Stirring Up a VAT of Trouble: An Analysis of the Pasty Tax

Let's not forget the humble pasty started life as a portable lunch for ordinary working fishermen and tin miners. Ken McMeikan, CEO of Greggs, summed it up well when he said: "people simply can not afford to pay 20% more for everyday food."

According to Mark Twain, "The only two certainties in life are death and taxes". In the case of food, however, there's nothing certain at all about taxation. It was a lesson I learnt the hard way when, as a new assistant buyer, I accidently set up the whole milk drinks category under the wrong VAT code and then spent weeks grovelling to the Accounts Dept. to clear up the mess.

The complexities of food VAT have never been more in the spotlight than recent weeks amidst the backlash against the so-called 'Pasty Tax'. Yet, the morning after the Budget when interviewing George Osborne for Today, the BBC didn't consider the tax change even worth mentioning. Why has it become one of the hottest news topics around?

The 2012 Budget introduced standard-rated (20%) VAT on all food and drink (apart freshly baked bread) "above ambient air temperature when provided to the customer". When VAT was introduced in the 1970s, the Heath government promised the necessities of life would not be subject to taxation. As a result, most retail foods were exempted but restaurant food was taxed: eating was deemed a necessity, but eating out was not.

In 1984, the scope of VAT was widened to include hot takeaways on the grounds they were designed for immediate consumption and so "in competition with meals served in restaurants and cafes". Of course, the world has moved on a lot since the '80s and many food retailers nowadays sell hot takeaway-style products such as pasties and rotisserie chickens. However, they've often avoided charging VAT, arguing products were only hot for reasons of health and safety or because they were fresh from the oven and not because they were meant to be eaten straight away.

So far, so good. As Sarah Teather MP put it on Question Time, it's "a simple matter of a level-playing field". How can it be right for a baker or big supermarket to sell a hot pasty VAT-free, whilst the family-run chippy next door must charge customers an extra 20%? Even without this disadvantage, recession always hits the restaurant trade particularly hard. "Eating out" is typically named as one of the first things consumers stop doing when times are tough: in 2011, over 680 restaurant groups went bust.

However, VAT on food is rife with anomalies and imbalances. No matter how much my husband may disagree, HMRC do not consider ice-cream one of life's necessities and so tax it at 20% but they exempt Baked Alaska. A strawberry smoothie is weighed-down with VAT but fresh strawberries aren't. Peanuts are a luxury unless they're still in their shell. In the context of the Pasty Tax, sandwiches are a particularly good case-in-point: buy a sandwich from your staff canteen and take it back to your desk, you'll pay 20%; pop out to M&S and do the same, you won't.

Why not iron out this anomaly too? How can this be any more fair? Not all Caterers are megaliths like Compass or Aramark; not all workplaces have access to a supermarket round the corner. A sandwich tax would probably also have been a lot easier to administer. The practical challenges of VAT on the basis of product vs ambient room temperature are mind-boggling: as the journalist Simon Jenkins remarked, "a shrewd politician says 'stop! this is a disaster area' and leaves it entirely alone."

So was the government just being daft? They may have felt there was no alternative, no matter how tricky the tax change would be: In March last year, a German fast-food operator Manfred Bog won a landmark case in the European Court of Justice: Under German tax law, foodstuffs are subject to a lower rate of VAT than restaurants and catering services. Manfred successfully argued that takeaway food for immediate consumption is a supply of foodstuff, not catering as the elements of service one would normally associate with a restaurant are not predominant.

Although the laws involved are extremely complex, the ruling theoretically paved the way to challenge the UK's position that hot takeaway food is catering and so VAT-able.

Last autumn, the National Federation of Fish Friers joined forces with accountants KPMG to start testing the waters. The implications of a victory are mind-blowing. The UK fish and chip industry is currently worth c.£1.2bn a year. A successful claim would not only cost HMRC £240m a year in future tax revenues but could also result in VAT reclaims for at least the last four years. We'd be talking at least £800m and this is before claims from all the other takeaways in the country - the Chinese, the Indians, the hot dog vans - have even been considered. One of the elements in HMRC's favour is the fact that, unlike Germany, the UK also takes heat into consideration in its VAT legislation. However, when some hot food in the UK is actually sold VAT-free, any case focussing on temperature would be potentially compromised: Failing to address the loop-hole was perhaps just too risky.

That said, whatever the rights or wrongs of the tax per se, the government have certainly come across as hopelessly out of touch in their handling of the case and it wouldn't be in the slightest bit surprising if they simply hadn't predicted the backlash. Whichever spin-doctor allowed George Osborne to talk in terms of 'the rich paying the most, the poor the least' in a Budget which cut the top rate of income tax, but increased VAT on ordinary foods frankly needs some serious medical attention of his own.

Let's not forget the humble pasty started life as a portable lunch for ordinary working fishermen and tin miners. Ken McMeikan, CEO of Greggs, summed it up well when he said: "people simply can not afford to pay 20% more for everyday food". He has repeatedly talked in terms of job losses and closures of businesses as a direct result of the Chancellor's proposals. Given that £30m was wiped off Greggs share value as a result of the tax, he may well have meant his own but even so, the impact on small business can't be under-estimated. Regardless of whether or not customers are willing to pay the extra 20%, the additional VAT complexity will cost money. As one small business owner put it, "I spend one week full time every quarter doing my VAT return; I recently asked my accountant if he would pick it up but he said he would charge me too much... the number of VAT rules... is bonkers... as it's so complicated, the chances of a mistake are so large, there's bound to be a need for me to pay more."

Perhaps the most fascinating part, however, is the way in which the Cornish Pasty suddenly seems to have captured the public imagination and ignited a fierce national pride: as one protestor outside Downing Street last week put it, "it's an attack on our heritage". It's all very unexpected given that a 2010 survey by This England magazine found we were the least patriotic country in Europe. As a nation, it's certainly true we're more uncomfortable than most with out-and-out anthem singing and flag-flying displays, but looking back over the years, we've often taken pride in the quirkier, quintessentially British aspects of life. This now seems to be manifesting itself in a new-found pride in our food. Celebrity chefs like Gary Rhodes who has long since championed the excellence of British produce and Heston Blumenthal, whose latest restaurant Dinner is a celebration of British cuisine, have undoubtedly helped. However, even at local level, there's a growing undercurrent: Over 40 regional foodstuffs from the Melton Mowbray Pork Pie to the Birmingham Balti are currently applying for Protected Geographic Indication status. Perhaps it's partly a reaction against our long-standing reputation as the culinary joke of Europe. There's nothing us Brits love more than an underdog.

So in this David and Goliath tale, what are the humble pasty's chances against the Big Bad Tax Man? As a spokesman for Rowe's Cornish Bakery put it, "never say never". Twelve days ago, an appeal against the VAT change was narrowly defeated in the House of Commons, but the consultation period on the tax has now been extended until 18 May: plenty of time for the troops to rally. In the last week alone, we've seen the presentation of a 500,000 strong petition to Downing Street and further marches in Cornwall. In this particular food fight, the Treasury should perhaps have listened more carefully to the old saying, "an army marches on its stomach".

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