When I first moved to this country more than eight years ago, among the (many) quirks of London life I encountered was that every day at lunch, the cashier at Pret would insist on asking if I planned to eat in or take my lunch away. After initially thinking ‘when in Rome’, one day I finally plucked up the courage to ask – what business did the cashier have in knowing whether I was to (miserably) eat my sandwich at my desk or (only slightly less miserably) eat it alone in one of the cramped tables while scrolling through my phone? And there I had my first encounter with one of the most (to my mind) absurd features of the British tax system – the quirks of the application of VAT on food.
Ahead of Rachel Reeves’ Budget of Doom™, the tangled mess of our VAT rules is a valuable reminder of how meddling politicians can make tax policy worse.
You see, VAT is meant to be a tax applied across the board, and the principle is sound – by taxing consumption rather than investment and taxing everything equally, you minimise the economically distortive effects of said taxation. And yet. Since the tax’s inception, politicians have not been able to resist putting in carve-outs for whatever they deemed a noble cause – baby clothes, domestic energy, and of course – food.
Most food is zero-rated, so raw meat and fish, fruit & vegetables – most of the things you would buy in a supermarket – are free of VAT. But the operative word here is ‘most’. Since the origins of the tax, the government has applied full VAT treatment to sweets and the like, as well as to food consumed in restaurants, on the basis of what the government deems a necessity or a luxury.
Even leaving aside the principle behind this differentiated treatment, the true absurdity begins at the margins of these policies. As Dan Neidle of Tax Policy Associates has put it, ‘any sufficiently detailed VAT rule is indistinguishable from satire’. What better subject for Budget eve?
Let’s return to the example we started with – food eaten in a restaurant attracts (standard rate) VAT, but what about takeaway food? In 1984, Nigel Lawson explained in his Budget speech that ‘take-away food clearly competes with other forms of catering’ (e.g. restaurants) and thus extended VAT to ‘hot take-away food and drinks’. But note the distinction of hot food – cold takeaway food kept its tax-free status. So still to this day, a cold sandwich is zero-rated, but a kebab is hit with the full rate.
This distinction can lead to some farcical outcomes – take the example of Itsu (an Asian food chain). Having spent an afternoon ringing up various items, I can personally confirm that their (hot) noodle dishes get hit with VAT, whereas their sushi does not. Sushi is a necessity, after all.
The same distinction applies to certain drinks. Taking away a (hot) latte or Americano is liable for VAT, but an iced coffee or a frappuccino is not. I’m a firm believer that every season is iced coffee season – and apparently so is the Treasury!
But the real fun begins in the semantics of this policy – how do you define what a hot item is? What about a croissant or a pasty that is freshly baked, and in the process of cooling down? Well given it’s meant to be sold at room temperature and just happens to be hot while being sold to certain customers, it’s tax-free. Unless of course the bakery is intentionally keeping it hot, under a heat lamp, say, in which case it is taxed at the full rate. Who could argue with the logic of that?
Now let’s go to the confectionery aisle in the supermarket, or rather the Treasury’s desire to keep you away from that aisle. Rather remarkably, this crusade dates to 1962 and the old Purchase Tax regime, the forerunner of VAT. Then Chancellor Selwyn Lloyd announced in his Budget Statement a new ‘tax on sweets’ (via expanding the Purchase Tax) which ‘will be welcomed by the medical professions, or ought to be’. Specifically, this would apply to ‘confectionery (in other words, sweets, including chocolate biscuits), soft drinks and ice-cream’. What’s even more remarkable is that specific (and narrow) definition has carried through to today, with only a few bumps along the road in the intervening 60 years. (For more on the history, see this excellent Tax Adviser blogpost).
Even today, ‘biscuits wholly or partly covered in chocolate’ get the full VAT treatment, but non-chocolate biscuits and cakes do not. So a chocolate-chip biscuit (e.g. where the chocolate is pressed into the dough before baking) is tax-free, but if that biscuit is instead coated in chocolate, it is taxed. What about a biscuit coated in caramel? VAT-free, of course. Ditto for a chocolate sandwich biscuit like a Bourbon (fine as long as the chocolate ‘is not continued onto the outer surface’, to quote the HMRC guidance), or for that matter, chocolate cake.
Is a chocolate digestive substantially more unhealthy than a millionaire’s shortbread, for example? A cursory comparison of their nutrition facts would suggest the opposite. Is said biscuit more of a luxury? It is called millionaire’s shortbread after all…
The boundary between what should and should not be taxed can be so complicated that the courts sometimes get involved. Indeed, the one VAT fact that many Brits may know is the famous Jaffa Cakes case of 1991, where McVities successfully argued in court that their product was more similar to a cake than a biscuit, and thus should not be liable for VAT.
And indeed such court cases continue to provide a rich vein for satire (and a rich living for lawyers, one imagines). Earlier this year, a company called Innovative Bites successfully saw off an appeal at the upper tier tribunal from HMRC, arguing that they had to pay VAT on their ‘Mega Marshmallows’. VAT is normally levied on any item of ‘sweetened prepared food, other than cakes and non-chocolate biscuits [naturally…], which is normally eaten with the fingers’, and thus marshmallows should fall under that definition.
However, the company successfully argued that ‘Mega Marshmallows’ are in fact more akin to a cooking ingredient, because as everyone knows, they’re meant to be roasted over the campfire rather than eaten straight away! As cooking ingredients (such as cooking chocolate) are not liable for VAT, the same should apply for these fireside companions. And the judges agreed – who knew tax policy could be so riveting?
These Kafkaesque examples illustrate a broader flaw in our tax system. Namely, all of these carve-outs mean we have a relatively narrow base of taxation (48% of potential sales are covered by VAT, compared with the OECD average of 58%). Coupled with our high registration threshold, our present VAT regime is a lot more distortionary than it needs to be. This is bad for growth – given that consumption taxes are among the least economically damaging, by keeping the VAT base so narrow we’re essentially forcing the Treasury to raise taxes in more anti-growth ways (such as stamp duty on shares and property).
Fixing all this isn’t easy of course – George Osborne discovered this the hard way in 2012 when he tried to remove the ‘cooling down’ distinction applied to freshly baked goods. As many will remember, it was dubbed ‘the pasty tax’, and The Sun dutifully launched its ‘Who VAT all the pies’ campaign. In the resulting furore Osborne was forced into a climbdown – with a satisfying Sun front page to match – and his Budget dubbed the ‘Omnishambles’ partly as a result.
So we should be under no illusions that Rachel Reeves is likely to change any of this in her upcoming Budget. Still, for a new Government with a huge majority and all the political wind at its back, it could do far worse than prune the jungle of exemptions that has grown up around our VAT regime.
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