Tax snatchers stall innovation as government tackles debt

HMRC's crackdown could compound the effect of government plans to raise VAT from 17.5% to 20% from January.

"We have had clients for which this has been a concern and one that has stopped doing something as a result [of fears about VAT liability]," said Alan Connell, director of indirect tax at law firm Eversheds. He said HMRC seemed to be seeking to apply a high court tax ruling in October 2007 about Premier Foods' Hartley's Fruit Bars to other items.

The Vice Chancellor of the high court ruled the product was confectionery, as was any inherently sweet food, and so was liable for input VAT.

Processors pay input VAT for some ingredients and retailers for some finished products. The VAT Act 1994 states most foods are exempt, except for confectionery, which includes sweetened prepared food "normally eaten with the fingers" and biscuits covered with chocolate or chocolate-like coating.

Connell said the law was confusing and the tax status of cereal bars in particular was disputable. One processor speaking to Food Manufacture last month said the VAT helpline and the VAT office gave it conflicting advice, but it was finally told that its yogurt-coated biscuits were exempt.

The government's tougher stance on tax was influencing HMRC action on VAT and food, said Connell. "There haven't been any new rules, it's just that they [HMRC] are looking at things in a slightly more restricted manner because of the economy."

Since May 1, 1997, HMRC can claim lost tax backdated for up to three years on items found to be VAT-liable. A long appeals process could cost hundreds of thousands of pounds, said Connell.

He said the only way to ensure a new product's tax status was to go to HMRC proactively. It rarely reversed opinions and the courts frowned on this. But he said manufacturers receiving advice would be expected to apply it to similar existing products.

An HMRC spokesman said: "HMRC looks at compliance risks across the business spectrum, and carries out targeted action where appropriate.

"The VAT treatment of food is an area of risk that HMRC has always checked, but it is just one of many risks."