As anticipated, Mr Darling announced a 2.5% VAT rate cut from 1 December for 13 months. At the same time he has increased duty rates on alcohol, tobacco and petrol so that these items will remain at their current prices and presumably help clawback a bit of the VAT given away elsewhere.
So what effect will the VAT rate have for businesses? To be frank, if you are "fully taxable" and can recover all of your input tax, there won't be much of a difference other than on cashflow. But if you are partly exempt or not registered for VAT, then you will benefit. If you purchase goods or services, you will save £2.50 per £100 net value of expenditure. So the rate cut will provided a helpful opportunity for such businesses to save VAT on major expenditure over the next 13 month period. You might want to consider delaying immediate purchases until 1 December to get the benefit.#
Retailers
In principle, the rate cut should be good news for retailers as it will enable them to reduce their prices further in the run up to Christmas. However the timing may actually be more hassle than it is worth. Imagine having to reprice a whole shopsworth of stock over night next Sunday to reflect the 1/47th reduction provided by the rate cut. (I’ll explain the reference to 1/47th below if you are confused).
You might assume that retailers with computerized systems would be able to adjust the price at the till with a simple instruction to the IT system to reduce everything that is coded as standard rated, but I know from experience that it just won’t be that simple to do.
The government clearly believes that the cut in VAT will encourage people to start buying again and expects retailers to pass on the VAT saving. But they can’t force retailers to do it. If the massive pre-Christmas sales with 50% (or even higher!) discounts can’t get people back shopping, a comparatively small VAT rate increase won’t have much of an effect.
The main thing about retail is that pricing is generally done by reference to “price points”, i.e. prices that will attract customers. For example many of the major supermarkets now price with amounts ending with the number 7 rather than the number 9, e.g. £9.97 instead of £9.99. Apparently customers feel that they are getting a better bargain if the number ends with a 7 rather than a 9. So that and other trends may still have more of a bearing on the price than a VAT rate cut.
Also, what if you are a smaller retailer who does things the old fashioned way, ie without a computer? Are you literally going to spend the whole of next Sunday night going round physically changing the prices on your goods? What about the fact that most retailers seem to be offering pre-Christmas sales and discounts at the minute and will already be overloaded with changing ticket and display prices?
2.5% or 1/47th?
Now about that 1/47th business. When a retailer prices goods, they are priced for the customer on a VAT inclusive or gross basis. This means that if the VAT rate is 17.5%, the proportion of the gross price which is VAT is just over 14.89% or 7/47ths. This is calculated by the fact that the gross price is the net price plus 17.5%. So the VAT element of the VAT inclusive price is 17.5/117.5, or 7/47.
If the rate is 15%, the proportion of the gross price which is VAT is 13.04%, or 3/23. The difference in fractal terms is 1/47ths.
How does this work in practice?
Normal business practice is to quote a net price and add VAT to the price afterwards. So if you are a retailer purchasing goods from a manufacturer, say teeshirts priced at £15 each net of VAT, the manufacturer will charge £15 per item plus VAT @17.5%, ie £2.62 . The retailer can recover the VAT as input tax.
Suppose I go to a shop and purchase a teeshirt for £23.50. This is the amount that is shown on the price ticket and the amount that I pay at the till, ie the gross price. It is normal practice in the UK and other EU countries for retail prices to be shown inclusive of VAT, unlike say the US where sales taxes are typically added onto the retail price at the till.
When the retailer priced that top at £23.50, it was calculated on the basis that the net price was £20 plus VAT at 17.5%, ie £3.50. But as explained above, the VAT of £3.50 as a proportion of £23.50 is just over 14.89% or 7/47ths.
So if the VAT rate is reduced by 2.5%, the effect on the price of my teeshirt is to reduce the gross price by 50 pence, or 2.12765…..%, or 1/47th of £23.50.
Anyway that hopefully makes sense to all of you business owners and accountants out there, but how do you explain to customers why the price of their item hasn’t been reduced by 2.5%, but 2.12765…%??? All I can say is good luck to anyone who has to try to explain it in simple English!
HMRC Information
HMRC have published a lot of information about the effect of the change on different types of business here . I recommend that you have a look particularly at the Technical Guide for Businesses as there are details about the implications for businesses with different types of VAT accounting procedures. Don’t forget to post your queries below if you can’t find the answer.
I will post another forum topic in the next day or so about the tax point implications of the change in rate for those of you whose sales or purchases might involve payments, delivery or tax invoices spanning the date of the change.