What is VAT and how does it work?

Updated on July 18, 2022

man cooking in restaurant

With effect from today, the VAT rate on hospitality and tourism has been reduced from 20% to 5% under the leadership of Finance Minister Rishi Sunak.

Food and nonalcoholic beverages, lodging, and entrance to attractions around the UK are all included in this offer, which is valid until 31 March 2021 (it was initially set to expire on 12 January but has been extended).

Mr. Sunak stated that the measure is intended to “get the sectors going and to protect jobs,” but what is VAT and how does it operate?

What exactly is the value-added tax (VAT)?

Taxes on products and services are known as value added taxes, or VAT.

In the UK, the usual VAT rate is 20%, and this applies to nearly half of the things consumers buy.

Some items, such as children’s car seats and home energy, are eligible for a 5% discount.

Currently, the lower rate also applies to sanitary products, however the government indicated in the March 2020 Budget that it will no longer charge VAT on these items as of 1 January 2021.

Any applicable value-added tax (VAT) will already be included in the item’s price when you look at it in a store.

Most supermarket food, clothing for children, and periodicals and magazines are examples of goods for which you don’t have to pay VAT.

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What is the revenue generated by the VAT?

VAT is expected to raise $136.6 billion in 2019-20, according to OBR estimates released in March.

Around £4,800 per home and 16.8 percent of all taxes collected, this amounts to a total of £7.6 billion.

The overall value of goods and services produced in the economy contributes for about 6.2 percent of GDP.

The evolution of the UK’s standard value added tax (VAT) rate

Which other taxes does this resemble?

Following income tax and national insurance contributions, VAT was the UK’s third-largest source of revenue in 2018-19.

More over half of all government tax revenue comes from a combination of these three taxes.

What has been the evolution of the VAT?

VAT increased to 20% on January 4, 2011, from 17.5 percent previously.

After the financial crisis of 2008, the government temporarily reduced the VAT rate to 15%.

Approximately £12.4 billion in revenue was lost as a result of the rate drop, which went into effect on December 1, 2008 and ended on December 31, 2009.

Retailers were supposed to pass along the savings to their customers in the form of higher sales.

Back then, the idea was polarizing, with former Conservative Party leader David Cameron labeling it a “unbelievable and expensive disaster”.

For its part, the Institute for Fiscal Studies was a little more positive. It expected a 1% increase in sales and indicated that a VAT reduction compared favorably to other economic incentives.

Because no one knew what would have happened in the absence of the rate drop, determining the overall impact was difficult.

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The government stands to lose £4.1 billion as a result of Mr Sunak’s six-month cut to hospitality and tourism.

Exactly how much savings from the VAT reduction are businesses passing on to customers?

According to Treasury projections, households might save an average of £160 annually, but not all businesses will pass the savings through to customers.

Instead of reducing prices, many businesses are anticipated to use the extra cash to bolster up finances that have been weakened by the lockout.

Even the head of VisitBritain Malcolm Bell said the decision was designed to help businesses, not tourists.

There are also a number of tourist attractions that may not pass on the savings.

For coffee served at Starbucks-operated locations, however, the full 15 percent discount will be passed on to customers.

Wetherspoon, a pub operator, and McDonald’s have both agreed to lower pricing on a variety of products, including meals, coffee, and soft drinks.

How does the United Kingdom stack up against other nations?

When compared to other EU countries, the UK’s VAT rate of 20% appears to be in the center.