Current VAT systems in many countries are too complicated and inefficient. Now it has left the EU, the UK has an opportunity to create a consistent, modern consumption tax, and reforms should focus on simplification and digitalisation. 

From the point of view of businesses, VAT can be very complicated to manage, with documentation requirements, exemptions and optional reverse charges, to name just a few issues. The more complicated the system, the riskier it becomes for businesses that are, in essence, collecting VAT on behalf of their domestic governments, but are subject to penalties for making mistakes. 

VAT is also becoming increasingly complex for tax administrations. In the EU, discrepancies between supranational legislation and national implementation create a lot of jurisprudence. Almost every week, there is a different European Court of Justice decision on how to interpret the VAT system, which is supposed to be harmonised. There are also challenges in managing the differences between physical goods and digital services. 

Simplification

The best way of radically simplifying the system is to remove all exemptions and apply a single VAT rate, using direct subsidies where necessary for those who need it. Applying a consistent, single rate is less complicated and more efficient for tax administrations and businesses alike.

Ultimately, though, VAT exemptions and reduced rates are, first of all, political decisions, often based on national economic and social conditions. Yet many studies have shown that they are not efficient instruments when it comes to income redistribution. There are often remnants of VAT left in the price of goods and services, notably for the exemptions, so they do not always lead to lower prices for consumers, and they do not distinguish between rich and poor. 

Challenges to reform

On an EU-wide scale, it can be difficult to make progress on reform because of, on the one hand, the unanimity rule for the adoption of European tax legislation and, on the other, the way the EU VAT system was constructed. Despite attempts, exemptions that have been in place in the EU since 1977 are still in effect. Going further afield, it would also be incredibly challenging to implement a single VAT blueprint globally, because systems depend on many national factors, including political and socioeconomic conditions, along with the make-up and attitudes of the business population.

However, now that it is outside the EU, the UK has the opportunity to create a more consistent, modern consumption tax system, without the challenges of EU harmonisation. The UK could even consider moving away from VAT towards a sales tax. When the EU decided to implement its VAT system in 1962, it was the only realistic way of securing tax revenue on the final consumption. A final sales tax was not possible, as there was no way of collecting commercial information at each stage of production and distribution. The VAT system was the only one that allowed for better control over the collection of consumption tax. This reasoning becomes less valid in today’s digital environment.

While revolutionary VAT reform is challenging, step-by-step changes can also have a significant impact and shouldn’t be overlooked. Digitalisation, with e-invoicing and real-time reporting, could eliminate the need for VAT returns and provide information directly to tax administrations. The advances made in South America and China highlight the extent to which the EU and the UK are falling behind in this respect.

Brexit presents the UK with a unique opportunity to deeply reform its VAT system. By focusing on simplification and digitalisation, the UK can create a more efficient and effective tax system, benefiting businesses, HMRC and, ultimately, the economy.