VAT gap and revenue pressures: what to expect
As we approach the Spring Statement, the Government faces significant pressure to address the widening VAT gap, which has grown to an estimated £9.5 billion for 2023/2024 – up from £8.1 billion in 2022/2023. This substantial increase highlights the urgent need for reforms to ensure the tax system operates efficiently while supporting economic recovery.
Despite these pressures, major VAT reforms are unlikely to feature prominently in the upcoming Spring Statement. Instead, we anticipate a continuation of the enforcement-focused approach already signaled by the Government’s August 2024 announcement of 5,000 additional HMRC officers.
Enhanced enforcement
The most probable VAT-related announcement will be a reinforcement of existing debt collection efforts, rather than structural reforms to the VAT system itself. We are already witnessing increased activity from HMRC, with more aggressive use of the insolvency process and Notices of Requirement to Provide Security for businesses with outstanding VAT liabilities.
This trend indicates a shift toward a more litigious approach from HMRC, with the tax authority increasingly willing to pursue enforcement actions against non-compliant businesses. Companies with existing VAT issues should prepare for heightened scrutiny as these additional resources come online throughout 2025.
Fuel duty: likely extension of temporary relief
One area where we do expect positive news is the continuation of the temporary 5p reduction in fuel duty. Given the upcoming changes to National Insurance Contributions (NICs) and the current upward trend in inflation, imposing additional costs on businesses through increased fuel duty would be counterproductive.
The Government will need to carefully balance its revenue requirements against the risk of contributing to inflationary pressures. Maintaining the fuel duty reduction represents a pragmatic compromise that would help businesses manage their overall cost base during this challenging economic period.
Strategic VAT reforms: what we’d like to see
While the Spring Statement is likely to focus on enforcement rather than reform, there are several strategic changes to the VAT system that could deliver significant benefits for both the economy and the public finances.
The hospitality industry continues to face exceptional challenges, from the lingering effects of the pandemic to rising operational costs and changing consumer behaviors. A reduction in the VAT rate for this sector to 10% would provide meaningful relief and stimulate growth, similar to the approach taken by the Irish government as detailed in our recent industry analysis.
This targeted intervention would help preserve jobs and businesses in a sector that contributes significantly to both the economy and communities. Unfortunately, despite its potential benefits, such a reform is unlikely to feature in the upcoming statement given the Government’s focus on revenue generation.
Another opportunity would be the potential to introduce differential VAT rates for online versus in-store retail. A reduction in the VAT rate to 15% for in-town shopping, coupled with an increase to 22% for online sales, could help reverse the decline of traditional high streets while generating additional revenue from the thriving e-commerce sector.
This approach would recognise the fundamental differences between these retail models and their impacts on local economies and communities. It would also provide a much-needed boost to physical retailers who face higher operational costs compared to their online competitors.
Perhaps the most transformative reform would be to reduce the VAT registration threshold to £0 while simultaneously reducing the standard rate to 18-19%. This comprehensive approach would significantly broaden the tax base by bringing all businesses into the VAT system regardless of turnover.
While increasing administrative requirements for smaller businesses, this change would eliminate the distortions created by the current threshold, where companies often artificially limit their growth to remain below the VAT registration requirement. The resulting efficiency gains and reduction in the VAT gap could allow for a lower standard rate, benefiting consumers and businesses alike.
Looking beyond immediate economic concerns, the VAT system could also play a role in addressing longer-term public health challenges. Utilising the industry’s traffic light system for food nutrition, VAT rates could be varied based on health content – with healthier foods (three green lights) remaining zero-rated while less healthy options (three red lights) subject to rates up to 30%.
This innovative approach would create financial incentives for both consumers and producers to prioritise healthier food options, potentially delivering significant benefits for public health and reducing pressure on the NHS over the coming decades.
Preparing for a more aggressive HMRC
While major reforms may not be forthcoming, businesses should certainly prepare for the reality of a more aggressive and better-resourced HMRC. Companies with VAT compliance issues or outstanding debts should take proactive steps to address these matters before they escalate into enforcement actions.
The anticipated continuance of the fuel duty reduction will provide some relief, but this is likely to be offset by other cost pressures, particularly the forthcoming changes to National Insurance Contributions. Businesses should review their overall tax position and ensure they are taking advantage of all available reliefs and planning opportunities.
While the upcoming Spring Statement may not deliver the transformative VAT reforms that many sectors are hoping for, it represents an important moment for businesses to reassess their tax position and prepare for the more rigorous enforcement environment that lies ahead.
If you would like to discuss how the Spring Statement might affect your business or how best to prepare for increased HMRC scrutiny, please contact our tax team.
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