20% VAT makes exploitation of LVCR even more tempting

With the government continuing to state that “The implication that businesses are simply setting up on the Channel Islands to take advantage of this relief is not true”, the Guardian published an interesting article just recently about The Hut Group who are the fast growing firm behind the CD and DVD sales for companies such as Asda and Argos.  Rather than worrying about the loophole being closed it would appear that this group are banking on not only it staying open but the new 20% VAT level actually encouraging future business growth ahead of their stock market floatation.

In the last few months they have begun expanding in to other product areas including cheap handbags, jewellery, novelty gifts, sun cream and underwear.

http://www.guardian.co.uk/business/2010/jun/27/hut-group-expansion-internet-vat-loophole

Richard Allen – Open Letter to the Chancellor

The below is an exact copy of an open letter written by one of our contributors, Richard Allen to the Chancellor of the Exchequer in which he explains the effect LVCR exploitation is having on both UK businesses and the Treasury.

Dear Mr. Osborne

I am writing directly to you to inform you of a significant tax avoidance scandal that is costing the Treasury several hundred million pounds a year.

This avoidance scheme arises from an issue of which you may be aware, but on which I cannot be sure that the facts have been fully and truthfully presented to you. The facts are as follows:

1. Low Value Consignment Relief (LVCR) is established by EU Directive 1983/181. It instructs member states to exempt from VAT any imports from outside the EU of a value below a threshold that they could set at least 10 ECU (£7) and at most 22 ECU (£18).

2. The UK government has always applied the threshold at its maximum level of 22 ECU. This brings CDs and DVDs within the scope of the exemption. Since the rise in popularity of Internet-based mail order, several large retailers have been shipping goods to the Channel Islands, which are outside the EU for fiscal purposes, and back to the UK free of VAT. They hence do not charge VAT on their products and obtain a price advantage over their VAT-paying competitors.

3. However, Directive 1983/181 also mandates that member states apply the Directive in such a way as to prevent any evasion, avoidance, or abuse. Solely in the CD and DVD industry, I calculate that the avoidance runs to nearly £200m a year. This trade is affecting several other industries, such as computer memory cards, an industry that dwarfs the CD and DVD industry. This avoidance can also be termed as abuse under the principles laid down by the Halifax case (2006), because it confers upon the retailers a VAT advantage that is contrary to the intention of the Directive, through an activity whose sole aim is to avoid tax. The UK government is hence under legal obligation to act to prevent the abuse, yet has failed to do so.

4. The abuse of LVCR has also caused a massive distortion of competition, contrary to the principles of free markets and fiscal neutrality. When one supplier has to charge VAT and another does not, clearly customers will choose the one that does not have to pay VAT, and a business that is viable in the absence of the VAT differential will go out of business. This happened to me. My business was a healthy, profitable, online mail order business until HMV moved operations to Guernsey. The majority of independent music retailers in business in the UK 5 years ago are now out of business. Their decline far exceeds that explainable by the decline in the overall UK CD market.

5. The previous Labour Government in conjunction with HMRC attempted to claim that the businesses shipping from the Channel Islands to the UK are bona fide Channel Islands companies, and that it could not be established beyond doubt that the products were being circularly shipped from the UK to the islands and back to order, or to establish upon importation where they were manufactured.

6. In fact, I have documentary evidence to prove the circular shipping. Plus, due to a number of visible features on a CD, it is possible to tell on import from where a CD originates. Furthermore, many such “bona fide Channel Islands companies” exist solely to provide fulfilment services to large UK or international retailers.

7. Even if the above were not true, the Halifax principle states that an abuse of rights can be ruled if the activity confers a fiscal advantage contrary to the intention of the Directive from which it derives, and if the essential aim of the transactions is to avoid tax. Even if the goods were not being circularly shipped (which I can prove that they are), the very existence of any facilities on the islands, with or without circular shipping, is due solely to the retailers’ desire to avoid VAT. Their major market is the UK. If choice of location were solely an operational business decision and not a decision based on tax treatment, the UK mainland would be the place to be located.

8. I have multiple quotations from numerous industry insiders highlighting that the only reason that retailers have any establishments on the Channel Islands is because of the VAT advantage, and that no business that had to charge VAT on its CDs could possibly compete.

9. The Labour Government also claimed that the number of retailers shipping to the UK from the islands was insignificant.

10. In fact, Matt Moulding, CEO of thehut.com, a provider of fulfilment services to several large retailers, has stated that offshore retailers account for 96% of the UK CD market. HMRC has already had to backtrack on its claims that only 2 companies were shipping from the Channel Islands.

11. The Labour government tried to claim that it had taken steps to prevent the abuse. These steps include working with the Channel Islands authorities to establish some form of “self-regulation.” Guernsey has drawn up a “code of conduct” for the offshore fulfilment industry. However, even if these were genuine efforts rather than pure window-dressing (which I doubt), they have clearly failed, because offshore retailers account for 96% of the CD market. Moreover, they were obviously always going to fail, because the islands’ governments have a vested interest in the continuation of the circular export and re-import trade. Indeed, Guernsey’s code of conduct actually cites as one of its aims the promotion of the LVCR fulfilment industry– and the code was supposed to be one of the measures to stop the abuse!!!!

While other countries, such as Denmark, took action when they were affected by LVCR, the Labour government, as we came to expect from them, invented several red herrings and ever more pathetic excuses to explain why it lacked the courage to take action. These excuses – all entirely irrelevant to the UK’s legal obligation to prevent the avoidance and abuse and moral obligation to prevent these and the distortion – include: (i) Aren’t independent retailers in decline irrespective of the VAT problem? (ii) Dealing with the issue would require a special derogation from the LVCR Directive (iii) There would be an administrative burden on HMRC to collect VAT on imported products (iv) the constitutional relationship between the UK and the Channel Islands, and (v)The benefits of stopping the trade have to be balanced against the fact that it would be “inconvenient” for consumers to have to pay VAT on CDs (and other products affected by the abuse). I will deal with each of these in turn:

1. This issue is entirely unconnected with the general demise of independent high-street retailers in the face of online competition. My business was an entirely online business, supplying CDs by mail order. It was viable until HMV opened operations in Guernsey. The only reason it could not compete was because of the VAT advantage afforded to my competitors.

2. The UK government does not need to obtain any derogations or special permissions from the EU to deal with this issue. The purpose of this letter is not to propose which action is best suited to deal with the problem, but I can give a sample of the options. The UK could easily reduce the threshold at which LVCR applies, apply the exemption allowed for in the LVCR Directive for mail order goods, or simply cite the abuse of rights principle provided for by the Halifax case. However, even if the UK did require a special derogation, the Labour government took no steps to initiate one.

3. If VAT were to become payable on imports from the Channel Islands, there would be no administrative impact on HMRC customs officers in collecting the VAT payable on goods arriving from the Channel Islands, because without the VAT advantage the circular trade would no longer be viable and would simply cease. There would be nothing to collect. The whole market for each industry currently affected would simply move back onshore. This is exactly what happened in the case of Small Consignment Relief.

4. The Channel Islands’ economy would not be massively damaged by the cessation of this trade. It would not affect the islands’ tax advantages in other of their major industries such as financial services, nor would it affect their important agriculture and tourism sectors. The islands’ reputation may even be enhanced by their not being associated with a tax avoidance scandal. Quite apart from this, the importance of the constitutional relationship between the UK and the Channel Islands must be set in context and balanced against the UK Government’s responsibility toward its own people, and the significant disadvantages that the continuation of this trade entails for the UK.

5. The argument that it would be “inconvenient” for consumers to have to pay VAT on their CDs (or other products affected by the abuse of LVCR) is specious at best. Consumers benefit most when there are many suppliers in the market, all competing for their business. When most suppliers have gone out of business and only a few are left, there is less competition and less incentive for firms to compete so aggressively on price.

However, even if certain consumers did benefit from the VAT avoidance, the point is this. If VAT is “inconvenient” for consumers why does it exist at all? If it is “inconvenient” to pay VAT on everyday household products, why doesn’t the Government exempt them too? In an ideal world, nobody would have to pay tax on anything, but in reality government revenue has to come from somewhere, and why should consumers of goods circularly exported and re-imported be treated differently to consumers of other, onshore, goods? Indeed, if VAT on CDs is “inconvenient” why not exempt CDs from onshore providers from VAT too? In reality, the real inconvenience currently lies with those consumers who do pay VAT on the products they buy, who are effectively subsidizing those who do not.

It is my opinion that the Labour Government constructed the elaborate web of lies detailed above to cover up its inaction on this issue largely because it did not want to be associated in the media with action that forced consumers to pay VAT. However, the incoming Conservative Government, by raising the main headline VAT rate to 20%, has already shown its readiness to take such a risk to its popularity in order to plug the massive fiscal deficit left by Gordon Brown.

Furthermore, if we are bringing in public interest arguments, there is the massive loss to the Treasury, which is being filled by those who actually are paying tax. There is Gordon Brown’s massive budget deficit, which this loss to the Treasury is exacerbating. There is the huge distortion of competition caused by the VAT differential. There is the disappearance of the majority of the UK’s independent music stores and the unnecessary offshoring of jobs, with a separate resulting loss of income tax and NI to the Treasury. Furthermore, there is the fact that many emerging artists have to work with an independent label when they are starting out. Independent record labels are reliant on independent retail which has traditionally supported new talent owing to the fact it is generally run by specialist enthusiasts. I discovered and developed a major specialist rock act called Porcupine Tree, that has gone on to be internationally successful, and I know at firsthand how important the independent sector is. In the absence of independent shops and with independent labels then struggling to get exposure, what does the future hold for the next generation of musicians? This is an important question given that music is the UK’s largest cultural export and one for which it is renowned throughout the world.

If we are “balancing” costs and benefits, the question is the following: does the “benefit” of giving special favourable treatment to one class of consumer and one class of supplier justify distortion of competition, distortion of free markets, massive loss of revenue to the Treasury, threat to a major UK export industry, offshoring of jobs, and failure of several viable businesses in many industries?

6. As stated above, ending this trade would not cause a loss of jobs on the mainland, as former Paymaster General Dawn Primarolo once claimed. It is the continuation of this trade that causes jobs to be offshored to the Channel Islands, and, through eliminating distortion, the ending of this trade would make the UK economy more efficient, enabling it to produce more jobs in the long-run. Protecting the UK’s ability to produce new musical talent would also protect jobs.

7. This issue is entirely unconnected with other VAT avoidance issues such as carousel fraud.

I see no reason why a Conservative Government would now not put an end to this abuse to which the Labour Government turned a blind eye, an abuse that is costing the Treasury hundreds of millions of pounds, distorting markets, offshoring jobs, and damaging the UK economy.

Indeed, if you require further help in detailing and documenting the Labour government’s elaborate duplicity on this issue, or if your staff wishes to discuss ways in which this abuse can be stopped, please do not hesitate to contact me.

I look forward to the Conservative Government’s imminent action to end this abuse.

Yours sincerely

Richard Allen

Cc Cheryl Gillan MP

Cc Eleanor Shawcross

Cc Rupert Harrison

Cc Poppy Mitchell-Rose

Cc Ramesh Chhabra

Cc Rt Hon Danny Alexander MP

Cc Will De Peyer

Cue Entertainment – Some Interesting Quotes

The Digital Home Entertainment Trade magazine Cue Entertainment recently published an in-depth overview of the exploitation of LVCR and the effect that it is having on mainland businesses.

The full article can be obtained at www.cueentertainment.com but below you will find a number of interesting quotes from the article.


The previous government denied there was any market distortion caused by the current system of tax relief. The Treasury’s Financial Secretary Stephen Timms MP stated in an email last February that: “The implication that businesses are simply setting up on the Channel Islands to take advantage of this relief is not true.”

His assertion flies in the face of direct statements made by offshore retailers. In its 2006 Year End Report, HMV cited competitive advantage as a means to improve competitiveness as a reason for relocating to Guernsey.

It states: “Fulfilment for hmv.co.uk was relocated to Guernsey in November 2005, enabling it to improve prices relative to our Internet-based competitors, and at Christmas sales increased by 78% on the prior year.

The internet fulfilment service of the Jersey Post Office, Jersey Post Logistics, marketed the circular shipping of goods on its website to potential customers. It advertised a service offering to collect goods at Portsmouth for transport to Jersey, before re-mailing back to the UK. When the VAT strategy unit at HM Revenue & Customs was informed, the website disappeared. The practice, however, has not.

One example is when the a new album or DVD is pre-sold ahead of its release date. On release, that item is shipped from the UK distributor to the Channel Islands for packaging and redelivered to a largely UK customer base. Some have questioned why simply storing goods in a warehouse for a predetermined period makes the setup any less noxious. The fact is that an industry exists in an area where it would not if purely market laws applied.

It is not just the music and film sectors that are affected. The range of vendors now taking advantage of LVCR in the Channel Islands has steadily expanded over recent years. Items such as memory sticks, memory cards, printer cartridges, camera peripherals, car parts, vitamins, contact lenses, lingerie and cosmetics are all available from the Channel Islands.

In fact, the global memory card business dwarfs the music business by over seven times, being worth an estimated £143 billion a year.

It finished by moving back to the Music and DVD industry with some interesting figures from the Entertainment Retailers Association :

INTERNET SALES VOLUMES

2005

Total Internet sales of CDs – 20 million units with a total value of £200 million

Total Internet sales of DVDs – 28 million units with a total value £335 million.

2009

Total Internet sales of CDs – 34 million units with a total value £280 million (increase on 2005 of 40%)

Total Internet sales of DVDs – 70 million units with a total value £700 million (increase on 2005 of 209%)

TOTAL MUSIC MARKET VALUES (BOTH INTERNET AND TRADITIONAL SHOPS)

2005

Total CD Sales £1,856m

Total DVD Sales £2,214m

2009

Total CD sales £1,314m  (decline of 29% on 2005)

Total DVD sales £2,111m (decline of 5% on 2005)

TOTAL NUMBER OF RETAIL OUTLETS ON UK MAINLAND

2005

Music Retailers 5,621

DVD Retailers 6,040

2009

Music Retailers 4,644 (19% decline on 2005)

DVD Retailers 5,181 (14% decline on 2005)

TOTAL NUMBER OF INDEPENDENT RETAIL OUTLETS ON UK MAINLAND

2005

Music Retailers 734

DVD Retailers 251

2009

Music Retailers 269 (63% decline on 2005)

DVD Retailers 175 (30% decline on 2005)

According to the ERA 2010 yearbook (stats on ERA website) 33.8% of DVD sales by value were internet sales and ca. 22% (figure less digital) of music sales by value i.e. £714m DVD and £289m music C Ds.  In terms of the volume figures it was ca. 71 million DVDs  (about 1 in 3) and ca. 38m CDs (about 1 in 4)  were sold via internet mail order.

Submit information to support EU Complaint

RAVAS is working with IMPALA (The European Independent Music Association) and has been making official representations to the European Taxation Directorate and the European Commission regarding the UKs failure to implement LVCR correctly thereby allowing it to become a vehicle for widespread tax avoidance.

The European Taxation Directorate has requested evidence of any competitive distortion within the UK created by the abuse of LVCR with a view to taking infraction proceedings against the UK if there is shown to be a market distortion arising from the UKs application of the relief.  RAVAS and IMPALA will be submitting evidence. If you wish to add to that submission please contact us through this site.

Your contributions will be entirely confidential.

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