LVCR is supposed to reduce collection costs of VAT on low value imports into the UK/EU. That is its only purpose in law. Those who support LVCR abuse often refuse to acknowledge the term ‘VAT loophole’ claiming that it isn’t a loophole. However as we will explain, the loophole is the interaction of The Channel Islands position alongside the UK/EU and the unintended result of the pre-paid VAT schemes and LVCR. These three factors have created a ‘loophole’ in the law that has allowed companies to turn a VAT import relief into a VAT free trading advantage, a purpose totally contra to the intention and purpose of LVCR.
The Channel Islands have a special relationship with the UK and whilst they are within the customs territory of the EU they remain outside of the EU for VAT purposes. Because of this VAT is payable on import for goods entering the EU from The Channel Islands.
From the introduction of VAT in 1972 up until 1983 VAT was pre-paid on most packages sent to the UK from The Channel Islands through what is known as the VAT pre-paid scheme. This came into existence because Channel Islanders complained that the collection of VAT on import into the UK was causing delays resulting in cream and flowers decaying in customs. The UK Authorities encouraged this scheme because it made VAT collection easy whilst CI horticultural mail order retailers were also happy to pre-pay VAT if the goods reached UK customers faster and in peak condition.
However, for reasons unknown, when LVCR was introduced in 1983 by the EU, the UK decided that they would also allow LVCR on mail order goods coming in from the CI, even though the arrangement would result in a loss of VAT that was already being collected on a pre-paid basis . Under the LVCR Directives 83/181 the UK could have excluded mail order goods since the pre-paid scheme was working well and LVCR was not required on goods from the Channel Islands as the cost of VAT collection was already zero. Why the UK didn’t exclude CI mail order goods at this point is a mystery. It almost appears deliberate.
The equally misguided document VAT : Assurance Review of Channel Island Goods, commissioned by HM Customs and Excise in 1997 concluded that LVCR wouldn’t be abused since the authors of the report took the view that the bulk shipping of goods from the UK to the islands for breaking down into VAT free mail order shipments to UK customers was not a viable practice. However it expressed this only in terms of horticultural goods, ignoring the impact on non-perishable items, even though there were already companies on the Islands ‘circular shipping’ from/to the UK both horticultural goods and non perishable goods in order to avoid VAT!. Again, another convenient ‘omission’ resulted in the report passing over the obvious advantage that LVCR would give retailers in the Channel Islands who wanted to sell UK goods VAT free by mail order.
The ‘VAT loophole’ was born as the direct result of the action of the VAT pre-paid schemes + LVCR which together gave CI mail order a huge advantage over UK retail. Additionally with the mid 1990s expansion of the pre-paid scheme to include non-horticultural goods, Channel Island mail order was now able to sell anything through the VAT Loophole. Is it a merely coincidence that a trading advantage of this kind emerged in the Islands just as internet retail started to take off ? Certainly the fact was not lost on Jersey Post Logistics who began advertising Jersey as a major internet fulfilment hub in Europe able to offer the advantage of VAT free internet retail to prospective clients.
From 1983 the pre-paid schemes allowed goods to enter the UK rapidly with VAT paid, as if they had been sent from a UK mainland destination, whilst LVCR also allowed the same retailers to trade within the EU but VAT free up to £18. This combination gave CI retailers an unfair advantage over UK retailers who began to see their customers migrate to offshore suppliers.
In 1998 Play247.com started trading and by 2004 Play.com was the most well known Channel Island VAT free retailer. Shortly after this the offshore VAT avoiding fulfilment industry grew rapidly in size destroying swathes of UK mainland retail.
The net result of the VAT Loophole was that a tax relief that was supposed to reduce tax collection costs in the UK had been implemented in such a way that it lost vast amounts of tax and destroyed UK mainland business.