Analysis: VAT rise will cost small business dear

HM Treasury

A £12bn shot in the arm for the British Treasury is hard to argue with, but
the extra tax income from raising VAT to 20% also means it is the third time UK
businesses have had to re-jig their systems in three years.

The VAT rate change – effective from January 2011 – has both financial and
resource implications at a time when businesses are still trying to survive the
uncertain economic conditions.

But which businesses will find the increase hardest to prepare for and deal
with? And will the costs incurred be just as high as in previous rate changes or
have businesses learned how to deal with the process better?

A VAT increase to 20% will have serious repercussions for some small
businesses which are unable to absorb the cost, particularly in those industries
which have tight profit margins.

And in terms of compliance it will also be the smaller businesses who will
struggle again.

Although businesses have gone through this change twice before in recent
times and know what to expect to a certain degree, the smaller companies with
manual VAT records as opposed to electronic VAT systems will still have a heavy
workload to deal with.

“It’s the ones with the manual pricing systems that will find it more
difficult than the ones with the electronic systems,” said Derek Allen, head of
tax at ICAS.

manual records means businesses will spend more time on billing and re-pricing
their goods in their accounting ledgers – or pay for an accountant to do it.
Another burden is the extra work needed to make sure that the first VAT return
submitted after the rate change is accurate.

Despite the administrative drain on smaller businesses, most companies sell
goods and services at prices including VAT. The physical re-pricing of the goods
on the shelves carries costs for businesses across the board. Typical costs
during previous rate changes ranged from £25 for very small businesses to £600
for the largest. HMRC’s own data supports the view that the compliance workload
for companies will be onerous.

A study by ORC compiled after previous rate changes found that businesses
spend the most time and money on extra bookkeeping, system changes and
re-pricing. However, the upcoming changes are not as bad as they could have
been. To the relief of retail groups and advisers, the VAT rise is not being
undertaken in stages, which would have caused more administrative headaches.

Businesses have also been given a longer lead time to prepare for the change
than on previous occasions.

Retailers complained bitt­erly about the administrative nightmare caused by
the short notice at the time of the last rate change in January this year.

The overall costs of the rate change for UK plc will still be significant,
but not as high as the two previous changes.

However, there is a final issue to consider. This may not be the last VAT
rise that businesses will have to face. Even at 20% the UK will still boast one
of the lowest VAT rates of the 27 member states in the EU so the chances of a
future hike isn’t outside the realms of possibility.

Related reading