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The VAT Increase, UK Retailing and the Consumer.
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VAT HIKE TO 20%: Effects on Retailers and Consumers

The VAT Increase

From 4 January 2011, the standard rate of VAT in the UK will be 20%, raising an extra £13 billion over a year.

The Centre for Retail Research estimated that this VAT increase would be passed on in full to the public as increased prices:

The CRR Report (April 2010) on the VAT increase was funded by Kelkoo, Europe's largest e-commerce website, as a contribution to debate within the industry.

Retail Impacts

How Soon will Prices Go Up? Retailers surveyed as part of the study showed that 64% of retailers would pass on 'most of' or the full amount of the VAT rise in the first month. 98% of retailers would ultimately pass on the whole of the VAT increase to customers.

Sales Impact. 73.3% expected that the VAT rise would cut sales and most would slim down their labour force.

Stores and Staff. We expect 9,480 stores to be closed as a result of the VAT rise in the 2011 and a further 5,000 in 2012. 47,000 staff or 1.6% of the labour force would go. The reduction in stores and staff would bear heavily upon petrol retailing, housewares, specialist food shops, furniture, electricals, bookshops and stationers/newsagents. Discounters and 'value' fashion expected to increase the number of stores they operate by around 850

Costs and Margins: VAT increased from the temporary rate of 15% on 1 January 2010. The further VAT increase in 2010, following on from a deep recession would have a sharply negative impact on retail costs and margins. Higher VAT will improve retailers' cash flow position, but negatively affect customer purchases at a time when trade (although better than 12 months before) has been poor for two years. Strong robust retailers will continue to do comparatively well, but the long tail of weak performers without a strong market position and (perhaps) stuffed with debt and expensive properties will be badly affected.


The VAT System

VAT is expected to raise a total of £81 billion in the financial (fiscal) year 2010-11, 14.8% of government receipts. This is slightly less than the amount raised by National Insurance and is double the proceeds of Corporation Tax.

VAT is levied on all goods and services bought by final consumers. Unlike most European countries, the UK has zero-rated VAT on food, although confectionery, chocolate-coated cakes, and cooked food (eaten in the store) pay full VAT.

Exceptions include: exempt goods such as education, health and financial services; zero-rated products such as children's clothing and footwear, food and books; and reduced rated items (5% VAT) such as household fuel and power, children's car seats, sanitary products and some environmental and safety items.

How Does VAT Work?

A product with a net retail value of, say, £20.00, would cost £23.50 when VAT is applied (£20.00 + [17.5% x £20.00]) and would increase to £24.00 after January 4 2011 (an increase of 2.1%). That is the theory.

VAT and Retail Prices

It is a lot more complicated than that, because there is no requirement to put VAT on individual products in that precise way. Retailers simply have to hand over to HMRC the total VAT chargeable on the goods they have sold in the previous quarter. In reality therefore, they do not decide on a net price, and then apply VAT, but decide on market prices which have got to be low enough to attract custom and high enough to cover the company's VAT bill.

For example. A retailer sells a pen with a retail price of £9.86. The price net of VAT at 17.5% would be £8.39.

When VAT goes up to 20%, then the new price notionally should be £10.07. A very unattractive price. If the retailer thinks that the better price is below the £10.00 barrier, he/she could adopt a new price of say £9.96. Effectively this is a price reduction (including VAT) on this item because the full VAT has not been passed on. But other prices could be realigned so that the total VAT raised by the company meets HMRC requirements. Small price adjustments can be made to keep prices within psychological bands.

This is all based on the assumption that some prices are 'better' (in generating total revenue) than others. '99p Stores' would look pretty stupid if they renamed themselves '£1.01 Stores' after the VAT rise.

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