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VAT increase confirms bleak midwinter
HMRC fills a hole in landfill details
Premium rate for IPT
Second delivery on postal services
Other indirect tax changes
The end of the road for Lennartz

VAT increase confirms bleak midwinter

In a the measure described by the Chancellor as 'unavoidable', the standard rate of VAT is to be increased from 17.5% to 20% with effect from 4 January 2011. It is estimated that the change will generate around £13bn of additional revenue per year.

Although the increase was widely predicted, the delayed introduction may be a surprise to some. By delaying the change for six months, the Chancellor has effectively foregone the £6.5bn of revenue that could have been raised during the remainder of this year. However, additional VAT revenue may still be generated during the next six months as some businesses and consumers try to avoid the effect of the increase by bringing forward their spending plans.

Businesses will have some concerns about the administrative and commercial costs of having to adapt to another rate change. Those that cannot recover all of the VAT that they incur (eg those in the charity and not-for-profit sector) will be hardest hit as the increase will represent a real increase in their operating costs. Even those that can fully recover the VAT incurred on eligible costs will need to be aware of the cash flow implications if they have to pay their suppliers before the VAT can be recovered from HMRC.

There is also a word of warning for businesses making supplies on or around the time of a VAT rate change. Although there are transitional rules for such transactions, new legislation will be introduced to prevent the widespread abuse of those provisions. This anti-forestalling legislation applies in specific circumstances ‑ although not normally where the purchaser of the goods or services can recover the VAT to be charged in full.

Finally, in order to address another consequence of the rate increase, the rates used by smaller businesses to account for VAT under the optional Flat Rate Scheme and the thresholds for joining and leaving it are to be increased from the date of the rate rise.

HMRC fills a hole in landfill details

At the Budget in March of this year, it was announced that it would become HMRC's responsibility to prepare and publish the environmental criteria to be used by the Treasury to determine what materials qualify for the lower rate of Landfill Tax (LFT). This would replace the previous rule that lower rated waste must be inactive or inert. The materials that currently qualify for the lower rate of LFT are set out in a Treasury Order introduced in 1996.

It was confirmed in today's Budget that the publication of the new criteria would be provided for in legislation in the autumn. Once the new law is introduced, the Treasury will be obliged to use the new criteria to determine whether the lower rate of tax applies to disposals made, or treated as made, on or after 11 April 2011. 

In practice, it is not anticipated that the scope of the lower rate will change. However, the Government has indicated that, in the event that the publication of the new criteria means that amendments to the 1996 Order are necessary, the Treasury will introduce a revised Order which will also come into effect from next April. If that becomes necessary, the terminology will be updated to reflect recent regulatory developments.

Premium rate for IPT

The emergency Budget has announced increases in the rates of Insurance Premium Tax (IPT). The standard rate will increase from 5% to 6%. The higher rate will rise from 17.5% to 20% in line with the increase in the standard rate of VAT. Both will take effect from 4 January 2011.

The standard rate of IPT applies to most general insurance, including home contents insurance, motor insurance (where the policy is based on the drivers risk and not simply sold with the car). It also applies to business insurance, including public liability cover. However, certain types of insurance will remain unaffected by the increase, notably life insurance and mortgage or pension linked insurance.

The higher rate of IPT affects mechanical breakdown cover and extended warranties taken out with the purchase of motor cars, motorcycles and domestic appliances. It also applies to travel insurance.

The higher rate was introduced to combat avoidance, by preventing businesses from artificially 'value shifting' between goods subject to the standard rate of VAT and the related insurance. As the standard rate of VAT has been increased, it comes as no surprise that the higher rate of IPT has also had to be raised.

It is anticipated that insurers will pass the rises in IPT on to policyholders. However, although that would create additional costs for businesses and consumers taking out insurance, the UK standard rate of IPT is still below that of many other European countries.

Second delivery on postal services

The Government has reconfirmed the intention to restrict the scope of VAT exemption to the services provided by Royal Mail Group, the UK's universal service provider of public postal services. 

The announcement will apply to supplies made on or after 31 January 2011and will mean that Royal Mail will charge VAT at the standard rate on services it is not required to provide under its Licence. In particular, VAT will apply to:

• Services provided on terms and conditions that have been individually negotiated between Royal Mail and its customers
• Services provided by Parcel Force

Public postal services, such as the handling of stamped mail and supplies of incidental goods, will continue to be exempt. Charges made by Royal Mail for allowing private postal operators access to the postal facilities that it provides under its Licence will also continue to benefit from exemption. Private individuals are, therefore, unlikely to be affected.

As highlighted in our Budget analysis in March of this year, customers of Royal Mail Group would be well advised to review any service contracts extending beyond 31 January 2011 to identify whether VAT will be added to the fees agreed.  For businesses that are unable to recover all of the eligible input tax that they incur, the addition of VAT will be a real cost. However, the majority of VAT registered businesses will generally be able to recover the tax.

Other indirect tax changes

As part of his Emergency Budget, the Chancellor took the opportunity to make a number of other announcements affecting indirect taxes.

Who's got the power?!
Legislation will be introduced to implement changes to the place of supply of gas, electricity, heat and cooling with effect from 1 January 2011.

Currently, electricity and gas supplied via the natural gas distribution system is treated as supplied where the wholesale customer is established or where the gas is consumed. UK customers are, therefore, required to self-account for VAT on such supplies when they are received from abroad. However, there are currently no rules covering the application of VAT to supplies of heat and cooling. The existing rules will, therefore, be amended to:

• Cover heat and cooling supplied through networks
• Cover supplies in all categories of natural gas pipeline but limiting their scope to supplies involving natural gas pipelines located in the EU or linked to EU pipelines
• Extend relief from VAT at importation to all natural gas imported via a network

Failing to qualify
Certain supplies of a 'qualifying aircraft' are zero-rated for VAT purposes. A qualifying aircraft is currently defined as one which weighs 8,000kg or more and which is not designed or adapted for recreation or pleasure use. However, with effect from 1 January next year, this definition will be brought into line with the principal EU legislation and will be based on the status of the customer. Broadly, this will mean that zero-rating will only apply to supplies of aircraft used by airlines operating for reward primarily international routes.

Size does matter!
With effect from 1 January 2011, an anti avoidance measure will be introduced changing the basis on which duty is calculated on long cigarettes (ie those that are 8cm or longer, excluding the filter). From that date, each additional 3cm, or part thereof, of cigarette will treated as an extra cigarette for the purposes of duty calculation. So for example, a 12cm cigarette will count as three cigarettes (effectively being 8cm, 3cm and 1cm long). 

The end of the road for Lennartz

More details have been provided on the introduction of a VAT measure previously announced in the March 2010 Budget. The change will affect businesses buying items such as land, property, boats or aircraft which are to be used for both business and private purposes.

From January 2011, such businesses will no longer be able to reclaim input tax incurred on these costs if they are to be used for non-business purposes. The so-called 'Lennartz accounting' has been around since 1991 and effectively allows businesses to reclaim all of the VAT incurred on the initial purchase of such goods provided that output VAT is subsequently paid over by the business, from time to time in relation to any private use. 

Where businesses have already adopted 'Lennartz accounting', they will be given a choice of either unravelling their position or, where the cost of this would be burdensome, continuing to account for VAT based on Lennartz.  However, legislation will be introduced to ensure that those choosing to carry on will have to continue to account for VAT on the future private use.

For a business that has already committed to and budgeted for Lennartz accounting, the complete unwinding of the previous calculations may not be beneficial. However, as the manner in which this accounting has been administered by HMRC has proved to be contrary to the EU VAT rules, it seems only fair that such businesses should be allowed to continue to use the mechanism as originally planned.