UK: Pre-Budget Report – Reduction In The Standard Rate Of VAT

In his Pre-Budget Report the Chancellor announced a 2.5% reduction in the standard rate of VAT. The new standard rate of 15% will be introduced on 1 December 2008 and will remain in place until 1 January 2010 when it will revert to 17.5%.

To read about the principal contract and timing issues surrounding the rate reduction please see below.

To view the article in full, please see below:

Full Article

In his Pre-Budget Report the Chancellor announced a 2.5% reduction in the standard rate of VAT. The new standard rate of 15% will be introduced on 1 December 2008 and will remain in place until 1 January 2010 when it will revert to 17.5%. This article briefly looks at the contract and timing issues surrounding the rate reduction. A further LawNow dealing specifically with issues relating to real estate will follow.

General

The new standard rate will apply to:

• supplies of goods and services made after 30 November 2008;
• imports after 30 November 2008; and
• acquisitions of goods from other member states after 30 November 2008.

Next year's Finance Act will include legislation designed to counteract avoidance schemes that artificially accelerate supplies in advance of the resumption of the 17.5% rate to take advantage of the 15% rate. The detail of these measures is not available.

Date of supply

The reduced rate only applies to supplies made after 30 November 2008. It is therefore important to ascertain the date that a supply is made in order to determine the applicable rate of VAT. The VAT legislation contains specific rules that determine the date when a supply of goods or services is made ("the tax point") and it is important that it is understood how the rules determining tax points apply to the type of supplies made by your business.

In the case of goods, the tax point is the date that the goods are "removed or made available" or, if earlier, payment or the issue of a tax invoice. Where there is no earlier payment or invoice and a tax invoice is issued within 14 days of the goods being made available, the date of the invoice would be the tax point. Not all supplies of goods are obvious. For example, the supply of a major interest in land (eg the sale of a freehold) is a supply of goods whereas land supplies that are not major interests (eg supplies made under a lease of less than 21 years) are supplies of services.

In the case of services, the basic rule is that the date of supply is the date that the services are performed or completed. However, the date of supply for certain types of services such as rents payable under a lease or continuous supplies of services (e.g. many types of consultancy or legal services) will be the earlier of the date of payment and the date of invoice.

Credit Notes

The announcement recognises that a payment may have been received or a VAT invoice issued before 1 December 2008 (charging VAT at 17.5%) and that it might relate to goods or services that are provided after 1 December 2008. In these circumstances the legislation allows the new rate to apply to the earlier payment or invoice provided that a credit note is issued to the recipient of the supply. Normally, the credit note must be given to the recipient within 14 days after the change of rate. However, this is to be extended to 45 days.

Must the VAT reduction be passed on to the recipient?

This might be either a commercial issue or a legal issue. If the supplier is not bound by the terms of a contract as to what action must be taken it will be a commercial decision as to whether to pass on the benefit of the rate reduction to the recipient.

Where a post-30 November supply is made under a pre-existing contract then the terms of the contract will determine whether the reduction in VAT must be reflected in the price. Where the supplies will be made under a contract yet to be concluded then how VAT is dealt with should be addressed in the contract both in relation to supplies made at the reduced rate as well as supplies that may be made at a time when the rate has reverted to 17.5%.

VAT legislation provides for what should happen when there is a change in the rate of VAT between the date of the contract and the date that a supply takes place. The basic rule is that unless the contract otherwise provides, the change in the rate will change the price. Whether a rate change will affect the price payable by the recipient of the supply of goods or services therefore depends on how the contract deals with VAT. Accordingly, it is generally desirable that a contract should deal specifically with VAT so as to provide certainty for the parties.

In assessing whether a change in the rate of VAT will affect the price, a contract generally falls within one of 3 categories:

• The price in the contract is expressed to be inclusive of VAT. For example, the price is 100 and is expressed to be inclusive of VAT. In this case a rate change will not affect the price paid by the recipient (since the contract does provide otherwise in that it makes it clear that the price of 100 includes any VAT chargeable). In effect, the contract price is fixed so that the recipient will pay 100 no matter what the rate of VAT is. Therefore, if the rate of VAT is 17.5 %, the supplier is required to account for VAT of 14.89 and retains 85.11 as turnover. If the rate of VAT is reduced to 15%, the supplier is required to account for VAT of 13.04 and retains turnover of 86.96.
• The contract does not mention VAT at all. Here, the legislation operates so that a change in the rate of VAT will affect the price (since the contract does not provide otherwise; indeed it does not mention VAT at all). Therefore, if the price inclusive of VAT has been 100 (85.11 plus VAT of 14.89), the new price will be 97.88 (85.11 plus VAT of 12.77).
• The contract provides that the price is 100 exclusive of VAT, which has to be paid in addition. In this type of contract the price that must be paid is 100 plus VAT at the rate prevailing at the time a supply is made under the contract. Therefore a rate change will affect the price. Previously the amount payable would be 100 plus VAT of 17.5. After the rate change the VAT payable would be 100 plus VAT of 15.

Post-30 November supplies made under existing contracts ought to be reviewed (particularly higher value contracts) to ascertain how VAT has been addressed.