The indirect tax landscape in the UK

The indirect tax landscape in the UK has never been more dynamic with VAT now a major revenue raiser for the government and other indirect taxes, such as landfill tax, air passenger duty and insurance premium tax, broadening in scope and increasing in rate. Businesses are acutely aware that indirect taxes need to be actively and accurately managed, and the focus from the UK government, through the offices of HM Revenue & Customs (HMRC), remains steadfastly on ensuring compliance and revenue protection. The standard rate of VAT in the UK is 20%. This rate came into force on January 4 2011 and is the highest rate since VAT was introduced in the country on April 1 1973. As compared to the VAT rates in other EU member states (which range from 15% in Luxembourg to 27% in Hungary), the UK rate is no longer one of the lowest, but is firmly in the middle range and there is little prospect of the rate decreasing in the near future unless there are severe economic reasons to reduce it as a temporary measure.

The raising of the UK standard VAT rate coincides with a lowering of the corporate tax rate, with the government seemingly focusing on policies to use lower corporate taxation as a way to improve the competitiveness of the UK.

In the recent budget, HMRC announced measures to mitigate perceived areas of VAT revenue loss and, at the same time, there is emerging case law at both the UK and EU level affecting VAT rules as they have applied retrospectively.

The UK budget announced on March 21 2012 included a number of indirect tax announcements, including a raft of measures intended to address what HMRC termed "borderline anomalies". These measures include:

• clarification of the treatment of catering and the meaning of "premises";

• taxation of sports nutrition drinks;

• removal of a VAT exemption for self storage; and

• removal of the zero-rating for approved alterations to listed buildings.

Many of these proposed measures have proved controversial, in particular, the clarification of the treatment of catering. Under this proposal, the definition of "hot takeaway food" was intended to be amended to treat all food and drink (with the exception of freshly baked bread) that is above the ambient air temperature when provided to the customer as standard-rated.

Though the measure attempted to provide clarity on an issue that has been the subject of litigation over a number of years, it generated considerable debate in the press and among industry representatives. Indeed, the issue has become a major headline grabber and resulted in an eventual softening in the proposed policy. All at a time when the government would rather focus on other issues. It is a reminder, however, that VAT affects everyone and if a 20% cost is to be added to a person's lunch, the policy underlying that increase needs to be clear and well thought through. We are yet to see whether there will be any further changes to the measures as announced.

As well as changes in VAT, there were a number of other indirect tax announcements in the 2012 budget, particularly in the area of green taxes, in line with the recent trend to increase their number and scale in the UK and globally. The announcements include changes to the climate change levy and landfill tax and further increases in air passenger duty. All of these taxes are significant revenue raisers for the UK government and to an extent the "green" premise that accompanied the taxes when they were introduced now takes a back seat compared to the largely open acceptance that the taxes raise much needed revenue.

Also consistent with recent trends is the importance of case law in developing UK indirect tax policy. There are two aspects to this trend: the first is HMRC's willingness to litigate tax disputes and the second is the impact of the European Court of Justice (ECJ) on UK tax law and policy.

While there is certainly a move towards resolving disputes before they get to court through HMRC's alternative dispute resolution (ADR) strategy, significant and important cases continue to be heard by the courts. Court decisions often have a broader impact on disputed issues, rather than just affecting the taxpayer in the lead case.

More recently, however, we have seen instances where HMRC has been unsuccessful in all or part of its case and has been reluctant to apply the principles of the case more broadly. A notable example is the Reed Employment case involving the VAT treatment of temporary staff. The decision in the case was that VAT was not due on the full amount charged by Reed to the temporary staff user and instead was only due on the commission element charged.

Following the case, HMRC issued a brief stating that the decision in Reed only applied to the taxpayer in the case and did not have any wider application. It seems likely that employment bureaus and taxpayers that use temporary staff will seek to clarify whether they have similar facts to Reed and, therefore, whether the decision should apply to them. If so it is likely that VAT has been overpaid and claims will need to be submitted to HMRC to protect their position.

HMRC's reluctance to extend the principles of court decisions is unfortunate, as it means that other taxpayers in a similar factual position may have to pursue the issue separately and it is not helpful for businesses, because the tax law remains uncertain and adds to the costs of those who wish to challenge the HMRC approach.

ECJ decisions also continue to have a considerable impact on UK tax law. Recent examples include the Astra Zeneca UK case, which led to a change in policy regarding the VAT treatment of salary sacrifice schemes, and the Lebara case regarding phone cards, which led to an immediate announcement from the UK government that the law on the VAT treatment of vouchers would be amended.

As mentioned, while there is no guarantee that a decision in a VAT case will lead to HMRC agreeing to a broad change in policy, the current landscape includes a number of ongoing court cases which taxpayers with appropriate fact patterns should monitor, since there is a possibility that the UK VAT law has been wrong and that VAT repayments may be due.

For example, the Wheels Common Investment Fund case involving the VAT treatment of pension fund services is one of a number of cases before the ECJ regarding the VAT treatment of services relating to investment funds. At issue in Wheels is whether pension fund management services should be subject to the standard VAT rate of 20% or whether they should be exempt. Clearly, if the ECJ decides that the services should be exempt, it should follow that many pension funds will have been overcharged VAT. The ECJ's decision could therefore have implications not only for pension funds and managers, but also for organisations with staff pension schemes, as the outcome will impact the costs incurred by such organisations.

Another upcoming case with potentially wide implications is GMAC UK, dealing with the VAT treatment of bad debt relief before May 1 1997 when, GMAC argues, the UK's rules for reclaiming VAT on bad debts were too stringent and that meant that bad debt relief was not claimed. In the current business environment, all businesses should ensure they take advantage of the VAT bad debt relief scheme, but businesses that operated before 1997 also may want to consider whether they could have claimed the relief but did not do so because the rules were too restrictive. The case could therefore have a wide application.

Clearly, it remains important for organisations to ensure they are compliant with their indirect tax obligations, while also meeting the need to be efficient in managing their indirect tax liability.

Many businesses already have resources in place to manage indirect taxes, particularly VAT. However, given the increasing size of the indirect tax bill and the growing scope and number of indirect taxes, they should question whether existing resources are sufficient or whether further help is needed, in terms of people, technology, and outsourcing aspects of compliance. For many other organisations, there are little or no resources allocated to managing indirect taxes. These taxpayers should consider whether this remains appropriate.

It should be said, however, that for most taxpayers, dealing with HMRC is a positive experience. HMRC is well placed to have ongoing and useful dialogue with taxpayers to ensure compliance and the expanding use of ADR means that when disputes do arise, there are mechanisms to deal with them that do not necessarily lead to expensive and time consuming litigation.

Nevertheless, court cases will continue to drive law and policy on particular indirect tax issues and, given the importance of indirect taxes in terms of tax paid by businesses and collected by HMRC, and the changes within businesses as they become more globally focused and technology driven, there is an obvious need for the government – in consultation with taxpayers – to work towards a modern, fair and robust indirect tax landscape.

Encouragingly, at the EU level, we are seeing this with the Commission's paper on the future of VAT, which sets out proposals to achieve a simpler, more efficient VAT system that is more robust and fraud proof, as well as being better tailored to meet the needs of the single market. Whether there will be any changes in the near future as a result of the Commission's paper remains to be seen but, as the birthplace of VAT, the EU needs to keep looking to the recent and future developments to ensure that VAT, and other indirect taxes, keep pace with the needs of business and changes in technology. The UK, and HMRC, should be at the heart of this.

Andrew Bradford is a director at Deloitte UK

Andrew Bradford