Every month, VAT collected from consumers is distributed down the value chain of the economy. The wheels of the VAT accounting system grind into motion. Consumer facing businesses collect VAT on their sales, then pay VAT on their expenditure to the businesses that supply them, and so on down the chain. The VAT on the purchases is offset against the VAT collected on the sales, and the net amount is paid to Her Majesty’s Government – it is hoped – by company upon company, business upon business.
But why? Why should this be? Why isn’t the VAT collected from consumers simply remitted to Government by the businesses doing the collection? This is a question Minsters should put to their officials. Is it to distribute the VAT as a safeguard against a loss from the bankruptcy of one major company, or is it simply a reflection of an intellectually coherent system based on the concept of value addition? The reason why the system was designed to distribute VAT receipts from the businesses collecting the VAT to their suppliers in the value chain is lost in the mists of time.
Whatever the reasons for adopting this approach when VAT was introduced in 1973, the world has moved on. Digital banking is now a fundamental aspect of the monetary system. If a busker in a Tube station can arrange to be paid electronically, a UK business can arrange to have its VAT transferred automatically to the Treasury at the point of sale.
To make this work within the existing system, it would be necessary to zero rate VAT supplies between VAT registered entities. This would have the significant advantage of eliminating many of the current opportunities for fraud inherent in the system. To a crooked trader, a VAT invoice is like a cheque from Government for the recoverable input VAT, a fact that has been exploited over the years in a variety of VAT “Missing Trader” fraud schemes that have involved either a cash refund for VAT paid, or a failure to account for VAT paid between companies. If VAT was accounted for directly at source, and supplies between VAT registered businesses zero rated, these schemes would not work. Missing Trader fraud may not be the concern it once was, but the so-called annual tax gap between VAT collected and VAT due is estimated at $10 billion on the latest available figures. Eliminating a major source of fraud would be an important step towards reducing that gap.
While these changes would be a positive and significant improvement to the existing VAT system, care would be required to ensure no unintended consequences from such changes. Some of the effects from these changes would be positive, for example in reducing the complexities surrounding bad debt relief, where VAT has been charged to a company that defaults. Other effects in areas such as VAT exemption may need to be addressed. What has been considered here is one aspect of a system that successfully provided a framework for trade within Europe for almost 50 years. As Britain leaves Europe, it should make a comprehensive review of its VAT system, and develop a modern regime that will serve its needs in today’s digital economy.
1946-11