DIFFERENTIAL VAT RATES

Value added tax is, as its name suggests, a consumption tax on the value added of goods and services (technically, supplies). It is a "good" tax, in the sense that businesses get relief for their inputs, so no tax is paid if there is no added value (eg because the good sold is unprofitable); contrast that with sales tax, which is applied even if the good supplied is loss-making. Critics of VAT say that the tax is regressive, meaning that it adversely affects the poor. However, this criticism is overblown. VAT is only regressive if rich and poor purchase the same basket of goods and services, and that they do not do. If the rich person buys champagne for £20 a bottle and the poor person plonk for £4, then the tax is regressive only if the rich person's income is more than five times that of the poor person. It is not quite as simple as that, not least because you have to look at everyone's purchases and everyone's incomes; but you get my point.

Under E.U. law, all Member States must have a VAT system (not least since the E.U. budget is fixed as a percentage of Member States' VAT revenues). There is a minimum percentage - 15% until the end of 2015 - but no maximum. Member States are also allowed to have certain categories of goods and services taxed at lower rates; and Governments accede to this, either in order to help certain classes of business (eg restaurants in France) or to deal with the regressive point outlined above. In Denmark VAT is 25% and is charged on virtually everything; in the U.K., on the other hand, the big exceptions have traditionally been food, books and children's clothing, which are zero rated. It has never been clear to me why Brits would starve if there were VAT on food, whereas Danes manage to survive paying 25% on it; but domestic political considerations are not always easy to follow.

So differential VAT rates are allowed; but it is now that the fun starts. Because once you have differential VAT rates, you start having quibbles about where the boundaries lie, as the recent "pasty" row in the U.K. demonstrates. Food, for zero-rating VAT purposes, generally means cold food; hot takeaway food has traditionally been treated akin to restaurant services rather than as a basic necessity, and so has been VAT-able. In the recent Budget, the Chancellor decided to levy VAT at the standard rate of 20% on cornish pasties, a peculiarly British invention, since they are often purchased hot. Enter the pasty lobby, fronted by the Cornish Pasty Association. After a sustained campaign, the Government has now backed down, sort of. If the hot pasty is sold straight from the oven, it is not being kept hot, and so is not VAT-able; if it is left on a rack to cool down, it is also not being kept hot, and so is not VAT-able; but if it is taken out of the oven and kept hot in a cabinet or similar, then it is being kept hot and so is VAT-able. Clear?

If you think that this is complicated, then you should read the history of the protracted litigation in the Marks and Spencer case, dealing with VAT on chocolate covered teacakes (of which M&S used to sell a lot). This went on for thirteen years, and involved two trips to the House of Lords and two references to the European Court of Justice. Food is in general zero-rated, but one exception is "confectionery", which is VAT-able. However, there is an exception to that exception, namely "biscuits". There is then an exception to that exception to that exception, namely biscuits wholly or partly covered with chocolate. Between 1973, when VAT was introduced, and 1994, the authorities treated the teacakes as biscuits, so the teacakes were VAT-able; they then changed their minds and decided that the teacakes were, in reality, cakes, and so should have been zero-rated. The case arose because M&S then claimed back all of the VAT which they had paid on the teacakes for some 20 years.

A salutary lesson in Governmental micro-management, if ever there was one. I eagerly await the case, which depends on defining what "being kept hot" means.

Walter Blotscher