Germany, UK, Ireland and many other countries are rushing through standard and reduced VAT cuts to help support consumer confident and bolster businesses in lockdown. But the economics and business benefits make little sense. The efforts to adjust and manage the changes, and whether they actually make it through to the consumer outweigh the loss in revenues.
An August 2021 study by the European Parliament highlighted how increased reduced VAT rates raises compliance costs of businesses.
Crisis VAT cuts don’t do what they say on the can
The case for crisis VAT cuts to stimulate demand in an economic crisis appears sound at first blush. As a tax on the consumer, prices should drop in line with the tax cut. This then encourages shoppers to go out – a vital requirement as the high-street reopens – and spend more.
However, this generally does not happen. The UK’s financial crisis VAT rate cut from 17.5% to 15% in 2009/10 led to an initial uptick in consumption. However, this quickly vanished, with no discernible net economic benefit once the reduction in tax revenues was taken into account. In France in 2009, restaurants were given a VAT rate cut from 19.7% to 5.5%. But prices only dropped by 40%; the balance was held back by businesses owners.
Many other studies show VAT rate changes have an asymmetrical tendency: rises are passed on to the consumer whilst cuts are retained by the vendor.
The one exception may be sectorial VAT cuts. There is a persuasive argument for reducing the VAT rate on restaurants, cafes and similar catering outlets. But this would effectively be a business subsidy. It could not be painted as a measure to nudge shoppers onto the high street.
Businesses burdened with the invisible implementation cost
Temporary VAT cuts create a huge business process drain. This could not come at a worse time for companies facing an existential crisis. Offices are largely closed, and staff face difficulties with remote access and communications. Many are also juggling childcare responsibilities. This means day-to-day workflows are hugely disrupted without the burden of two temporary VAT rate implementations: a cut; and then a reversing rise.
The burden splits into two: VAT calculations; accounting system changes.
Getting the VAT right
The extra workload created by a temporary rate change is around the suspension of the normal ‘time of supply’ rules. These set the date that VAT is due, and therefore which VAT rate to use during a rate change. Generally, it is the earlier of the invoice, payment or supply of the goods or services. This doesn’t work because businesses may accidentally, or intentionally, manipulate any of these to change the tax due by customers or to the government.
Businesses therefore must scrutinise the treatment of supplies through the rate change period to ensure VAT calculations is reporting accurate. The common issues businesses will have to look out for include:
- Invoicing in the notice period prior the VAT rise; which VAT rate should be applied and how to report
- Partially completed supplies over the implementation dates must have split VAT rates allocated
- Continuous service contracts, and the allocation of the VAT change must be reviewed and agreed with customers or suppliers
- Advance or instalment payments made over the implementation date by need to be re-invoiced with the correct VAT rate to match the actual time of supply
- VAT on simplified invoices which have different tax calculations will have to be adjusted
- Processing deductions on input VAT paid before the implementation date but under the new rate may be incorrect
- Import VAT charges and credits need to be checked to ensure no over-payment or claims of VAT
- Outstanding vouchers redeemed during the VAT cut may carry excess tax
- Processing refunds of VAT, including dispute management will require extra manual input
- Changes of the VAT return, which may be altered by the tax authorities to gauge the effects of the measure
- Subsequent additional bills after the implementation period for services concluded prior to the date will have to be confirmed and invoiced for
- Refund of deposit amounts accepted prior to the implementation but then refunded after the implementation date will need new VAT calculation and reporting
- Exchange of goods, which includes a cancellation of the previous delivery and the invoicing of a new delivery
- VAT rate treatment for specific industries with specialised VAT regimes, including travel and second-hand goods, will need extra consideration
Accounting system changes
For small businesses, with basic accounting packages, an overnight VAT rate change may be sufficient. It will undoubtably incorrectly report transactions stretching over the implementation period (see above). However, it is questionable whether tax authorities will give any discrepancies a close investigation given the magnitude of the COVID-19 crisis.
Mid and large enterprises will not be permitted the same grace. They cannot ignore the details of the changes, either for their own VAT declarations or matching the treatment of their B2B counter-parties.
Key system tasks will include:
- Liaising with businesses’ accounting and ERP providers to understand their interpretation of the implementation rules and if they are fully updating their software. For on-premise installed accounting systems, businesses will have to ensure they get updates as early as possible to ensure they are getting the VAT right
- Sales ordering systems, if not integrated into the updated accounting system, will have to be addressed. Manual intervention may be required on some transactions with irregular delivery terms over the implementation period
- Tax codes, which set the correct tax rates on a transaction-by-transaction basis in accounting systems, will have to be reset, implemented in customised tables and thoroughly tested. This often requires the creation of new tax codes, which need to be agreed by all stakeholders across the business
- Invoices, whether through dedicated AR invoicing or accounting / ERP system, will have to be reconfigured
- To support the above, tax and accounting teams must liaise closely with their IT or engineering colleagues to plan a roadmap and implementation plan for the recoding required
Prepare for the inevitable
There is now little serious academic doubt that temporary VAT cuts bring more trouble for the whole of the business community than the value they deliver in boosting consumption. At best, they just carry forward some levels of inevitable spend by a few months.
But that will not stop politicians anxious to be seen to be acting to save the economy. So, businesses should start planning now to avoid incorrect tax charges, upset customers and unwelcome questions from the tax office.
And, if it is any consolation, this is a good warm-up for the big VAT hikes that are inescapable in the forthcoming years when countries pivot to hiking VAT rates to pay for the colossal COVID debts they are racking up.