VAT zero ratings

January 2025 TAX DEADLINE DATES
December 11, 2024
Nature of trading stock
January 18, 2025

Too many zeros

Key points

  • Supplies of goods and services qualify for zero rating by virtue of VATA 1994, Sch 8.
  • Clients must take extra caution with ‘indirect exports’, in particular when the customer collects the goods in the UK and arranges the export themselves.
  • HMRC carries out various checks to ensure that zero-rated take-away food sales are accurate.
  • Builders must decide the rate of VAT to charge and not rely on their customers to do it.

I always enjoy telling the tale about my time in Customs and Excise – about 40 years ago – when I visited a take-away kebab business that only sold one zero-rated item: milk shake drinks. At the time of the previous inspection four years earlier, the milk shake sales were 2% of his total turnover, the balance being standard rated as hot take-away food. So far, so good. However, in the interim period, the percentage of milk shake sales declared in his accounting records increased to 40% of total turnover, a gradual increase occurring each year. On New Year’s Day in 1987, when it snowed all day, and was about minus six degrees, his records said that he sold a record-breaking 500 milk shakes. Fantastic! You can probably guess the rest of the story.

Anyway, back to 2024, and I was recently discussing with tax guru and long-suffering West Ham supporter Peter Rayney the extra 5,000 compliance staff who will be recruited by HMRC and the priority work they could do to increase the Treasury’s tax yield. ‘Sort out the excessive zero-rated sales,’ was my contribution about VAT.

In this article, I will highlight my concerns that many businesses are not keeping the necessary records to support their zero-rated supplies and could risk an expensive four-year assessment – plus interest and potential penalties – if they get a call from HMRC. Urgent action is needed. I will also highlight HMRC’s recent successes in the First-tier Tribunal (FTT) – by my reckoning, the score in the last 12 months is that it is winning 5-0 on cases involving zero rates.

High-risk trade sectors

The UK’s list of supplies that qualify for zero rating is more extensive than those in all EU member states. It is also acknowledged that some of our zero ratings make as much sense as a vegetarian buying a strip of tickets in a meat raffle – if you’re buying a pet, make it a rabbit rather than a dog and then the pet shop won’t charge VAT because rabbits are edible.

Supplies of goods and services qualify for zero rating by virtue of VATA 1994, Sch 8, but I will focus on three categories where HMRC could enjoy rich pickings from the orchard if it put on some gardening gloves:

  • Export of goods – particularly the quality of evidence needed to clearly prove that goods have left the UK.
  • Take-away sales of cold food – and the accuracy of splitting zero-rated and standard-rated supplies at the point of sale.
  • Construction services – this has been a source of major errors since VAT was first introduced to the UK in 1973.

When I advise accountants about the nation’s favourite tax, I always encourage them to ensure that clients are not complacent when it comes to holding supporting evidence about their zero-rated sales. Just because a business has not had an HMRC compliance review for 12 years doesn’t mean that it will be another 12 until the next one. Definitely not.

The commercial reality is that zero ratings are an important privilege in the tax legislation and are there to be enjoyed, rather like one of Hyacinth Bucket’s famous candlelight suppers in the comedy series Keeping Up Appearances. Many businesses fall short of the standards necessary to ensure there is no potential challenge from HMRC. Read on!

Export of goods

Since the UK’s final departure from the EU on 31 December 2021, all sales made by a GB business where the goods leave the UK are classed as exports and are therefore zero rated. There are special rules for Northern Ireland, which is still part of the EU’s single market for goods but not services.

If you have any clients that export goods, my advice is that they should spend a couple of hours reading HMRC’s well-written VAT Notice 703. I strongly recommend section 6 as a priority, which is helpfully headed ‘Proof of export’. The evidence to support zero rating must be a combination of two sources:

  • Commercial documentation – eg insurance documents, copies of sales invoices.
  • Transport evidence – which shows the route of the goods and mode of transport from the time they leave the UK to their arrival in the overseas country. See Zero-rating exports of goods – complying with the law.

The paperwork should be sufficient to describe the goods fully. To quote from the notice at paragraph 6.5: ‘Vague descriptions of goods, quantities or values are not acceptable.’

In the FTT case of Maron Plant Ltd (TC8523), the directors could not prove to either HMRC or the judge that goods had been shipped to Ireland and were therefore zero rated as an export. The company sold 29 items of plant and machinery – mainly JCB excavators – to two linked customers based in Ireland. The sales were made in 16 different shipments, covering 20 sales invoices.

HMRC challenged the zero rating because the company had not provided adequate proof that the goods had been shipped to Ireland; there were no bills of loading or evidence of the route taken to ship the JCBs to Ireland. There were many invoicing discrepancies and some goods appeared to have been resold in Northern Ireland, ie had never left the UK.

The tribunal agreed that the ‘burden of proof is on the appellant’ to show that zero rating is appropriate. Not surprisingly, the appeal was dismissed and HMRC’s assessment for £201,025 issued in February 2019 was confirmed, ie the sales were treated as standard rated because the goods had never left the UK.

As a final tip about exports, make sure that clients take extra caution with ‘indirect exports’, ie when the customer collects the goods in the UK and arranges the export themselves. The customer must forward export evidence to the supplier but as the old saying goes: ‘Out of sight, out of mind.’

Take-away food

It always amuses me when I go into a particular food shop – a national chain – and order a sandwich and the cashier doesn’t ask if I will eat it in the store or take it away from the premises. Without asking this question, the cashier has no choice but to charge the lower amount and zero rate the sale as cold take-away food, otherwise customers would rightly complain that they were overcharged – ‘I’m taking it back to the office, I want £1.10 VAT refunded.’

HMRC’s computer can identify specific businesses within a particular trade category that are paying less output tax – or claiming more input tax – than the average business in that sector. VAT enthusiasts might recall that HMRC had success several years ago identifying Subway franchises that had overstated their zero-rated sales.

In the case of Peppermint Foods Ltd (TC8553), an officer with experience of Subway outlets decided that 58% of standard rated sales ‘seemed low’. An assessment based on 78% of sales being standard rated was issued and the judge agreed that the officer had used his ‘best judgment’ with the calculations (VATA 1994, s 73(1)). See HMRC checks on zero-rated take-away food sales.

In the recent case of BJ Shere Khan Star City Ltd (TC9244), a restaurant over-stated its zero-rated takings. The tills did not distinguish the liability of sales and the judge referred to the ‘chaotic way that the tax affairs of the business was conducted’.

In the separate case of Queenscourt Ltd (TC9184), the judge agreed with HMRC that cold ‘dip pots’ were not a zero-rated supply in a hot take-away meal deal. Hot food is always standard rated.

Construction services

Why do many builders incorrectly zero-rate sales that should be standard rated or – in other cases – charge 5% VAT instead of 20%?

Putting aside any deliberate actions, my view is that too many builders let their customers decide the rate of VAT to charge. As we know, the supplier must always decide the rate of VAT, even in the case of self-billing arrangements where the customer issues the invoices.

  • ‘We’re putting in a new kitchen at the office of a local charity, they say they we shouldn’t charge VAT if they give us their charity number with the Charity Commission. Is that correct?’
  • ‘We’ve agreed to do a job for a wealthy man in Midsomer village. He claims that our work is zero rated because his house is a listed building. Is that correct?’
  • ‘We’re building a bungalow for a farmer next to the farmhouse for his mother-in-law to live there. The farmer says our work is zero rated because it is a new bungalow that has no physical link to the farmhouse.’

The answer to these questions is the same as the famous words of former prime minister Margaret Thatcher in 1990 about closer ties between the UK and Europe: ‘No, no, no.’

Note – in the case of the farmer’s bungalow, the reason that the work will almost certainly be standard rated is because the planning conditions will usually state that the bungalow and farmhouse can only be sold as a single package, ie it fails one of the conditions of a new dwelling necessary for the zero rating of construction services. See VAT Notice 708, para 14.2.

As a separate issue, even when builders have correctly zero rated their services, it is important that supporting evidence can be produced to confirm the rate is correct – for example, architect’s plans, correspondence with surveyors and property address.

Final cases

To complete the loop, here are a few words about two other cases won by HMRC in 2024 about zero ratings.

  • Mark Glenn Ltd (TC9255) – a hair-loss procedure known as the Kensey System did not qualify for zero rating as a supply of goods to a disabled person. The judge agreed with HMRC that the taxpayer had failed to produce any evidence that ‘baldness in women is considered as a chronic sickness by the medical profession’.
  • Duelfuel Nutrition Ltd (TC9055) – a sports nutrition bar did not qualify as a zero-rated cake. The judge noted that the ingredients were quite different to those used in a cake; a cake was a treat but the bars had tastes and textures that were different to a treat. As the product did not qualify as a cake, it had to be classed as confectionery. The decision is consistent with HMRC’s policy manual at VFOOD4380.

As I said at the beginning of the article, that makes the score 5-0 to HMRC – not even Manchester City win by that margin. 

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