It’s become evident over the last week that VAT is likely to turn out to be a major issue in the Scottish Independence debate.

As long ago as November, the Institute of Fiscal Studies was suggesting that VAT could have to rise to 28% to balance budgets in an independent Scotland.

But with the intervention last week of Donato Raponi, Head of VAT Division at the European Commission, the specific and alarming implications of independence for VAT in Scotland are becoming clearer. In a letter seized on by Ruth Davidson, leader of the Scottish Conservatives, Raponi says:

Under the current EU VAT rules, member states are obliged to apply a standard rate of at least 15 per cent and may also apply one or two reduced rates, set no lower than five per cent… Once the accession treaty is agreed along with any VAT derogations, it is no longer possible for a member state to introduce special VAT rates… The member state must apply the EU rules.

This is an extremely significant statement, because it makes plain that Scotland would not have the right to ‘introduce special VAT rates’. Crucially, Scotland would lose the right to apply zero rates to any items. Scotland currently, as part of the UK, applies zero rates to fifty-four areas.

Scotland would lose the right to apply zero rates to any items.

At the very least, Scotland would need to apply the standard (full) rate to items such as children’s clothing and footwear. Of all EU member states, only the UK and ROI have negotiated zero rates for children’s clothes; Scotland faces losing the right to apply the exemption. If the IFS is correct, this could see a 28% cost increase in Scotland on children’s clothes.

Nor would books any longer have a zero VAT rate applied to them; there would be a minimum 5% charge (assuming Scotland chose to apply the reduced rate for books permitted by the EU – otherwise the full standard rate would apply). The Scottish book trade is extremely concerned by the prospect of such a rise, especially as it would be so easy for Scottish book-buyers to make their purchases over the border in England. Hugh Andrew, chief executive of publisher Birlinn, is clear about the risk: ‘to create a price differential in a single English-language market would potentially be fatal to the Scottish book trade.’

The Scottish Nationalists have responded robustly to Ruth Davidson’s attack: they claim that ‘an independent Scotland will not be an accession country and will negotiate the specific terms of our continued EU membership from within.’ But, as I said in my blog last week, this is hopeful speculation rather than a statement of fact. It may even just be wishful thinking. The President of the European Commission, Jose Manuel Barroso, gave an interview to the BBC in December that included an exchange about Scottish independence. He said:

If a country becomes independent it is a new state and it has to renegotiate with the European Union… If there is a new state of course that state has to apply for membership and negotiate the conditions with other member states  

It is, then, extremely probable that an independent Scotland would have to apply considerably higher VAT charges than its English neighbour to culturally sensitive items. For Alex Salmond, this raises the terrifying spectre of Scottish mothers crossing the border to buy clothes and shoes for their children.

These serious problems may be the reason the ‘Yes’ campaign has tried to stop VAT becoming an issue in the debate. My colleague James Forward has pointed out to me that the SNP Government’s White Paper on independence explicitly sets a timeframe for looking at VAT that is past the date of the referendum. The white paper says:

Detailed policies on tax and spending will be set out in party manifestos for the 2016 election and thereafter in the first budget in an independent Scotland…

Powers over VAT, currently exercised by the Westminster Government, will transfer to the Scottish Parliament as a result of independence. The tax system in place immediately before independence will be inherited at that time. Thereafter decisions on the tax system and all specific taxes – including tax rates, allowances and credits for VAT and other taxes – will be made by the parliament and government of an independent Scotland.

Again, the problem with this as a policy position is that it assumes that Scotland will be legally entitled to inherit the ‘tax system in place’. But, as we have seen, if Scotland is to become a member of the EU – an essential plank of Mr. Salmon’s independence platform – it is highly unlikely that it will be able to keep the current system.

One reason the European Union will be extremely reluctant to allow a ‘new’ member state to enjoy special VAT benefits accruing to old ones is that the European Commission is actively attempting to standardize VAT across Europe. The Commission published in October 2013 a proposal that would, if implemented, see the introduction on January 1st, 2017 of a standard EU VAT return, permitting only limited VAT differences between member states. The proposal, produced by a team led by Signor Raponi, was approved by the European Parliament last week. It is currently being reviewed by member states, and has the potential to be highly controversial. The new sovereignty desired by the SNP cuts against the grain of the efficiency sought by the European Commission.

If these were not troubles enough for Mr. Salmond, there is yet another serious VAT issue for an independent Scotland, this time affecting businesses right around Europe. Andy Spencer, Director of Professional Services at Accordance, makes the crucial observation that if Scotland ‘is treated like any other Member State, businesses making taxable supplies in Scotland may have to register for VAT there’.

So, if Scotland becomes an independent Member State of the EU, with different VAT rates to the remaining parts of the UK, companies based outside of Scotland but trading into Scotland (for example, online retailers) may have to register separately for VAT in Scotland. They will also have to file additional ongoing VAT returns there. Over 150 million VAT returns are filed across the EU annually. It is estimated that over one million companies based in the EU trade cross-border and require non-resident VAT registrations. Many of these companies trade into the UK. English and EU based firms may need new Scottish VAT registrations; it is possible that Scottish companies may also need new Scottish VAT registrations!

Not only will this represent a significant administrative burden for companies in Scotland, the UK and the EU as a whole, discouraging business activity in Scotland; it is also very likely to have the effect of driving down tax revenue in Scotland. If businesses alarmed by the uncertainty surrounding administrative and commercial frameworks in an independent Scotland elect to leave the country, this will further drive down the country’s VAT take. Standard Life’s announcement last week is an illustration of the problem. And the higher VAT rates for Scotland implied by the statements of Mr. Raponi and Mr. Barroso make it probable that Scots will seek to make purchases outside the country.

The VAT loss to the new Scottish exchequer could be immense.

By |March 3rd, 2014|