The Withdrawal Agreement means that different rules apply on VAT and excise apply to Northern Ireland.

Why will VAT be affected by Brexit?

Value Added Tax (VAT) is a tax on the consumption of goods and services. In general, a business charges its customers VAT on its sales (output tax). It then remits the VAT it has collected to the national tax authority, offsetting the VAT it has paid to its own suppliers (input tax). In this way, at each stage in a good or service’s production, tax is collected on the value added at that stage.

The UK was obliged to introduce VAT when it joined the European Economic Community (EEC) in 1973. VAT broadly replaced a purchase tax on luxury goods. The six original members of the EEC harmonised their VAT regimes^[1] to reduce the distortion of export refunds, which gave member states a potential competitive advantage over one another and produced economically distortionary effects.

The UK VAT system operates within parameters set by EU VAT directives, a system that only applies to EU member states. Typically EU VAT directives^[2] do not apply to members of the European Economic Area (EEA). 

At the end of the transition period, the UK will leave the VAT area. However, under the terms of the Withdrawal Agreement, Northern Ireland will remain fully aligned with the EU’s VAT rules on goods. The UK government will be responsible for implementing these rules in Northern Ireland and the UK will retain any revenue raised, rather than passing it on to the EU as now.

Would the UK abolish VAT after Brexit?

In theory the UK could abolish VAT after Brexit, but in practice it is very unlikely. VAT is a major revenue raiser^[3], forecast to raise approximately £125bn in 2017/18, which amounts to 18% of tax receipts.

VAT is also the International Monetary Fund's “tax of choice” and over 160 countries have now introduced it – it accounts for 20% of tax revenue globally. The UK has been party to the internationally agreed standards of the OECD International VAT/GST guidelines^[4] and is unlikely to reject this approach.

The government’s technical guidance for businesses preparing for the end of transition indicates the government plans to continue to have a VAT system in the UK.^[5]

Will the UK change its VAT regime after Brexit?

The UK could, depending on the terms of the final agreement, gain more flexibility on the structure of VAT after Brexit.

The current constraints include:

• The UK can maintain its existing zero rates^[6] on items such as most food, children’s clothes and shoes, and books, agreed as part of its original accession deal to the EEC. But it cannot create new zero-rated items and if it moves an item out of the zero rate band it cannot move it back.
• There is a prescribed list of goods and services that EU member states can subject to a reduced rate of VAT. This is set at a minimum of 5% with only two reduced rates allowed.
• The minimum standard rate of VAT is set at 15%. There is currently no maximum, but the European Parliament has passed an amendment proposing a cap at 25% (the current highest rate being 27%). The current UK standard rate is 20%.
• Member states cannot levy a rate of VAT that is higher than the standard rate - so the UK cannot, for example, have a luxury goods rate.                              

The EU has become increasingly concerned that intra-EU trade has become a major source of fraud and it plans to move to a single EU VAT area^[7] which would see a fundamental shift in the way VAT is accounted for. Measures have recently been agreed to reform the VAT^[8]system, including proposals for more flexible VAT rates^[9]. It remains to be seen to what extent the UK will adopt these measures in its own system.

The potential flexibility created by Brexit means UK ministers may come under more pressure to lower VAT rates or remove and reform exemptions and reduced rates. This could lead to further complexity and is likely to be politically challenging.

But this flexibility could open the way to more radical reform like a lower standard rate of VAT on everything. For example, the Goods and Services Taxes of New Zealand and Australia apply a single rate of 15% and 10% respectively, with far fewer exceptions. But there would be many potential winners and losers from such reform.

The UK already has a comparatively high registration threshold for VAT at £85,000, which has been fixed until April 2022 whilst the government consults on the recommendations from the Office of Tax Simplification.^[10]

VAT law is interpreted, ultimately, by the Court of Justice of the European Union which is binding on the UK. Post-Brexit, this will change, although the UK’s courts may need to take account of previous CJEU’s decisions when deciding VAT cases. How this will affect the interpretation and direction of the UK’s case law remains to be seen, especially when dealing with general VAT principles that have evolved over several decades.

In Northern Ireland, the UK government will be only be able to change VAT rates on goods in line with EU rules. It may also apply VAT exemptions and reductions, including zero rating, to goods in Northern Ireland if they are also applicable in the Republic of Ireland.

How will the operation of VAT change after Brexit?

The big change after Brexit will be how VAT is charged on trade with the remaining 27 member states. The scale of change will be contingent on the final negotiated outcome.

In normal domestic transactions, the seller charges the buyer VAT and then pays the money collected to the tax authority. At the moment, for EU transactions, VAT is generally not charged on the supply of goods between businesses from another European country by the supplier. Instead, a business recipient is generally required to charge itself VAT, known as acquisition VAT, which is typically an accounting transaction on the VAT return. There are different rules for private customers and other exceptions. For services, the ‘place of supply’ rules determine the country in which VAT is charged and accounted for.

How will VAT on cross-border goods change?

When the UK leaves the EU VAT area, it will become a third country. This means that the way businesses manage VAT on goods and services exported and imported to/from the EU will change. Sellers will not charge VAT, but buyers will have to pay VAT to HMRC at the point of import (alongside any applicable customs duties).

The payment of VAT at the border will have potential cash flow consequences^[11] which the UK government proposes to mitigate  for imports, through the introduction of postponed accounting for import VAT. This would shift the VAT accounting and payment away from the border to the VAT return. Postponed accounting would also apply to rest of the world imports, not just those from EU countries.^[12]