VAT changeback to cause potential blackspot for FDs

With VAT due to revert to 17.5% from 1 January 2010, finance
departments have been readying themselves for the change by focusing resources
on their pricing, billing and VAT recovery operations.

When the government cut VAT from 17.5% to 15% on 1 December 2008 it was clear
that this act of fiscal stimulation would be a temporary one ­ so while
companies had little warning of the cut, they had plenty of notice about its
reversion to the higher rate.

Gary Harley, head of indirect tax at KPMG, says that having gone through one
rate change, finance departments should be set fair to comply on time. “They
already have a process in place. It is a relatively straightforward issue and
they will have documented the changes they had to go through when the rate went
down. If they haven’t asked for system changes already, they will need to make
sure the organisation has a robust manual workaround for that period between the
new rate coming in and any upgrade to their system.”

New Year’s hangover
But while system changes seem to be a straightforward matter, there have been
some questions on making the change workable for those businesses trading over
New Year’s Eve and into January. Concessions have been made for businesses
operating beyond midnight on New Year’s Eve: pubs, clubs, restaurants, some
retailers and telecoms companies have until 6am on 1 January 2010 before they
need to start charging the additional 2.5%. Bill Dodwell, head of tax policy at
Deloitte, says the rise is still likely to prove a headache elsewhere,
particularly for major retailers.

There are two areas of concern that strategically involved FDs will need to
ponder and plan for. The first is around ticketing, advertising and promotional
material. “Legally, you are not supposed to charge more than advertised, so
there is an issue for retailers who will have to get tickets on items changed in
a very short space of time,” says Dodwell. They will have to do that in advance
of the January sales at a time when staff are already hard pressed, he points
out.

Finance directors have also had to identify nuances such as those around
credit notes. “If an invoice has been raised with VAT at 15% they will need to
be careful that any credit note isn’t issued at 17.5%,” says KPMG’s Harley.

The second issue is the potentially thornier one of consumer perception. “The
real question is how is that going to play with consumers. The idea that you are
going to charge more than the advertised price is a deeply unappealing one. It
is clear that people are going to have to put a lot of effort into this and it
is likely that we will see different consumer strategies around handling it.”

The reversion to 17.5% is not the only VAT change on the horizon. The New
Year also brings in changes to rules meaning that companies sourcing
administrative, helpline or back office services from locations outside the EU
may now incur VAT, where previously they did not.

After 1 January 2010, those companies operating in sectors such as banking,
insurance and healthcare that outsource functions abroad will have to account
for VAT under the reverse charge mechanism and incur 17.5%, unless they can show
that those functions, if provided by a UK company, would be exempt from VAT.

Cost concerns
KPMG’s Harley says this fundamental shift could lead to significant cost for
businesses, with call centre services, data processing and other administrative
functions likely to be caught. In addition, all sectors will have to complete
statistical declarations recording the value of services supplied to business
customers across the European Union. “This is an additional compliance cost for
business at a time when they are facing very difficult conditions.
Unfortunately, there is plenty of stick but not much carrot in these proposals,”
he says.

Belinda Doshi, outsourcing and technology lawyer at Field Fisher Waterhouse,
says the changes may make outsourcing more costly, but a knee-jerk reaction ­ to
terminate outsourcing arrangements, for example – is to be avoided. “That is the
nuclear option and can take months to renegotiate, if not a year. While 17.5% is
a big hit, you can mitigate the cost increase.”

Contracts up for renewal still have scope for renegotiation and further
savings, says Doshi ­ and FDs may want to revisit benchmarking and open book
rights with outsourcing contracts, so they can assess where their contracts are
in the marketplace.

Many companies argue that their arrangements are sufficiently circumspect to
avoid being caught out. “Virtually all services received by AXA from third
parties outside the UK already fall into the ‘defined categories’, as UK VAT has
always applied to such services,” explains Tony Greenman, senior manager of
group tax at AXA. I don’t anticipate any new, material VAT cost or procedural
change to arise.”

Martin Scott, FD at regional brewing and pub company Hall & Woodhouse,
says his is one such business. From a systems point of view, the changeover will
be a simple matter. “Luckily our technology is up to date. We have just put in a
new accounting system. The change in VAT is very simple and doesn’t have to be
implemented at midnight because [the system] is not customer-facing,” he says.

Putting prices back up to compensate, however, is not an option, with
consumers still hard-pressed. Hall & Woodhouse will not be able to start
charging more on food and drink on 1 January because consumers are still
spending conservatively. “Going into January there is a bit of a fear that the
VAT change will have quite a significant impact. The chance of getting a price
increase through to consumers in 2010 is zero. The high days are good, but there
is a compact spending pattern overall. People aren’t going out more than once a
week. So we have got to grow turnover by 2.5% before we even start.”

Dario Garcia, head of VAT and transfer pricing at Barclays, thinks the
changes won’t affect the decision on whether to outsource or not, but might in
marginal cases cause organisations to look closely at costs between Indian
suppliers and those in Eastern Europe, for instance.

Not a bad exercise for cost-conscious companies anyway. But from a systems
point of view, the changes actually simplify things, he says. “You don’t have a
classification issue. Everything is coded as reverse chargeable.”

Garcia thinks the VAT increase is more of an issue for the banks. Commodities
trading, commercial leasing and other property transactions will all be
affected by the rate rise, but by and large, the measures taken when the rate
went down will stand the finance function in good stead. “We obviously kept that
change programme alive because we knew the rate was going back up. And who is to
say it won’t go back up again.”

VAT cut: much ado about nothing?
In a recent survey of KPMG clients, 83% had a high or very high awareness of the
rate change and 88% were confident they would meet the deadline.

Respondents were less happy, though, as to the success of the reduction
measure, as implementation has not been cost-free.

Around 61% said benefits such as driving increased sales, for instance, had
not outweighed the costs of compliance – and 60% said they would not be able to
pass on those costs to customers.

The tax authorities will be keen to get back to business as normal. According
to HM Treasury, the 2.5% reduction has cost the Exchequer an estimated £12bn
over 12 months.

For more on the changes to outsourcing, go to

www.hmrc.gov.uk/VAT/ec-sales-lists.pdf