If you own a business in the hospitality industry you are likely being crucified with high VAT bills which seem to decimate your cash reserves each quarter. Across the UK many businesses are feeling the squeeze of the cost-of-living crisis however the hospitality industry is one sector bearing the brunt of the increasing prices. According to a report by UKHospitality, 6,180 hospitality businesses closed in 2023 which brings the total closures from December 2020 to December 2023 to a staggering 22,859.
What the problem is?
VAT can be a very complex tax but in simple terms it is the difference between VAT you charge on your sales and the VAT you can reclaim on your purchases. For a lot of businesses this is manageable, and some may even choose to register voluntarily to take advantage of potential VAT refunds. However, for the hospitality industry there is a big problem with both the sales (output VAT) and purchases (input VAT).
Output VAT
Firstly, it is a very price sensitive market which means you can’t set your price and add 20% VAT on top of your sales as this would drive customers out the door. In reality lots of businesses have to take the hit themselves on the VAT charged out and a result drive their already small margins down further.
Input VAT
Secondly, the two big costs for businesses in the hospitality industry are wages and food. With wages there is no VAT, and cold food is zero rated. This means that the majority of restaurants are able to reclaim very little input VAT to offset the output VAT leading to large VAT liabilities.
Case Study
An example we have come across on one of our clients most recent quarterly VAT returns demonstrates this point (figures have been rounding to nearest £1000 for illustrative purposes)
This doesn’t even take account of the staff wages which for the period after considering employer’s NIC and pensions was £239,000. Which leaves them with a profit of only £9,000 for the quarter before any other deductions are taken into account.
To put this into perspective, despite generating over £500,000 in net sales, the business is left with a minuscule profit margin of less than 2%. Such tight margins are unsustainable in the long term, especially when unexpected costs arise.
Looking at the figures there is no wonder that many of our favourite restaurants are closing down.
COVID Pandemic vs Cost of Living Crisis
Not too long ago we all witnessed the devasting impacts COVID-19 had on the hospitality industry and the effects it had on people not being able to go out and enjoy a drink with friends or a meal with their family. At the time the government recognised this, and their intervention perhaps saved the industry with the eat out to help out scheme and even a reduction in hospitality VAT rates. Now we are dealing with the cost-of-living crisis which is threatening the industry once again.
So why is there no help now for the hospitality industry this time around? As I already mentioned they have done it before in reducing the VAT rate down to 5% from July 2020 to September 2021 and 12.5% from September 2021 to March 2022. As you can see cutting VAT for the hospitality industry isn’t an unprecedented or radical idea.
The difference between the Pandemic and cost-of-living crisis is that prices have skyrocketed from supplies of food increasing and minimum wage also increasing rapidly. This means that for restaurants to survive they need to increase their prices from say £18 for a meal to £25 for a meal just to keep up with the costs. However, in doing this they would most certainly loss customers and this is where the government can intervene to help.
What could a VAT rate cut do?
It is clear that the current VAT rate for the hospitality industry is a problem, but what could a cut in the VAT rate do for businesses?
Stop Businesses closing down
A major problem in towns and cities across the UK is seeing shuttered doors on high streets of popular restaurants that are unable to afford to stay open. As a customer this can be very disappointing but a lot of time you don’t know the answer for the closure of restaurants but as accountants, we get a behind the scenes look at the businesses and it is evident that VAT payments are a major contributing factor in hospitality businesses struggling. A reduction in the VAT rate can help decrease the number of closures and keep the high streets across the UK vibrant and appealing to customers. This will in turn help footfall in the areas and help drive sales of other surrounding businesses too.
In fact, some studies have shown that during the temporary VAT reduction during the pandemic, many businesses were able to stay afloat, preserving jobs and contributing to the local economy.
Increase employment
If the VAT rate was reduced this could allow businesses to charge customers less which in turn would bring an increased number of customers through the door. Due to the increase in customers the amount of staff numbers would also need to increase to accommodate the extra customers. This would help in decreasing the unemployment rate, which would reduce the amount benefits needing to be paid due to unemployment which is currently an objective of the Labour government.
A report by the Centre for Economics and Business Research indicated that a permanent VAT cut to hospitality industry VAT rate to 12.5% could create up to 250,000 jobs in the hospitality sector.
Higher quality produce
Investment in using higher quality produce would allow higher quality meals to be purchased at a more reasonable price, this would boost the customer experience and additionally provide health benefits by opting for more fresh produce and less processed ingredients for the customer. There are two main reasons that restaurants currently opt for lower quality processed ingredients as opposed to fresh produce. The first reason is the cost of higher quality fresh produce can be a lot higher than the processed ingredients. The cost problem could be solved by a VAT rate cut which would free additional cash to allow investment in higher quality produce. The second reason is fears of wastage; however, a VAT rate cut could help reduce waste too as prices decrease customer demand increases. Add in the better quality of ingredients and this should increase customer demand further.
Economic Growth
This may sound counter intuitive but decreasing the VAT rate could in fact help in stimulating economic growth in the UK. This can be achieved through the increase in business profits through increased customer demand and increase in turnover. The increased profits lead to higher corporation tax monies collected by HMRC. There would also be an increase in PAYE tax from the already mentioned increased staffing numbers. With the addition of decreasing the benefits paid out there is scope to increase the money the treasury receives by cutting the VAT rate.
Some may argue that reducing VAT would decrease government revenue in the short term. However, the boost in economic activity could offset this. Higher employment rates mean more income tax collected, and more profitable businesses pay more in corporation tax. Additionally, reduced unemployment lessens the burden on government welfare systems.
Other Countries
We have explored the potential benefits of reducing the VAT rate and the fact that it has been done before during COVID times but how does the UK compare with Ireland? Ireland has a higher standard rate of VAT at 23% but a reduced hospitality rate of 13.5%. There have been calls for the UK and especially Northern Ireland to adopt a similar approach. Looking across the EU many have reduced rates for the hospitality industry so it isn’t new territory the UK would be embarking on by cutting the rate. For example, Germany temporarily reduced VAT on hospitality services from 19% to 7% during the pandemic, and countries like France have maintained reduced rates for the sector. This widespread adoption of lower VAT rates in the EU for hospitality underscores the viability of such a measure.
Closing thoughts
We have explored several benefits to reducing the VAT rate for the hospitality industry. By implementing a VAT rate cut, the government could stimulate economic growth, preserve jobs, and help businesses thrive during these challenging times. However, while the rate remains as it is and if you are a business owner in the hospitality sector and are under pressure from VAT – please contact us and we can look at your business and help assist in managing your cash flows and help you manage the large vat bills.
The mention of a £22bn ‘black hole’ refers to the current deficit in public finances, as reported by the IFS. By stimulating economic growth through a VAT rate cut, the government could potentially increase tax revenues in other areas, helping to bridge this gap.
What’s next?
Our team at MJ Kane, aims to help keep you right. Schedule a free consultation call today to discuss your bsusinesses circumstances and understand what you need to do if VAT is causing you issues. If you already have a grasp, you may benefit more from one of our tax advice/planning meetings.