A brief summary of VAT, tariffs and duties

VAT and tariffs

Suddenly, customs duties and tariffs have captured the spotlight and are dominating global news. Who would have thought that such a mundane topic would play such an important part of both domestic and international commerce?

There is a lot of talk from the US President that VAT is a tariff, and if the logic is “a tax is a tax” then Trump would be right, but not all taxes are taxes, and VAT is not a tariff because whilst they are both “a tax” their purpose have very different objectives.

Difference between VAT and tariffs

VAT (Value Added Tax)

In simple terms, VAT is a tax applied  on the end consumer affecting both domestic and imported goods and does not discriminate whether the goods are made locally or are imported from overseas.  The supplier is selling to the domestic customer, and competitors will also be charging the same VAT rate. Therefore  the government collects VAT and the customer is not discriminated against, as to whether you buy a locally made chair, or an Italian made sofa, the end customer uniformly pays 20%.

Whilst we realise that some suppliers may be under the VAT threshold and gain a competitive advantage, and there may be overseas traders importing into the UK avoiding import VAT, these are separate issues. Here we are examining the conceptual purpose of VAT, which is to raise revenue and to be applied equally and only at a domestic level.

Tariffs

Tariffs are taxes levied on imports or exports as a protective measure, designed to either protect a domestic trade industry sector from cheaper overseas competition or if a Country wants more of something, then a low tariff can be applied to encourage more of what you want from overseas suppliers.

Tariffs do not apply to locally produced goods, but tariffs are applied to the same goods made overseas, and a tariff gives a price advantage to a domestic supplier, in effect any price advantage the overseas supplier has (because of government subsidy, cheap labour or tax labour laws) is reduced or wiped out as a result of a tariff.

Globally, tariffs are kept to a minimum to allow relatively free trade, but certain sectors have always needed protection from low wage workforces and government subsidies, sectors such as the steel industry, cars, solar panels and even shirts and shoes.

Without tariffs these cheaper Countries would flood the market with subsidised, cheap products, making it impossible for domestic industries to compete. In such a competitive environment, this would likely lead to the closure of these domestic industries, and consequently, significant job losses. Essentially, that’s the nub of it, jobs and industries could cease to exist in a truly free-trade environment.

The “art of the deal” is to limit the number of protective measures to certain sectors rather than blanket tariffs on everything because:

1. it starts a tit-for-tat trade war;
2. you may actually want some things imported from abroad to satisfy your own domestic market shortfalls and;
3.  it increases the price to the end consumer which means less is spent domestically as people tighten their belts, and this could lead to a recession as consumer confidence drops or the fear of increased costs deterring big ticket purchases.

Tariffs are also known as duties, they mean the same thing, but one reason tariff is the preferred word is because duties can have multiple meanings, for example, alcohol duty, cigarette duty and fuel duty and these three duties are applied equally to domestic and overseas producers like a tariff (and then VAT is added on top at a domestic level).

Tariffs and duties are eventually paid for by the end consumer on the basis that a company will seek to maintain its profit levels, where a tariff increases, the company can either absorb some, all or none of that. 

Certainly at the levels now in effect in the USA, it is doubtful any company can absorb a 10% or 20% increase, let alone the 50%+ applied to some Countries.  Digging beyond the headlines, the USA has created exceptions to these new tariffs on goods the USA needs, so there are concessions for copper, aluminium, lumber, pharmaceuticals (but presumably not fentanyl), and semi conductors.  Although these sectors may also see changes in future announcements.

The Butterfly Effect

This phrase describes how a small change in an initial condition can lead to vastly different outcomes in a complex system, making long-term predictions difficult to predict.

These tariffs, applying overnight, will cause immense challenges for all manufacturers globally, and “Country of Origin” will be ever more important. The new tariffs imposed by the USA requires at least 20% of goods to have U.S.A origin, that opens the door for U.S.A manufactured cars for example, to have some components from outside the USA.

The impact and repercussions of these tariffs are many. For example, the U.S.A tariffs also included the removal of the de minimis limit for imported goods from China, which previously allowed small shipments to enter the country without duty.  In contrast, the UK had an £135 de minimis threshold, whereby small value goods were not subject to import duty. A de minimis previously applied because there is an admin cost to government in collecting low value duties.

This removal of the de minimis threshold in the U.S.A means that now all goods from China are subject to duties, regardless of their value. This could lead Chinese suppliers to shift their sales focus towards the UK and EU markets. As a result this could see further pressure and increased competition for domestic manufacturers and suppliers, potentially flooding the market with surplus products that are no longer economically viable to export to the U.S.

This scenario shows how small changes in one area can have extensive consequences globally, much like the butterfly effect. –  When a butterfly flaps its wing, it really does cause a tsunami effect at the other end of the world.

Get in touch

For further information on VAT and tariffs, or on how your business may be impacted, or to discuss custom duties and taxes affecting UK or international trade, please contact our VAT experts today.