It seemed to me that there was some doubt as to whether the VAT registration threshold would be increased at all, or if it was, whether by very much. After all, it is higher than the European average and effectively allows many micro-businesses, the cost base of which are largely the human cost of an employee or director, to work legally in a VAT-free environment denied to their larger comparators. A stand-still in the threshold would have been a real terms reduction, thus giving rise in effect to a stealth tax. But as “we are all in this together” perhaps micro-businesses could gradually start to bear some of the burden.

 

But no: The threshold increased by 4.2% which sounds quite a lot like the level of inflation. A micro-business can turnover £73k, making a good living, and undercut the VAT paying trader when making supplies to final consumers. With the rate having increased to 20%, that relief becomes more valuable than ever, and the penalty for the larger business more dramatic as well.

 

Put another way, in order for a business which incurs minimal input tax to earn as much by selling services to final consumers above £73k, they need to make turnover instead of £87,601. That’s £14.5k more. While they are grafting to add that £14.5k, they are out of pocket. It creates a significant disincentive to effort, and creates too much temptation to evade or take ill advised grey area measures for avoidance.

 

What happens if the VAT rate increases to 22% in future years (far from unlikely)? Again, the disparity between the micro-business and the small but larger business increases further, and the turnover needed to justify going above a threshold of £73k increases to £89k. The trap gets more difficult to escape, and dark temptations increase.

 

Is this wise, all in the name of “less red tape”?

 

The Office for Tax Simplification (OTS) tell us they have looked at it and have heard some people asking for the threshold to increase dramatically, while others ask for its reduction. Their conclusion - to split the difference and maintain the status quo. With due respect, that is not a case of democracy at work, or the result of positive “listening”. It is simply evading an issue and leaving no-one happy. This needs serious consideration from economists and behavioural scientists alike, so we do not fall into the trap of tolerating a system which stifles enterprise and encourages dubious working practices. The Chancellor ought to announce a review.

 

This is the rule that allows personal importation of goods from outside the EU to escape VAT if their value is less than £18. It is a de minimis principle which is intended to avoid administrative cost for minimal revenue gain. But it has been seized upon as a loophole for systematic exploitation by e-businesses selling units from the Channel Islands. These are mainly CDs and DVDs (books being zero rated in any case). Enormous businesses are operating outside VAT altogether by using this “de minimis” rule deliberately. It not only deprives the public purse of much needed revenue but cripples bricks-and-mortar businesses selling similar goods from our high streets, and thereby distorts the market place in a manner which has environmental consequences.

 

No-one is in any serious doubt that this needs to be shut down. I doubt very much that the businesses set up in the Channel Islands actually like it themselves. They probably feel that there is no alternative since someone would come along and under-cut them if they did not do it. Stop everyone doing it, and they might well be happy to compete on that levelled up playing field.

 

So I think most people (bar selfish consumers) will have cheered the Chancellor when he announced his measures to stop this. But then we looked at the detail and it was striking just how disappointing it was. A reduction in the limit from £18 to a mere £15. Is that really sufficient? And implementation only from November. Too long a gap for businesses that may already be on their knees. And it is not merely my response to say this is disappointing. The HMRC Information and Impact Note oozes frustration and exasperation at apparently being unable to be more radical. We are told about urgent discussions of the matter in the EU to find a permanent solution, and of a review in 2012.  Well, the requisite sense of urgency in rectifying this unfairness between business models is clearly there, but how exasperating it is that the process will be, put simply, far too slow. This is something that needs to be “gripped” and could prove to be a case study in the levels of virility of the new administration.

 

Finally, we come to the dog that whimpered but would not bark. This is a reference to an EU rule that allows exempt businesses (e.g. education, health, charity, finance, insurance) to share costs on a pure divided up basis (no added value) without building in a VAT cost element that would not have arisen had costs not been shared. It is mainly about sharing staff. It allows small operating units to operate more efficiently than they otherwise could, by sharing key staff whose time would not be fully utilised by any one of the businesses. Whereas the cost of an employee has no VAT element, the cost of recharging one’s employee’s time to another entity does (or usually does), as it is seen to be an “economic activity”. But all that is being done is sharing an employment cost. We are not talking here about proper “out sourcing” where businesses hope for a fundamental change in the way they purchase services. The EU rule does not cover that situation at all.

 

Notoriously, the UK has never implemented this rule, for reasons that are frankly beyond anyone’s comprehension. It has a legal duty to do so. It prevaricates by citing the possibility of abuse and how important it is to understand how the arrangements would be used, or whether they are really “needed”. There is a feeling that the civil servants involved wish to be shown examples of arrangements that already suffer unfair VAT and which could benefit. Of course, such arrangements have been deliberately avoided because the VAT made them unfeasible, so there are no models on which to work.

 

I hear that the government also wishes to understand the cost to the Exchequer. We have to query why that is, considering that they are legally obliged to introduce a workable implementation of the rule. The reason can only be that they need to raise taxes elsewhere to compensate and balance the national budget. That seems reasonable (if it is the reason) but the fact is that the position is more or less unascertainable. It is certainly not the case that the “savings” that will arise when the system is introduced will equate with the “lost revenue” associated with the introduction. The current position stifles freedom of organisation of the business, so the tax is not being paid because the activities are not being carried out.

 

Does that equate with “Britain being open for business”? Plainly not. The government has to push ahead with this discussion. If it fails to do so in the near future, it can expect to face a legal challenge which will take the process out of its hands and make it a victim of external forces.

 

And so, at the end of a very long blog, what ties these points together? It is the fact that the higher the VAT rate goes, the more important it is that level playing fields are scrupulously maintained. Differing levels of playing fields are barriers to entry, and stifle success. What looks like a relief can be a trap, and a kind of inadvertent protectionism is the result. It is bad for trade, and needs urgent attention.