VAT: Questions and answers

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THE axe has come down on the island’s VAT revenues.

And the damage was even worse than feared – reducing government income by up to a further £75m, although the blow will be softened by phasing it over three years.

So why has this happened?

The UK has insisted that the sharing arrangement within the Customs Agreement is changed, saying a fairer and more equitable formula was needed. The fact that the UK economy is in dire straits is also likely to have played a part.

But the deal was only changed in October 2009 – why did it have to change again?

Revenue shares were worked out by calculating growth in national income. But when a new way of measuring national income was introduced in 2010, based more closely on international standards, the UK said the increase in the island’s share of revenue became unsustainable.

HM Treasury realised that in contrast to the UK, the island had a higher proportion of businesses that were exempt from paying VAT.

How much did we lose in the 2009 changes?

The changes in 2009 directly resulted in the Manx government losing £50 million in the first year and £100 million in every year thereafter. The total loss once the figures were plugged into the formula was expected to be £85m for last year and £142m for this year and every year after that.

In the event, however, the increase in the VAT rate helped to offset the loss which was reduced to £68m last year and £114m this year.

So what’s changed in the new deal?

The new Tax Based Measurement Method is still based on economic activity but it looks at national income on sector-by-sector basis.

What will this mean for our share in VAT revenue?

Total revenue this year from the Customs duties is £342m, of which £40m is raised directly and is not pooled with the UK, leaving £302m. That figure includes the £114m reduction from the last change.

Government revenue will fall as a direct result of the changes announced this week by £75m, taking the figure to £227m. But the UK has agreed transitional payments of £45m and £25m this year and next, taking the revenue share back up to £272m and £252m respectively, a net reduction of £30m this current financial year and £50m in 2012-13.

Why did we agree to such a large cut?

The government said negotiations were robust but the UK Treasury had made it clear that unless a new sharing arrangement was agreed, it would terminate the Customs Agreement. The Manx government said this would have been too high a price to pay.

What would have happened if the Customs Agreement had ended?

Businesses would have suffered increased administration, compliance and cash flow costs to register and file indirect tax returns and customs declarations. Customs barriers would have to be set up and island residents could face customs barriers when they travelled.

So how is the shortfall going to be tackled?

Treasury Minister Anne Craine says the broad strategy for rebalancing the budget after the 2009 VAT bombshell remains valid but the balance of spending reductions, taxation revenues and use of reserves will need to be adjusted. She said front line services and the vulnerable would be protected ‘where possible’.

‘We will look at all options,’ she said, adding that it would be difficult to implement any major cuts in the current financial year.

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