VAT surprises highlighted this Christmas

Before the VAT increase hits on January 4 2011, ICAEW is advising us what we do and do not pay VAT on this Christmas.

VAT is the tax on consumer spending which is automatically added to the goods you buy in shops and the services you purchase.

Frank Haskew, Head of ICAEW's Tax Faculty, explains: "The vast majority of things you pay for will be subject to VAT at the standard rate, which is currently 17.5%. However, this is due to increase to 20% on 4 January which means things are going to be more expensive next year. However, the VAT rules are often difficult to understand as not all purchases or transactions are subject to VAT, whilst others have it applied at a lower rate".

Reduced-rate VAT

VAT is normally seen as a tax on "luxury" items. However, many of the items subject to tax are viewed by most as essentials. For example, domestic gas and electricity and other fuels all have VAT charged on them at a reduced rate of 5%. Other goods and services subject to reduced-rate VAT include energy-saving materials installed in personal or business premises such as solar panels, mobility aids for the elderly and children's car seats.

VAT-free

There are also items that for VAT are zero-rated or exempt. Consumers do not have to pay VAT on items including most food, baby wear, children's clothing and footwear, books, newspapers, magazines, water supplied to homes, donated goods sold in charity shops and caravans (depending on their size).

Good and services that are exempt from VAT include betting and gaming, physical education and sports activities, medical treatment and healthcare, burials and cremations, funeral plans and financial services such as loans and other forms of credit.

Frank concludes: "It is worth being aware that the exact definition of a particular item can affect whether VAT is applied to it. There are a number of irregularities in the VAT system, some of which have resulted in fierce debates between businesses and HMRC".

One famous example is the ‘Jaffa Cakes case' which went all the way to a tribunal to determine whether they were classed as cakes or luxury biscuits. While cakes are exempt from tax, luxury biscuits are subject to VAT at the standard rate. McVities, the makers of Jaffa Cakes, insisted they were small cakes and eventually the tribunal ruled in favour of this.

In addition, cold take-away food is zero-rated for VAT, while hot take-away food is subject to standard-rate VAT. Similarly, frozen foods are VAT free, yet standard-rate VAT is applied to ice-cream and frozen yoghurt.

Further info can be found at hmrc.gov.uk.