Why is a proposed VAT cut so important for hospitality businesses?

Hussein explains: It’s relatively straightforward to implement, in line with the rest of Europe, and would be a game-changer for businesses of all sizes.

Adam Coghlan

First off, can you explain how VAT in restaurants works?

Hussein Ahmad

VAT is tax and it's charged on most goods and services. In a restaurant sense – let's think about alcohol: A supplier will bring wine into this country, and they'll send that wine to a restaurant, and they'll charge 20% VAT on top of the wine. The restaurant then pays that invoice, pays the VAT, and then when they sell the wine, they also charge 20% on wine. The restaurant gets to reclaim the VAT that they've paid, but has to send the government the VAT that they've taken from the consumer. So all businesses act as tax collectors in effect for the end user, which is the consumer. 

It kind of goes back like concertinas until it goes, eventually goes to the government. I think the key thing to note is that it's on top of your sale, so all the numbers in your profit and loss (P&L) don't include VAT.

Hussein

A rough example: if I've turned over £120,000 in a month in a restaurant, £20,000 of that is VAT, not £100,000 of that is considered turnover in my P&L, so that's why theoretically if the VAT rate changes to 10% then total turnover should be £110,000 rather than £120,000. That is assuming I don’t pass any of the VAT saving onto the customer.

Adam

If there's a reduction, is the idea that hospitality businesses won't change their prices, but they'll reach 10% extra profit?

Hussein

That's the idea, whether it's spoken or unspoken.

Another good example: during Covid, the VAT rate for food and soft drinks was dropped from 20% to 5% and then gradually increased to 12.5% percent for another period of time.

The majority of our clients didn't pass that saving on, they just kept the additional 15% on those sales, and it was the difference between a lot of clients being open and being profitable or closing. But it's a difficult message for the government to say that they're changing the VAT rate in order to allow businesses to hold on to an additional 10% in this case. 

In the proposals from the Tom Kerridge-fronted campaign, which Labour leadership hopeful (and potential next Prime Minister) Andy Burnham has committed to, they said that, and there's no details behind it, that the hospitality VAT rate will move from 20% to 10%

The effect if the hospitality businesses did not pass on that tax cut to the consumers would mean an additional just over 9% on the bottom line of restaurants, if everything else – costs, prices, etc. – remained the same. Considering a successful business is achieving between 10% and 15% of net net profit, if you add another almost 10%, that's massive. And it means that those businesses that are currently making a small loss, could easily be moved into either break-even or profit-making scenarios. Those businesses that are already making handsome profits could start opening more restaurants.

Adam

Would restaurants perhaps consider passing on some of the saving to the consumers, so say reducing their menu prices by 5% so they give the customer incentive, and then also they're still making an extra 5% themselves?

Hussein

I think what it gives is leeway, it gives them options.

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Adam

Does this then exist in the minds of restaurants because it happened during Covid, and it obviously worked, and it's sort of fresh in memory as a lever that policymakers can pull?

Hussein 

I think so. I think because it was proven to work and it's not complicated in terms of the admin compliance around it. No matter what restaurants would say, all you have to do is reprogram the till, which might be a few hours work, but not rigorous. 

I think the other reason why it might be at the forefront of restaurants’ minds is because the UK is one of the only countries in Europe that doesn't have a different VAT rate for hospitality. Italy, Spain, Italy, France, 10%; Germany, 7% for food served in restaurants, Ireland 13.5%. So the UK is a slight outlier.

Adam

Why hasn't it happened before now do you think?

Hussein

Probably because it's quite unusual. So, there are only three VAT rates in the UK, as it is 20% standard rate, applicable to most products or services. There is also a 5% rate for a few categories – energy, a couple other things – and then zero rated, which is for goods considered essentials, so like children's clothes, groceries. 

So creating another code or VAT number for hospitality is I guess, because it hasn't been done before, quite a big idea. Other industries would soon pipe up and say, ‘why is hospitality being allowed to have this, and we aren’t?’

But hospitality is the third biggest employer so the government takes quite a lot of money in VAT from hospitality businesses, so in theory they're going to take a hit on revenue generation from VAT if they cut the rate. But it also might be offset if hospitality businesses are growing or not closing and keeping people employed, because payroll taxes, corporation tax and a greater volume of VAT revenues come in that way. But I think it's quite a big political step to do it, and I guess no government has been incentivized to do that. There's been no real requirement until now.

Adam

Is one option available to the government that it could tailor the rate-cut to different sized businesses?

Hussein

Potentially, but then that adds in different layers of compliance, yeah, which removes the simplicity and adds to intra-industry conflicts and tensions, I'm sure.

Adam

What do you think's behind this increase in noise around the issue at the moment? Like, what's happened recently?

Hussein 

I think it's since Covid the industry has been hammered with rising costs, along with the cost-of-living crisis that has reduced spend and so the hospitality businesses have been squeezed from both sides. Also, because of changing consumer behavior and change in the world we live in, delivery is now a huge, much bigger alternative to dining in as well.

Adam 

Is there a sense in which there's not really anything they can do about any of the other costs, and this is one number where there's the possibility that it can be changed.

Hussein

Yeah, it's the only one. This is a very simple way of helping every hospitality business relatively equally. The other costs, by comparison: energy, you’d have to negotiate with all the different energy companies, landlords, and rents. How do you go about fixing rents? It’s all much more difficult.

This is the easiest way to do it, and seemingly with a more friendly new Prime Minister, it appears now is the time to make that move. It would be a game changer.

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Adam 

What else could be done? And indeed, if this reduction doesn't happen, what should be done in order to improve the fortunes of hospitality businesses. Are there any other options? 

Keep calm and carry on…?

Hussein

Yeah, because the UK economy is predicted to not grow or grow very slowly. The pie is not growing. The pie is remaining the same, so the only way for businesses to increase their revenue or profits is to take on other businesses so in that case, in order for A to survive, they have to take B's market share, and therefore B closes. So if nothing changes, then it will be restaurants closing in order for others to survive.

Adam

Natural selection…

Hussein

There is an argument that it is natural selection, and the restaurants that aren't surviving are not good enough in the market.

Adam

But it’s not as simple as that is it? Despite ‘the market’, some have what you could argue are ‘unfair’ advantages, whether that’s cash or investor capital or a demographic advantage in terms of being well-known because of who they are.

Husein

I imagine there are restaurants who are struggling which will argue that they provide something for their community, they provide jobs for people in society and if more and more hospitality venues are shutting, there's fewer and fewer opportunities for young people who historically are employed within the hospitality sector.

So, I think the government is probably having to take a broader view of the importance of the hospitality sector.

Adam

Do you think the conditions for hospitality businesses are objectively and fundamentally unfair?

It feels to me like the narrative around this campaign for reduction in VATfeels somewhat desperate, and existential and that it would be a measure that would make operating the conditions in which they operate more, it's not like a leniency thing, or like an unfair advantage. It feels to me like it would, it would just make it a little bit more fair.

Hussein

I’m hesitant to say fair or unfair, because I don't know anything about any other industry, really, apart from broad brushstrokes. I think a lot of retail businesses are struggling, you know, they're competing against the internet. The high street, in general, is struggling.

I think it would just give hospitality businesses breathing room to survive, and hopefully thrive.

Adam 

Is this all it takes, do you think?

Hussein

I think we need a shift in mentality more broadly. Are businesses being given breathing room just to keep doing what they've always been doing, and then when, if they get hit by other external factors, then what? You're sort of back to square one.

I feel like there has to be a more of a structural or change of perspective that comes with this because it's a tax break or tax subsidy for hospitality businesses as a recognition of how important they are in society, and so I think that operators also have to recognise that and actually put the conditions in place to make these professions for young people to join and start and progress.

Adam

More like in Europe you mean?

Hussein

Yeah, in Europe it is considered like a proper vocation and is treated as such. The operators treat their staff with the respect that they've taken on a vocation, and I think that if we are then granting hospitality business status to that same standard standard, then the operators, and people within it, the bodies around it, the talk on social media needs to recognise that. 

I see this is an opportunity for us all to work together in order to keep the cogs oiled and the machine functioning – and it has a knock-on effect. That's how the government has to see it in order for them to actually do it long term: that they won’t lose, per se, instead it'll create conditions for the industry to grow.