“It is not an exaggeration to say that there are hospitals, schools and roads that would not exist today were it not for VAT,” says Professor Rita de la Feria, Chair in Tax Law at the University of Leeds, reflecting on what VAT has done for the UK over the past 50 years. However, she adds in her opinion piece for ICAEW’s How to Fix VAT series: “It is also true that UK VAT is now old and outdated.”

The UK VAT system creates challenges for businesses and tax administrators alike. As Donato Raponi, former Head of the VAT Unit at the European Commission, explains: “VAT can be very complicated to manage … The more complicated the system, the riskier it becomes for businesses that are, in essence, collecting VAT on behalf of their domestic governments.”

The case for reform

The UK’s current VAT system suffers from two fundamental weaknesses. First, the UK only taxes approximately half of all consumption – a figure that’s remarkably low by international standards. This narrow base, riddled with exemptions and different rates, makes the system needlessly complex and less efficient than it could be.

Second, the UK lags significantly behind other nations in digitalisation. While countries in South America and Asia have embraced real-time reporting and e-invoicing, the UK’s digital transformation of VAT administration has been limited. This technological gap not only increases compliance costs for businesses but also hampers HMRC's ability to collect tax efficiently.

Brexit presents a unique chance to address these issues. Free from EU VAT harmonisation requirements, the UK can now craft a more consistent and modern consumption tax system. 

Political realities

Reform won’t be easy. David Gauke, a former Treasury minister with extensive experience in tax policy, cautions that “reforming VAT can be incredibly challenging”. The infamous ‘pasty tax’ episode of 2012 demonstrates how even modest reforms can generate significant political resistance.

Yet, the scale of the challenge shouldn’t deter action. Mike Cunningham, former Deputy Director at HM Treasury, suggests that while wholesale change might be difficult, an evolutionary approach focusing on specific areas could yield meaningful improvements. This could include reviewing VAT exemptions, reconsidering the registration threshold, and closing the ‘VAT gap’ between expected and actual revenue.

The path forward

ICAEW believes the time for VAT reform is now. With post-Brexit freedoms and advancing technology, we have both the opportunity and tools to create lasting change. The current system’s inefficiencies cost the economy billions in lost revenue while burdening businesses with unnecessary complexity. 

While the political challenges are significant, recent international examples prove that meaningful reform is possible. Brazil’s 2023 tax system overhaul shows that even large-scale changes can be achieved with sufficient political will and public support.

The cost of inaction grows with each passing year. As other nations modernise their consumption tax systems, the UK risks falling further behind. Businesses struggle with outdated compliance requirements, while the government misses out on revenue that could fund vital public services.

While there is broad agreement on what an ideal VAT system should look like – simpler, digital, and more efficient – the path to achieve this vision is less clear. Some advocate for wholesale reform, others for an evolutionary approach. What's certain is that maintaining the status quo is no longer an option.

That’s why ICAEW is launching its How to Fix VAT campaign, bringing together experts, businesses, and policymakers to generate serious debate about how to create a tax system fit for the 21st century. The destination is clear – now we must decide how we get there.