Will the Recent Reduction in the Standard Rate of VAT Actually Make Any Difference?

Will the Recent Reduction in the Standard Rate of VAT Actually Make Any Difference?
As we all know, the Chancellor announced in the Pre-Budget Report on 24 November 2008 that the UK standard-rate of VAT would reduce from 17.5% to 15% for the period 1 December 2008 to 31 December 2009.


Clearly, the aim of the reduction was to get consumers spending again by bringing about lower prices, particularly in the retail sector.


However, given that the reduction only reduces a £20.00 purchase to £19.58, there is considerable doubt as to whether the hoped for rise in spending will actually occur. Individuals may be expecting a greater impact on their household budgets than is likely to be the case, as many basic day- to-day purchases and essentials (i.e. most foods, domestic fuel and power, children’s clothes, insurance, mortgage and credit card interest) are not subject to standard-rate VAT, and will be unaffected by the change.


The general consensus of experts seems to be that, in terms of benefit to the public, the VAT reduction will be incidental, if not irrelevant. This was a view shared by many opposition MPs at the time, but interestingly, the most critical comment appears to belong to Labour MP Frank Field, who described the measure as being akin to “spitting at a hurricane”!


In the business world, the reduction will undoubtedly benefit those businesses which are unable to recover partially or fully the VAT that they incur. Assuming the rate cut is passed on, there will be a benefit to those businesses or organisations in the exempt and non-business sectors (e.g. financial service providers, insurers, care homes, welfare providers, nurseries, and charities).


They will also see a tangible reduction in costs, as the amount of irrecoverable VAT they suffer on standard-rated goods and services decreases.


However, in administrative terms, all businesses are likely to be affected, as any change in VAT rate creates numerous accounting and systems issues.


Some larger retail businesses, which will be under pressure to pass the rate cut on, will suffer significant administrative costs in having to implement price changes across multiple product lines with only a week’s notice. The suggestion in some quarters is that a lot of the smaller retailers won't bother changing their prices, and will instead pocket the small difference for themselves as an offset against falling profits.


As mentioned above, businesses only had a very short period of time in which to amend their accounting systems and, where applicable, their prices. However, as deferring the rate cut may have deferred consumer spending, it was no doubt felt that any further delay into the busy Christmas period would have been counter-productive.


The last change in the standard rate of VAT was over 17 years ago, when sophisticated ERP systems were in their relative infancy. This time around, it will have been a far more difficult task to re-configure systems-based processes in order to comply with the rate change by the due date. Retailers will also have had to consider the impact of the change on their price point policy, and how they pass on the related reduced VAT charge to their customers.


(By way of a helpful calculation tool, the old 7/47ths formula for working out the VAT element of VAT inclusive amounts has now become 3/23rds)


Andrew Needham