up-to-date so improves a business’ record keeping, although this on its own is unlikely to prompt voluntary registration.

1.2. What would be the impact of raising the threshold significantly? With and without the option for voluntary registration? 21. The impact of raising the registration threshold would reduce the administrative burden of the tax for smaller businesses which would no longer need to file VAT returns. For those affected by partial exemption or more complex VAT issues, this would be particularly significant. As there is no VAT registration threshold for non-established businesses this would give UK established businesses supplying customers in the UK, such as on-line retailers, a more significant advantage when setting prices of consumer goods and services than their overseas competitors. 22. If the threshold was raised without the option of voluntary registration, there would be an increase in costs for those businesses that are no longer able to register in order to recover VAT on their inputs. In industries such as financial services and supplies to customers outside the EU, they currently attract input tax credit provided the supplier is VAT registered. If that benefit were to be removed, that would place such suppliers at a disadvantage relative to their overseas competitors supplying services to customers outside the EU. 23. If voluntary registration were no longer possible, there would be significant transitional problems for those who were already registered (including to existing capital goods scheme calculations), but who were below the limit. It would be likely that those businesses would need to be allowed to continue to be VAT registered. 24. Raising the VAT threshold would not remove the problems for businesses considering the need to register, either compulsorily or voluntarily, but merely moves the bar to a different level. There would continue to be distortive effects to the economy due to the “cliff edge” effect, but at a higher level of turnover and therefore affecting fewer businesses.

1.3. What would be the impact of reducing the threshold significantly? How would HMRC and businesses who were brought into the VAT net manage? 25. The high VAT threshold is in practice a major tax simplification for smaller businesses. As noted the original VAT registration threshold was £5,000 which, if indexed at RPI since then, would result in a VAT threshold of about £50,000. But the complexity of VAT, and the associated admin burdens and costs, have continued to increase and impose disproportionate costs on smaller businesses. It was for this reason that in the early 1990s the Government 5


raised the VAT limit materially, thereby lifting many more smaller businesses out of the VAT system. The current Government is also concerned not to impose further burdens on smaller businesses and also increase growth. If the threshold is lowered it would appear to just add more burdens on those businesses least able to cope with it and stifle growth, which is the opposite of what a simplification project should be recommending. We recommend that consideration is given to the cliff edge effect and how it could be mitigated, which might be easier to achieve if and when we are no longer subject to the EU VAT directives. 26. For very small businesses selling to the public, the additional 20% on selling prices would mean higher prices. Consequently, if the business had to reduce its own margins, a higher volume of business would be needed to become profitable. By not forcing a business to register for VAT during its low income start-up period, the VAT registration threshold effectively helps business to become established, thereby helping to contribute to growth. 27. Reducing the VAT registration threshold could therefore reduce the success rate of start-up businesses selling to non VAT registered customers, unless a compensating factor were to be introduced to mitigate the effect on those affected businesses.

1.4. In both cases what would be the impact on economic activity? 28. When a business crosses the registration threshold, it pays VAT on its entire turnover, not merely the excess over the thresholds. Unless the business is able to add 20% VAT to the prices it charged to its customers and see no change in its underlying sales, a situation which in practice is likely to be unusual, it will have to absorb some or all of the VAT charge and accordingly the businesses’ net turnover will fall, subject to recovery of any input VAT on purchases which would otherwise not be recoverable. 29. This means that crossing the threshold is disadvantageous until the turnover increases sufficiently to absorb the VAT on the first £85,000. With an £85,000 threshold, the VAT exclusive turnover falls below £85,000 until turnover increases to £102,000 (see Appendix 2). We have also set out in Appendix 2 a suggested approach to ease the ‘cliff edge’ effect of exceeding the VAT registration threshold. 30. The flat rate scheme currently affords small businesses some relief insofar as they are only required to account for a flat rate percentage of their turnover as output tax. These rates are less than the standard rate of VAT. However, as noted above, the Government has recently acted to reduce the benefits of the flat rate scheme for limited cost traders. One area which could be examined would be the extension of the flat rate scheme concept and a reduction in the rates of tax payable for smaller businesses so as to compensate for the impact of a reduction in the VAT threshold.

1.5. Are there any other approaches that could simplify the regime? Does Making Tax Digital (see below) have an impact? 31. MTD for VAT should in principle help to lead to administrative simplification but the proposed imposition of digital record-keeping and quarterly reporting for most businesses will result in greater admin complexity and costs, especially for smaller businesses below the VAT threshold. We very much welcomed the recent announcement that businesses trading below the VAT registration limit will not be required to keep digital records by April 2019 and believe that this position should be placed on a longer term footing pending the successful roll-out of MTD. 2. Multiple rates: Causes of complexity?

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2.1. Where are the categories that most give rise to boundary issues and so complexity for traders? 32. As a general principle, complications arise when the VAT liability of a supply can be changed by the nature or status of the customer. Examples include:   

Charcoal – where the supply is subject to 5% when sold to the end user or 20% otherwise. Advertising – can be zero rated for certain supplies to charities – otherwise standard rated. Property and construction services – there are many examples of where the status of the customer affects the VAT liability.

33. In many cases, the difficulties could be overcome by allowing the customer to recover VAT charged to it, so that there would be no benefit in having different VAT treatments on the sale. 34. Perhaps the most obvious example of this would be charities, where many specialised and specific exemptions would become obsolete and could be removed if the charity could recover the VAT charged to it. In cases where a charity was not registered for VAT, there could perhaps be a mechanism for them to recover the VAT, akin to the systems for claims by parish councils or the DIY house builders scheme. 35. In the case of charcoal, it is difficult to see what VAT loss there would be if all sales of charcoal were subject to VAT at 5%. Where the sale was not to an end user, the purchaser would normally be able to recover the VAT incurred, be that at 5% or 20%, so why complicate the issue? 36. Another category of supply which gives rise to uncertainty is the determination of whether a transaction is made up of one composite supply or multiple separate supplies. The recent litigation in the case of Wheels Private Hire Limited 2017 UKUT51 (TCC) illustrates the difficulties faced by business and the courts in determining the way the VAT system should be applied when we have a VAT system using multiple rates (or exemptions). It is hard to see how this area can be simplified unless the number of VAT rates/exemptions is limited or new overarching VAT principles are introduced which determine the VAT liability of such “complex” supplies. 37. Other examples of areas where the VAT liability of a product is unnecessarily complex in itself are food, printed matter, financial services and children’s clothing. Consideration should be given to a significant simplification of the legislation in these areas, eliminating all exceptions to exceptions. Clearly, improved definitions are likely to be of assistance here.

2.2. Why have these difficulties arisen? Is it product development/technological advance or other reasons? 38. To a large extent many of these difficulties manifest themselves due to the very existence of the system of different VAT rates and exemptions inherent in our current VAT system. It seems inevitable that many of these “boundary” difficulties will remain so long as different VAT liabilities remain a feature of the system. 39. In some instances the law has just become too complicated and, on the face of it, there is an opportunity to simplify it. To take the case of food, there are many products available in the UK today that were not available when VAT was introduced in 1973. When a new product is developed, its VAT liability needs to be considered against legislation that did not envisage certain types of product that are now available. 40. Some of the less intuitive VAT liabilities are based on historic reasoning. For example, chocolate milkshake powder is zero rated, but strawberry milkshake powder is standard rated. 7


This distinction is believed to originate from cocoa being a drink that was expected to be served to the troops during the Second World War. Other notably complex recent amendments are in the definition of hot food introduced in 2012.

2.3. Would it be possible to simplify some of the definitions to allow more leeway for reasonable trade decisions? 41. It may be possible to structure the VAT legislation in such a way as to allow the definitions of particular products to be agreed with trade associations covering those particular products. If included in secondary legislation, this could be developed and amended by agreement with designated trade associations in affected areas.

2.4. If part of the problem is commerce developing faster than the VAT law, how might VAT law best keep up? 42. As in 2.3 above, it may be possible to create a framework that would allow secondary VAT legislation to be amended by agreement with designated trade associations covering affected areas as new products are developed.

2.5. What would be the impact of introducing much broader definitions in areas such as food? Would this help or cause more difficulties in practice? 43. Broader definitions could simplify the legislation, but would need to be very carefully worded to clarify the boundaries of which products were included in those definitions. Some anomalies could also be removed. Using the milkshake example mentioned at 2.2 above, why should different milk flavourings attract different VAT liabilities? Is it right that a bottle of milk should be zero rated when a bottle of water (the latter did not really exist when VAT was introduced) is standard rated? Should all drinks attract the same rate of VAT, as this would certainly be a simplification? 2.6. Could Making Tax Digital (see below) be used to resolve complexities associated with types of supply, either on its own or in conjunction with other changes? 44. The introduction of Making Tax Digital will provide opportunities for simplification, but the currently proposed timetable is too tight to allow for potential simplification in the VAT system to be incorporated. Also, Brexit will inevitably lead to some VAT changes, if only in relation to trade with the EU. The proposed introduction date of MTD for VAT of 1 April 2019 is so close to the anticipated date of Brexit, that to introduce any further changes at that time could be a recipe for disaster. It might make more sense to delay the introduction of MTD for VAT until the date that it is also introduced for corporation tax, currently 1 April 2020. This would give businesses more time to prepare for the MTD VAT changes, give greater time to assess the potential benefits of simplification in the VAT system and allow any VAT changes required by Brexit to become established before making the MTD VAT changes. 45. MTD will create further opportunities for other VAT related simplifications, such as the possible abolition of the annual accounting and flat rate schemes. 3. Partial exemption methodologies, options to tax and capital goods scheme simplification Partial Exemption 3.1. Where does partial exemption arise in practice unexpectedly? What is the impact on the businesses concerned?

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46. Partial exemption can arise in almost any business, due to a one-off exempt supply being made that is not normally made by the business concerned, or one that is not the intention of the business. An example could be the sale of a property used by a business that does not normally engage in property transactions. Such businesses will, in many cases, be completely unaware that they have made an exempt supply and the VAT consequences of having made it. 3.2. Would it be practical to exclude more of these ‘accidental’ partially exempt businesses in some way? Would that just mean raising the de minimis amounts and changing incidentals guidelines? 47. There needs to be a change in approach regarding perceived avoidance. Practical situations arise where avoidance is never considered, or where a business exceeds a de minimis threshold by a small amount. 48. The sale of a habitually occupied property used to be disregarded for partial exemption purposes until a change in the standard method on 1 April 1987. 49. Paragraph 9 of HM Customs & Excise Partial Exemption Notice 706 dated 1 April 1984 reads as follows: 50. “If you are fully taxable you remain so if you receive a capital sum for the exempt grant, assignment or surrender of an interest in land or buildings which you have habitually occupied in the course of carrying on a business (for example, if you are a shopkeeper and you sell one of your shops). You must not take account of the value of any such supply in applying the outputs rules. Any input tax related to such a supply is to be disregarded in applying the inputs rule”. 51. This rule was abandoned when the standard partial exemption method was changed to an input tax based method with effect from 1 April 1987, but was not reinstated when the standard method reverted to an output based method on 1 April 1992. 52. The reintroduction of a rule such as that above would eliminate the need for some businesses to consider partial exemption where they make no exempt supplies in their normal course of business. A simple rule might be to exclude for partial exemption purposes, any exempt supplies that are not made in the normal course of business. It may be necessary to except capital goods scheme items from such a simplification. 3.3. What alternatives methods would you recommend – or recommend avoiding? 53. The abolition of exempt supplies would be a major step on the road to VAT simplification. In principle, why should a business be denied input VAT recovery merely because its business is in a sector where some or all of its supplies are exempt, whilst businesses which apply the zero-rate or reduced rate to their output supplies are entitled to full input tax recovery? If a business was able to recover all of its input VAT, there would clearly need to be a compensating output VAT charge, for reasons of revenue protection. However, this would only need to compensate for the increase in input VAT being claimed, which in principle would not necessarily result in any redistribution in the burden of taxation. 54. For example, if the current exemption for supplies of education were abolished, it would result in VAT being charged on fees, either at the standard or, given the measure is aimed at tax simplification rather than a tax increase, a reduced rate. There would be a corresponding right to deduct all input tax, including on items such as new buildings and overheads. In terms of the market impact, there would need to be a resetting of the level of fees net of VAT to take

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account of input tax recovery, output tax due and the level of demand and competitive pressures etc. 55. In another example, there is an argument in the insurance sector to abolish IPT and make those supplies currently subject to IPT as subject to the standard rate of VAT. The additional VAT raised at 20% over 12% IPT may be sufficient to compensate for the additional input VAT recovery that would then be claimed by the insurance companies. Any net difference could be resolved by introducing a slightly reduced rate of VAT or minor adjustments to insurance premiums.

3.4. What alternatives or improvements could be put in place to make the process of agreeing a partial exemption special method with HMRC simpler, easier and quicker? Would a flat rate or sector-specific methodology for PE calculations be better than the flexibility of agreeing a bespoke method? 56. When the fair and reasonable declarations were introduced by HMRC, it was expected that approvals would become easier and quicker, because HMRC would be able to go back to the date of the declaration and correct any errors. However, this change does not appear to have improved the situation and an alternative is clearly required. 57. It is questionable whether a partial exemption method should require approval. It could be left to a business to determine whether or not it was making a fair and reasonable declaration on a VAT return without formal approval. It would then be up to HMRC to determine on a future visit whether or not it considered that the VAT return declarations had been fair and reasonable, and issue an assessment if a business had been under declaring VAT. In such cases, we would expect HMRC to only take action where there the business had been making declarations that were clearly contrary to the spirit of the law or blatantly acting against published guidance. 58. In this scenario, a business should still be able to apply to HMRC for approval of a method if it required certainty over the acceptability of the method it was using to calculate deductible input VAT, but this procedure could be made optional. 59. Another alternative might be to introduce a time limit along the lines that a method would be deemed to have been automatically approved if no approval had been formally advised by HMRC within twelve months of the original application by the business. 60. It may be feasible to introduce a scheme whereby a business could elect to adopt a fixed rate percentage recovery based on its trade classification. In such circumstances, we would recommend that this should be optional to the business concerned.

Option to Tax 3.5. Could the process of Opting to Tax be simplified? How? 61. The problems of a system requiring a formal notification of an option to tax are well documented. Problems can arise in establishing beyond doubt that no option to tax has been made in cases where a property is to be sold on an exempt basis. There are also many instances where VAT is being charged in relation to a property as though the option had been made and properly notified, when in fact no notice of the option has ever been made. Difficulties can also arise in the present system where an option to tax has been made without permission in cases where this is required. 62. There is something to be said for a system in which all property is taxable unless an election to opt out of taxation is exercised. However, we comment on some of the practical difficulties with such a system below. 10


3.6. Could a system where, say, all commercial property is considered as opted by default work? Would this cause complexities with awareness? 63. This could work in the longer term, but transitional arrangements would need to be carefully considered. There would inevitably be complexities around the time of the change, while businesses, their advisers and HMRC became familiar with the new procedures. The option to exempt could only apply to land and buildings over which there is currently no option to tax. That of itself may create uncertainties as there is no definitive means of proving that an option to tax has not been made in the past. An adequate time period would be needed to give all business property owners the opportunity to make elections to exempt land and buildings. Procedures would be required to cover situations such as making an election to exempt a property that had previously been opted to tax. On balance it seems to us that there are as many disadvantages as advantages to such a change.

3.7. Could a central database be created? What value would this provide and would that outweigh privacy considerations? Would you be willing to incur the burden of providing data to HMRC to allow such a database to be accurate and up-to-date? 64. If a change towards an election to exempt were to be made, we would strongly recommend that a national database be established from the very beginning, so that that any notifications to exempt would be readily available. Such a database might best be maintained by the land registry, but with access to view being through either the land registry or HMRC.

3.8. Can the notification process be improved? Does this require confirmation from HMRC? 65. As in 3.5 above, we suggest that HMRC considers the introduction of an electronic system to notify options to tax, with instant acknowledgements being automatically sent to the declarants. A more formal notice of the option to tax could then be sent within 14 days. In conjunction with this, we suggest that the requirement to obtain permission to opt in certain circumstances be abolished. Capital Goods Scheme (CGS) 3.9. What burdens does the CGS create in practice? 66. Given the ten year adjustment period of the CGS, retention of records beyond the normal six year period can be an issue in some circumstances. 67. The initial identification of the costs to be included in a refurbishment and whether a large refurbishment should be treated as one or more separate items can be particularly problematic. 3.10. Are there examples in practice of the application of the computer strand of CGS? What of ships and aircraft? 68. We are not aware of any. We recommend that everything other than a purchase of property be excluded from the capital goods scheme. 3.11. Can the aims of CGS be achieved in simpler – possibly more targeted – ways? 69. When the CGS was introduced on 1 April 1990, it was limited to computer equipment valued at £50,000 or more and land and buildings valued at £250,000 or more. These values have never 11


been changed, but the scheme has been further complicated by the addition of refurbishments, ships and aircraft. 70. We understand that there are very few occasions where the CGS is applied to computer equipment, boats or aircraft. We therefore suggest that the scheme be limited to property purchases only. In most cases, any adjustments are small and disproportionate to the amount of time and effort needed for their calculation. 71. One of the most difficult aspects of the CGS is to establish which costs should be included in cases of refurbishment and whether a large refurbishment should be treated as one or more separate capital items. These difficulties could be eliminated by removing refurbishments from the list of capital items included in the scheme. 72. If the CGS is to continue, we suggest that the thresholds should be increased and changed from the value to the VAT incurred. For example, the current £250,000 purchase value could be amended to £250,000 VAT incurred on the purchase.

3.12. As far as land and property is concerned, does the option to tax make a difference or have a part to play? 73. If a property is not opted, there is no VAT incurred on its purchase that will require subsequent adjustments. 4. Special Accounting Schemes Flat Rate Accounting Schemes 4.1. Is it possible to reduce the number of different FRS rates? 74. When the FRS rates were set, they tended to be on the low side to encourage businesses to use the FRS. Most of the flat rate category descriptions cover several trade classifications, so if the required trade classifications are narrowed and made more specific, this is likely to result FRS rates being increased rather than lowered. A possible alternative might be to allocate a percentage to each individual trade classification. This could be notified to a business upon VAT registration and used to help the business decide if it wanted to use the FRS percentage applied to its trade classification or normal VAT accounting.

4.2. Will there be a sufficient simplification benefit to require traders to state what scheme they are using on their VAT return? 75. This probably depends upon the scheme being used. However, to tick a box on a VAT return stating any scheme used would not appear to be a significant burden in itself. There used to be a requirement for retail scheme users to declare the scheme letter on each VAT return that it was used, but this was abandoned many years ago by HM Customs & Excise, presumably because it was unreliable and of little use.

4.3. Is it possible to further increase knowledge of schemes up front when traders first register? 76. Newly registered businesses should be informed by HMRC at the time of initial registration of any special schemes that may be available to them. It should then be up to the individual business to decide, with professional help if necessary, which, if any, scheme it wanted to adopt.

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4.4. Can measures directed at abuses of the schemes be better targeted? Perhaps by framing eligibility differently? 77. It may be possible to limit the use of some schemes to specific trade classifications that are consistent with the use for which they were intended.

4.5. Overall, do these schemes still work? Is there still a sufficient simplification benefit to justify their retention or would it be simpler just to simplify particular aspects of the general VAT system? Will MTD make them less relevant? 78. Some special schemes work better than others and have more widespread use. If the general VAT system could be simplified to the extent that some of the special schemes became obsolete, then this would almost certainly be a good thing. 79. MTD will make a difference to some schemes, the most obvious probably being the annual accounting scheme and the flat rate scheme. Retail schemes 4.6. Do any complexities arise in operating retail schemes? 80. Although modern tills eliminate the need for the basic identification of products at different rates, there will continue to be a need to make adjustments to the takings. Examples may include wastage and use of vouchers.

4.7. How common is modern accounting software is in the retail sector? 81. We believe that modern accounting software has been widely adopted, but that there are still many small businesses that do not have access to this.

4.8. What specific complexities with VAT accounting do the retail schemes help manage? 82. With developments in technology since retail schemes were first devised, it is difficult to see what remaining issues these help to manage which cannot be resolved by the use of technology. 4.9. Would there be a simplification benefit in moving to systems that send information to HMRC straight from the till, as is now in use in some other countries? And would the simplification outweigh any implementation and running costs? 83. We find it difficult to see how this would be a simplification.

Tour Operators Margin Scheme (TOMS) 4.10. What arrangements and transactions are caught in TOMS nowadays? Are these ‘tours’ as envisaged? 84. Charges for conferences that include overnight accommodation are caught by TOMS. These cause difficulties for organisations that may hold an annual conference, but have no other TOMS related activity in the year. Such organisations are clearly not tour operators in the commercial sense and should not be caught by the complexities of TOMS calculations for 13


occasional or one off events. However, we understand that any simplification to the system of TOMS needs to take account of the UK obligations to comply with EU VAT law at present and that any simplification in UK VAT law may still leave businesses in a position where they are unable to recover VAT paid on overseas costs of items such as hotel accommodation due to the operation of the special scheme for Travel Agents in Articles 306 to 310 Council Directive 2006/112/EC.

4.11. Does TOMS still help the sort of tour operators originally targeted? 85. We understand that many internet based tour operators have organised their businesses to avoid being caught by TOMS. Some traditional tour operators are happy to use TOMS. It may therefore be worth considering the use of TOMS on an optional basis.

4.12. Can TOMS be simplified to still target the original arrangements but excluding things that should not be in its ambit? 86. Its use could be limited to those businesses that are classified as tour operators.

4.13. Should TOMS apply to supplies that solely occur in the UK? 87. It should not be compulsory for supplies made solely in the UK to fall under TOMS. However, a business using TOMS for its international operations should be able to do so voluntarily if it was easier for it to do so. 4.14. What should be done to maintain or increase alignment with international regimes where this offers greater simplicity? 88. This may be an issue to consider under the Brexit negotiations.

Agricultural flat rate scheme (AFRS) 4.15. How widely used is the AFRS and is it still necessary? 89. No comment.

4.16. What would be the impact of removing this scheme: what sort of businesses would lose out? How much would they lose, bearing in mind administrative costs? 90. No comment.

Cash Accounting 4.17. Are there any problems with the current VAT cash accounting system? 91. We are unaware of any significant problems and suggest that the cash accounting scheme continues unaltered.

4.18. Does the impact of wider direct tax cash accounting with MTD, with its differing thresholds, cause any difficulties?

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92. No comment.

Annual Accounting Scheme 4.19. How much simplification does the AAS provide in practice? Since its presence adds yet one more scheme for a business to consider, should this be retained at all? 93. This should be retained until the introduction of MTD, so that small business do not have two changes in a short period of time. Consideration should be given to discontinuing the annual accounting scheme when MTD is introduced for VAT.

4.20. Will the AAS be compatible with Making Tax Digital plans, given quarterly reporting? 94. If businesses using the AAS are required to submit quarterly information under MTD, it would appear that its continued availability would become irrelevant.

5. VAT admin, penalty and appeals processes Administration 5.1. We would be interested in your experience in relation to VAT guidance. Are there particular types of guidance that cause issues? Or issues about accessing guidance? 95. The main problem with the VAT guidance is that it lacks sufficient detail in many areas to enable businesses to rely upon it, or to find the answer to specific queries. This results in resource intensive enquiries being to HMRC, either to the VAT helpline or written enquires, that would otherwise be unnecessary.

5.2. Would it help if there was a search function or site map for guidance? 96. Yes.

5.3. Would it be simpler if there was an automatic notification feature for all new and amended guidance that also told you precisely what the amendments were? 97. Yes.

5.4. What other areas of VAT administration cause complexity? Are VAT repayments a problem in practice? 98. VAT repayments are normally received fairly promptly, although there can occasionally be long delays when VAT returns showing a repayment are referred for credibility checks.

5.5. How could the VAT overpayments regime operate fairly to ensure that only one repayment of the overpaid VAT is made and that it is made to the right person (the person who bore the economic burden)? 99. Proof of original payment could be requested if the correct recipient of a refund was in dispute. Penalties 5.6. What are the major concerns with the penalties regime? 15


100. In some cases, the penalties are disproportionate to the offence, such as a default surcharge applying to a large payment that was made only a few days late.

5.7. How could we provide more clarity regarding the voluntary disclosure regime to encourage more compliance? 101. If a VAT return has been used to correct an error that was not deliberate, it should be automatically treated as having been voluntarily disclosed. 102. We understand that the penalty regime is currently under review by HMRC and that a more proportionate points system is likely to be introduced. It may be more appropriate to comment on the new proposals when they are announced. 5.8. Could the penalties system be more like speeding fines, with only exceptional excuses? 103.

Yes.

Appeals procedure 5.9. Would improvements to decision letters help improve understanding about the statutory review process? 104. Yes. We suggest that HMRC produces a standard document that explains the statutory review process in detail, which should then be included with all decision letters sent to businesses.

5.10. Are there areas of complexity with the statutory review process that need addressing? If you don’t use statutory review, why not? Is your experience different in the context of other taxes? 105.

No comment.

5.11. Should anything be done to encourage greater use of ADR in VAT? 106. As ADR has potentially significant benefits to businesses, saving the time and cost of a formal appeal, its use should be wider encouraged and publicised. 5.12. In general, are there any simple routes to making the dispute resolution process, including the Tribunal stage, less time consuming and costly? Would lowering barriers risk encouraging too many appeals? Could anything be done to make a tribunal less time consuming and costly? And would lowering these barriers help or simply result in more appeals that could congest the system? 107.

No comment.

6. Formal ruling system 6.1. What are the areas of the VAT system that most need rulings? Why are these needed – and how many would arise in a year?

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108. Transfer of a business as a going concern is the area where rulings are probably most required, due to the importance and value of the transactions involved. In many cases, a ruling will also be required urgently, if a proposed sale is not to fall through. 6.2. Could an agreed certification procedure between a buyer and seller work for issues such as compliance with TOGC liability rules? How could HMRC be protected against abuse? 109. We cannot see how a self-certification system will remove the uncertainty and risk of a future challenge to the treatment of a transaction as a TOGC. Where there is tax at stake, such as in cases in which the purchaser is partly exempt, there would be inevitably risks to the revenue over the incorrect treatment of a transaction as a TOGC. On the other hand a system which enables the parties to a transaction involving part of a business to elect to have a transaction treated as a TOGC in certain circumstances may simplify VAT compliance. 6.3. Are there examples of practices in other countries that are particularly worth investigating – or emulating? 110.

We are unaware of any.

6.4. What other routes could be used to achieve the needs of businesses for rulings without setting up a formal system? 111. If a letter from the written enquiries could be relied upon, a more formal system would be largely unnecessary. 7. VAT and Making Tax Digital Alignment Opportunities 7.1. What are the areas of the VAT regime that require simplification to be compatible with MTD? 112. It is difficult to see how a single declaration from a VAT group registration that includes many companies will be compatible with MTD. It will presumably be necessary to create a link between the companies involved within MTD so that a VAT declaration is only required from the representative member. 113. Where a business, group registration or otherwise, has several locations with independent accounting systems, the uploading of data for MTD may be very difficult if not practically impossible. How many computerised accounting systems can be linked into one MTD company account? 114. Calculations that are done outside the normal accounting system, such as those relating to partial exemption, capital goods scheme, retail scheme and TOMS, will require facilitation within MTD if significant problems are to be avoided.

7.2. Does MTD mean that VAT annual accounting and other simplified schemes are redundant? 115. On the face of it, if all VAT registered businesses will be required to submit information quarterly under MTD, then the annual accounting scheme would appear to be redundant. However, the annual accounting scheme is designed as a simplification so those businesses that use it are likely to be faced with increased admin burdens and costs. There might therefore still be a good case to retain annual accounting even within MTD. 17


116. Other schemes that have been developed to simplify VAT for smaller businesses may also be potentially redundant following the introduction of MTD, of which the flat rate scheme is probably the prime example. However, a judgment will need to be made as to whether the schemes still provide useful simplifications and are therefore worth retaining.

7.3. What opportunities does MTD offer to further simplify VAT for businesses? 117. It is difficult to see how anything could be simpler than the current system of completing nine figures on the online VAT return form. We do not believe that MTD has anything to offer by way of VAT simplification for businesses.

7.4. What can we learn from other countries that have a more digitised VAT system? 118.

No comment.

8. Further areas for investigation 8.1. Are there other business sectors that have particular VAT issues beyond those we have noted? 119. The fuel and power suppliers have issues with the de minimis limits applied to their commercial supplies, which determine where the reduced rate of 5% can apply, especially where the use fluctuates throughout the year. Another issue for these suppliers is the acceptability of declarations from customers for domestic or charitable use. 8.2. Do you have examples to contribute of good and less good communications issues? Are there ways to improve matters easily? 120. ICAEW supplied details of poor communication regarding supplies in the health sector, which we understand has been useful. 8.3. Bearing in mind our terms of reference, are there other areas of VAT that we should be investigating 121. The OECD VAT guidelines recommend that where a supply of services is made to a consumer in another country, the place of supply for VAT purposes should be the country in the customer belongs. This recommendation is being increasingly adopted worldwide, which creates practical difficulties for businesses selling to consumers in other countries. In theory, a business will need to become familiar with the VAT rules of every country to which is making supplies of services to consumers. 122. In order to assist with this problem, the EU operates the Mini One Stop Shop. It is unclear as to how this will be available to UK suppliers after Brexit. However, the particular regime only applies to supplies to customers in the other 27 Member States. It does not help with supplies to the many other countries that operate a VAT system. We suggest that a move towards a worldwide system akin to MOSS would be very welcome and ease the burdens of international trade, particularly for small businesses. After the UK leaves the EU, this could be applied to sales to EU and non-EU countries alike, if agreements can be made with the tax authorities of the other countries concerned. For EU countries, this would appear to fall within the scope of the Brexit negotiations.

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APPENDIX 1 SOLVING THE VAT CLIFF EDGE PROBLEM What is the problem? When a business crosses the registration threshold, it pays VAT on its entire turnover, not merely the excess over the thresholds. Accordingly the proprietor’s net turnover drops. This means that crossing the threshold is disadvantageous until the turnover increases sufficiently to absorb the VAT on the first £85,000. With a £85,000 threshold, the VAT exclusive turnover falls below £85,000 until turnover increases to around £102,000, i.e. Turnover

VAT

Net Turnover

£85,000 £85,001 £90,000 £100,000 £102,000 £110,000

Nil £14,167 £15,000 £16,667 £17,000 £18,333

£85,000 £70,834 £75,000 £83,333 £85,000 £91,667

What might be the solution? Limit the tax to the excess over £85,000. That still provides no incentive to increase turnover, i.e. to build the business. Accordingly an alternative would be to limit the tax to, say, 80% of the excess, i.e. Turnover

Excess

VAT

Limited to 80% of excess

£85,000 £85,001 £90,000 £100,000 £102,000 £105,000 £107,370 £110,000

£1 £5,000 £15,000 £17,000 £20,000 £22,370 £25,000

Nil £14,167 £15,000 £16,667 £17,000 £17,500 £17,895 £18,333

Nil £ 1 £4,000 £12,000 £13,600 £16,000 *£N/A £N/A

Cost to government

£14,166 £11,000 £ 4,667 £ 3,400 £ 1,500 -

*80% of £22,370 = £17,896 so the limitation ceases to apply. The break-even point is accordingly just below £107,370. It will be seen that the cost to the government decreases as turnover increases. A £15,000 increase in a business’s turnover reduces the cost to the government by approximately 67%. The cap should not apply where a business voluntarily registers for VAT as it will have made a commercial decision to accept the cliff-edge. In practice most businesses that voluntarily register for VAT are able to increase their prices to absorb the VAT, so there is no need for relief. The problem arises with those businesses that are forced into the tax system but do not have the ability to raise their prices to absorb the VAT because most of their customers are not VAT registered traders and so cannot recover the VAT.

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APPENDIX 2 ICAEW TAX FACULTY’S TEN TENETS FOR A BETTER TAX SYSTEM The tax system should be: 1.

Statutory: tax legislation should be enacted by statute and subject to proper democratic scrutiny by Parliament.

2.

Certain: in virtually all circumstances the application of the tax rules should be certain. It should not normally be necessary for anyone to resort to the courts in order to resolve how the rules operate in relation to his or her tax affairs.

3.

Simple: the tax rules should aim to be simple, understandable and clear in their objectives.

4.

Easy to collect and to calculate: a person’s tax liability should be easy to calculate and straightforward and cheap to collect.

5.

Properly targeted: when anti-avoidance legislation is passed, due regard should be had to maintaining the simplicity and certainty of the tax system by targeting it to close specific loopholes.

6.

Constant: Changes to the underlying rules should be kept to a minimum. There should be a justifiable economic and/or social basis for any change to the tax rules and this justification should be made public and the underlying policy made clear.

7.

Subject to proper consultation: other than in exceptional circumstances, the Government should allow adequate time for both the drafting of tax legislation and full consultation on it.

8.

Regularly reviewed: the tax rules should be subject to a regular public review to determine their continuing relevance and whether their original justification has been realised. If a tax rule is no longer relevant, then it should be repealed.

9.

Fair and reasonable: the revenue authorities have a duty to exercise their powers reasonably. There should be a right of appeal to an independent tribunal against all their decisions.

10.

Competitive: tax rules and rates should be framed so as to encourage investment, capital and trade in and with the UK.

These are explained in more detail in our discussion document published in October 1999 as TAXGUIDE 4/99 (see http://www.icaew.com/-/media/corporate/files/technical/tax/taxnews/taxguides/taxguide-0499.ashx).

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