From 15 July 2020 to 12 January 2021 many businesses in the hospitality and leisure sectors are enjoying temporary cuts to the rate of VAT from 20 per cent to five per cent on certain supplies.
Announced in the Chancellor’s Summer Economic Update, the change to the VAT rules have been welcomed by businesses in these sectors, but there are certain practicalities related to the reduction that businesses have questions regarding.
What does the new rate apply to?
The reduced rate applies to all supplies of:
- food and non-alcoholic beverages sold for on-premises consumption, for example, in restaurants, cafes and pubs
- hot takeaway food and hot takeaway non-alcoholic beverages
- sleeping accommodation in hotels or similar establishments, holiday accommodation, pitch fees for caravans and tents, and associated facilities.
The reduction also applies to admission to the following attractions, where they do not qualify for the cultural VAT exemption:
- amusement parks
- similar cultural events and facilities.
This last point creates somewhat of a grey area for businesses. HMRC provides the example of a botanical garden that doesn’t fit within the other categories.
HMRC makes it clear that “it is the responsibility of the taxpayer to demonstrate that the supplies are eligible for the reduced rate” but rather than leaving it to chance, venues should check with HMRC. Sporting venues and events are specifically excluded from the rate reduction.
Bob goes to his local pub and buys a ham sandwich, a packet of nuts and a pint of bitter and purchases a tea and a pizza for his friend. All sales will benefit from the reduced VAT rate of five per cent, apart from the alcoholic drink.
The following day he goes to the local takeaway and orders the same food and drinks. This time the tea and pizza benefit from the five per cent reduced rate of VAT as they are hot takeaway food and a hot takeaway non-alcoholic drink. The crisps will be charged at the normal rate of 20 per cent and the ham roll at the typical zero-rate. Beer will, as before, not benefit from the reduced VAT rate.
How is VAT calculated under the reduced rate?
Where an amount is inclusive of VAT, this can be calculated by applying the VAT fraction to work out the amount of tax due, which has changed to 1/21.
As an example, where a supply has been made for a gross amount of £210, the VAT included within this amount can be calculated as £210 x 1/21. This gives a net amount of £200 and the VAT amount as £10.
This is significantly lower than the standard VAT rate, which would see £35 VAT charged on the same transaction.
Does a business need to reduce its prices?
Part of the reason for the VAT cut is to encourage businesses to reduce the costs of their goods and services to encourage spending and stimulate the economy.
However, it is up to businesses to decide whether or not they reduce their costs or maintain prices as they are and keep the money from the reduced VAT rate for themselves.
Where a business decides that they do wish to reduce their price they will need to make sure they take into consideration the VAT inclusive prices to reflect the reduction. To calculate this, multiply your original prices by the VAT fraction 7/8 on their gross sales
For example, if you wanted to reduce the VAT inclusive cost of a supply you make for an admission that costs £3.45, you would multiply this by 7/8 to provide the new gross value of £3.01.
How do businesses report VAT?
Tax point rules that decide when a supply takes place for VAT purposes are complex.
The relevant tax point could be when you receive payment, when you raise an invoice or when your customer receives your supply.
What happens if the booking was made prior to the reduced rate but takes place during the period when the rate is reduced?
There may be situations where you receive payments or issue invoices before 15 July 2020 for supplies that take place on or after 15 July 2020 and before the rate reduction ends.
Where an invoice or booking is raised this creates an actual tax point and VAT rate depends on when the invoice was issued and the payment was made by the customer.
If this was prior to 15 July the rate would seem to be 20 per cent but there is a concession in the legislation that allows the charge to be issued at the basic tax point i.e. when the person receives the service.
This concession is at the discretion of the supplier and not the customer and means that if a business elects to use this method and it has already received payment prior to the change in the rules any VAT reduction must be passed back to the customer as a credit note.
Angela has paid an advanced deposit of £250 on a stay at a hotel. She made and paid for the reservation in January but isn’t staying at the hotel until September. The remaining balance of £500 plus VAT she had intended to pay on her arrival.
The hotel could decide to charge just five per cent on the total balance of £500 plus VAT and it should then issue a credit note of £27.50 to ensure Angela benefits from the five per cent reduction on all her booking fees. This must be paid within 45 days.
Frank owns a small B&B and is a sole trader. He does not issue invoices to his customers and charges on a VAT-inclusive basis for all bookings. He only requests a non-refundable deposit of £50 from each of his guests.
Let’s imagine that Angela makes a booking in January and pays the £50 deposit and will pay a balance of £400 for her stay in September. In this scenario Frank’s tax liability would be £450 x 1/21, thus equalling £21.43.
Using the basic tax point method, he will have already paid £8.33 in January and will need to include the balance of £13.10 on his VAT return in August.
How will the scheme affect those on the Flat Rate Scheme?
For those businesses that are still on the Flat Rate Scheme, the rates applicable to each business activity will be subject to change as well. The new rates are as follows:
- Catering services, including restaurants and takeaways – 4.5 per cent (down from 12.5 per cent)
- Hotel or accommodation – 0 per cent (down from 10.5 per cent)
- Pubs – 1 per cent (down from 6.5 per cent)
In some cases, it may be beneficial to temporarily leave the flat rate scheme if a business has a large proportion of sales subject to the five per cent reduced rate. These businesses should be aware that once they leave the scheme they cannot re-join for 12 months.