The IoD's View

Taxes on sales have their place in the tax system, but like all taxes they must not get too high, otherwise they will damage the economy. Business rates are a well-entrenched and comparatively simple tax, but their level needs to be kept under tight control because they bear no relation to profit.

Key Points

• The main tax on sales is vat (value added tax). This is normally charged at 17.5%, but the rate has been reduced to 15% until the end of 2009. Some supplies are exempt under European regulations: vat is not charged on them, but the suppliers cannot reclaim the vat they have suffered on their purchases so those amounts are the effective tax on the supply. Other supplies are zero-rated, or subject to vat at only 5%, because the UK has chosen to do so. Suppliers can reclaim the vat on their purchases, so the effective rate is indeed zero or 5%.
  
  
• The vat rate is reasonable in a European context, where rates range from 15% to 25%, but it is markedly higher than typical sales taxes in the United States.
  
  
• The administration of vat can be complex, particularly for anyone making a mixture of taxable and exempt supplies, or a mixture of supplies taxable at different rates. There have also been problems with the standard of service provided by HM Revenue & Customs, especially in relation to registration for vat, although there was a marked improvement towards the end of 2007.
  
  
• There are other sales taxes and taxes which have broadly the same economic effect, including insurance premium tax, excise duties on fuel, alcohol and tobacco, and customs duties on goods entering the European Union.
  
  
• Business rates are levied on the notional annual rental value of business premises. Properties are re-valued every five years. The rate in the pound is set nationally in such a way that the total take from rates cannot increase faster than the retail price index. (There are different rates in the pound for England, Wales, Scotland and the City of London. Different arrangements apply in Northern Ireland.)
  
  
• The main problem with business rates is that they are a fixed cost, payable whether or not profits are being made. The current link to the retail prices index has the great advantage that with economic growth, rates become a less and less significant part of the tax base. It is important to resist attempts to change the rules so that the burden of rates could grow.

Q & a

Q. Is vat at the right level?

a. vat is the third largest source of tax revenue, after income tax and national insurance. The level is not unreasonably high, and under European Union rules it could not fall below 15% anyway. an increase in the rate of vat is always a temptation for a Chancellor who is strapped for cash, because every percentage point increase can be expected to bring in £5bn a year of additional tax revenue. Of course the direct impact on prices in the shops puts governments off such measures. If the vat rate were ever to be increased, we would only see that as acceptable if it were balanced by revenue-reducing changes elsewhere in the tax system.

Q. When vat was introduced in 1973, we were told that it would be a simple tax. What went wrong, and how can we get back to simplicity?

a. If all supplies were subject to vat at 17.5%, the tax would indeed be pretty simple. But some supplies are exempt, and others are subject to vat at 0% or at 5%. The exemption of some supplies can require complicated calculations of the vat recoverable on purchases, and the 0% and 5% rates lead to difficulties in determining which supplies are entitled to these rates.

It would be possible to abolish the 0% and 5% rates, but this would have political and social consequences. The same is true for many of the exemptions. However, the exemption which exists for some, but not all, financial services would be very difficult to abolish. abolition would for example mean vat being charged on interest.

There are also complexities surrounding imports and exports. Movements of goods within the European Union are subject to special rules and special record-keeping requirements. It is our view that these requirements, called Intrastat, are in need of simplification, and that simplification would be possible.

The Government has announced new work on the simplification of vat. It remains to be seen what will be achieved.

Q. Why is vat policy set for us by the European Union, and does it matter?

a. vat was introduced in the UK because it was the standard European turnover tax when the UK joined in 1973. It has always been a creature of European Union directives. Having said that, more local variation probably could be permitted without obstructing free trade within the Union if the goal of an origin system, under which businesses in country X buying goods from country Y would simply pay country Y’s vat, were abandoned.

One difficulty created by the role of European Union directives is that significant changes, including changes to the scope of exemptions and other measures that could bring simplification, require the agreement of all 27 member states. So reform can be a slow process.

Q. Delays in vat registration were a big problem for businesses in 2007. are things better now?

a. There were long delays in vat registration, but businesses still had to collect vat while waiting for their registration numbers and issue vat invoices once they had their numbers. One reason for delays was the extra checks needed to prevent carousel fraud, but these checks only affected the small minority of businesses that trade in the small, high-value goods which are suitable for that fraud, such as computer chips. The main problem was inefficiency and a lack of resources. Things got a lot better towards the end of 2007. But the standard of service offered by a Government department which expects businesses to comply with all of its rules must never again be allowed to fall so low.

Q. Can non-UK traders undercut UK traders by selling from outside the European Union?

a. When goods are imported from outside the EU, UK vat is charged. But this does not apply to low-value postal packages. So sellers of compact discs or of printer ink cartridges based outside the EU have been able to undercut UK sellers who have to charge vat. Private individuals, and businesses which are not registered for vat or which make vat-exempt supplies, can make a saving this way.

The issue is still a live one, although bases for such trade close to the UK are not encouraging such trade. The main difficulty in tackling the issue is that a requirement to collect vat on all postal packages would be a large administrative burden.

Q. Should business rates be returned to local control, either in total or by allowing modest supplementary business rates to be charged?

a. No. There would be a very real danger that some local authorities would increase burdens on businesses, inflicting long-term damage on their local economies in return for short-term revenue.

Q. Would business rate supplements for specific projects be acceptable?

a. The IoD strongly opposes supplementary business rates in principle. They would be an additional burden on business which would bear no relation to profits and could jeopardise their commercial viability. Supplements might not lead to an increase in overall spending to the benefit of business if there was a reduction in spending to the benefit of business that was financed from other sources. There may however be a case for short-term levies linked to specific infrastructure projects, such as Crossrail, so long as such levies are ring-fenced, time-limited, and subject to the approval of the business community itself in each case. There would then be a direct and highly visible link between any extra tax that businesses paid and the extra service they got in return.