Taxable supplies for UK value added tax (VAT) purposes include sales at the standard rate (17.5%, rising to 20% in January 2011), at the reduced rate of 5% and at the zero rate. When supplies are zero rated for VAT purposes, the registered business does not charge VAT on the sale but retains the right to recover the VAT incurred on expenses relating to the sale.
The UK VAT system has more zero ratings than other EU systems and has negotiated exceptions to the EU rules to retain these zero ratings. The zero ratings were originally introduced in the UK as part of the political process of introducing VAT, and it has now become politically difficult for any government to remove them, although in other EU countries these items (apart from exports) are frequently charged to VAT at a rate of at least 5%. In January 2011 the UK is raising the standard rate of VAT 20% but the zero rated items are remaining in place.
An argument for retaining the zero ratings is that they apply to goods and services that take up a higher proportion of the spending for those on lower incomes, so they make the VAT a more progressive tax than it would otherwise be. The argument against the zero ratings is that they result in a distortion of trade and spending patterns are therefore not optimal from an economist’s point of view.
Zero rating for food
Food is zero rated, although confectionery is subject to the standard rate of VAT. Some of the problems and disputes arising with this category of zero-rating are at the borderline between food and confectionery. For example cakes and biscuits are zero rated as food, however if a biscuit contains a layer of chocolate it is subject to VAT at the standard rate. Drinks such as fruit juice and bottled water are standard rated, but coffee and tea are zero rated.
Catering is standard rated, including food sold by restaurants for consumption on the premises and hot take-away food. Cold take-away food is zero-rated. The distinction between zero-rated food and standard rated catering has also given rise to many disputes. One example is where a shop produces pies for sale, and they are still hot when sold because they have just been cooked. This sale is classified as a zero rated sale of food, as the pies are not being sold in the course of catering, but there is a very thin dividing line between the sale of hot pies and the sale of a hot take-away meal.
Construction of buildings
Zero rating is available for the construction and sale or long lease of a building designed as a dwelling (i.e. residential property) or a number of dwellings. The zero rating is also given for a building that is designed for a relevant residential or relevant charitable purpose. The definition of a relevant residential purpose covers homes providing residential accommodation for children, students or people in need of care. The definition also covers hospices but does not include hospitals, hotels or prisons. A relevant charitable purpose includes a building used by a charity for non-business purposes and a building used as a village hall.
There is also a zero rating for the alteration of listed dwellings. This zero rating applies where the building is designed as a dwelling or a number of dwellings or is intended for use solely for a relevant residential or a relevant charitable purpose; or is converted to a residential building as a result of the work done. The work must qualify as an approved alteration, as opposed to repair or maintenance work. To obtain the zero rating for VAT, the work must require, and receive, listed buildings consent.
Exports are zero rated for VAT, provided that HMRC are satisfied that the goods have left the UK. Exporters must ensure that they retain sufficient documentation that can be produced as evidence that the goods have left the country. This could include the order from the customer, advice note and invoice, insurance and freight documents and evidence of receipt of the goods abroad. A business should obtain the records relating to the export within three months of the transaction. Some relevant records will be available in electronic form as a result of using the National Export System (NES).
Other VAT zero ratings
Other zero ratings include sewerage services and water, residential caravans and houseboats, books and newspapers, children’s clothing and footwear, some supplies of transport, certain medicine and aids for the disabled and certain supplies involving charities. Banknotes and certain supplies of gold are also zero rated.
Certain businesses are registered for VAT but making mainly zero rated supplies, for example retailers selling mainly books or food items. Certain businesses, such as food retailers, may make a mixture of zero rated and standard rated supplies. For example, shops selling zero rated food and perhaps newspapers will also sell standard rated confectionery and drinks. The businesses that are selling mostly zero rated items may receive VAT repayments, and for this reason they should consider requesting monthly VAT returns so that they can obtain monthly repayments of VAT and improve their cash flow.
HM Revenue and Customs www.hmrc.gov.uk
“Value Added Tax” by Andrew Needham and Steve Allan, Bloomsbury Professional, 2009