The government returned the rate of VAT to its previous level of 17.5 per cent on January 1st, despite retailers’ insistence that the lower rate should be maintained.
When the government announced previously that it would be cutting the rate of VAT by 2.5 per cent to 15 per cent, it was met with derision from many quarters. Opposition politicians and many business groups accused the government of tinkering around the edges of the economic problem, and suggested that the reduction was a waste of time and money.
In retrospect, it seems that the VAT reduction actually had a broadly positive effect – to the point where many of those who had previously derided the idea found themselves lobbying for the reduction to be kept.
But the rate is back to 17.5 per cent again and although many shoppers apparently hit the shops on New Year’s Eve in order to beat the increase, the medium-term economic effects are yet to be seen.
But what does the VAT increase mean for your business?
On the most basic level, the VAT increase means that your prices are likely to change. If you sell products or services that are liable for VAT, you will need to consider increasing your prices. This may involve you altering price tags or changing your promotional material.
However, many large businesses are choosing not to increase their prices – and you might wish to consider doing the same. Somewhat misleadingly, many of these retailers say they have ‘frozen VAT’ in their stores. This is not the case; instead, they have absorbed the increase and have accepted a reduction in their profit.
This might well be a sensible option if you operate in a particularly competitive environment, in which price is an important differentiator. If your competitors are absorbing the VAT increase, you should seriously consider following suit. On the other hand, if you have few competitors, or if your customers tend to make their decision based on differentiators other than price, you may be able to increase your prices without sacrificing custom.
Input vs Output VAT
The balance between input and output tax is one of the primary considerations when a business is deciding whether to become VAT registered. Input tax is the VAT you pay on goods or services that you buy, while output tax is the VAT you take on goods or services you sell. If your output tax exceeds your input tax in any financial year, you will have to pay the difference to HMRC.
The change in the VAT rate may well have an effect on the balance between your input and your output tax. For example, if you choose to increase your prices in line with the new VAT rate, your output tax will be higher than it was last year. However, some of your suppliers may have chosen not to raise their prices and, as a result, your input tax will be lower. At the end of the tax year you are therefore more likely to be forced to pay VAT to HMRC.
When considering whether or not to absorb the VAT increase, you should therefore look carefully at what your suppliers are doing. If you suspect that you will see only a small drop in trade if you bump your prices up, it may be that this is more than offset by your increased tax bill. Remember, of course, that you will still be paying 17.5 per cent on things you buy, regardless of whether or not your suppliers have ‘frozen’ their prices – but it will be 17.5 per cent of a lower figure.
This gives rise to a curious situation in which you may be better off finding a supplier that has put their prices up, rather than stick with one that has absorbed the VAT increase. Before switching suppliers you should ensure that you have made careful calculations based on your predicted sales; often, the time and work required to switch suppliers may offset the tax saving.
The VAT reduction and the subsequent increase have both been contentious. However, while many retailers benefited from the reduction, all those affected will now have to deal with the consequences of the increase. The choice of whether to raise your prices or absorb the increase will depend on a number of factors, including the state of your competitors, your existing customers’ loyalty, and the financial necessity of maintaining your sales volumes.
But regardless of your individual situation you must ensure that you properly consider the implications of the VAT increase, and are ready to take steps to mitigate any negative effects.