Don't expect HMRC to be rational with VAT rules

February 14th saw Nestlé lose an appeal made to the UK’s Upper Tribunal Tax Court regarding the VAT rating of their strawberry and banana flavoured Nesquik powders. This case provides an excellent example of the complications and oddities that can arise in the VAT realm, and especially when it comes to food products.

Everyone will remember the Jaffa Cakes case where McVities managed to come on top in its fight with HMRC. No VAT is charged on plain biscuits or cakes. But when a biscuit is covered in chocolate it becomes a luxury and standard rate VAT at 20% is added to the price. Mcvities, the market leaders for Jaffa Cakes added chocolate to the cake and tangy orange base, so classifying them as cakes, not biscuits. Although the taxman challenged this, claiming chocolate biscuit status, the court ruled in favour of McVities and we don’t have to pay VAT on our Jaffa Cakes.

As a reminder, chocolate chip biscuits where the chips are included in the dough or pressed into the surface before baking are zero-rated. Bourbon and other biscuits with a chocolate sandwich layer between two halves also escape VAT. However, if your biscuit is wholly or partly coated in chocolate then VAT will be added at the standard rate. The situation is even more complex for Gingerbread biscuits. No VAT is charged for gingerbread with just two chocolate spots for eyes. However, if your gingerbread man is dressed in any chocolate-based additions, such as trousers, 20% VAT will be added.

In the case of Nestlé, unfortunately, they were not able to convince the UTT who found in favour of HMRC not repaying over £4 million in VAT on the grounds that the fruit flavoured powders were “a powder for the preparation of beverages” and therefore covered by the exception from zero-rating for such products. Hence, they remain standard rated and no retrospective claim for over-declared output tax is permitted.

Nestlé had sought to argue that strawberry and banana Nesquik should be zero rated on the basis that they encourage milk drinking and that milk is zero rated. They also made the case they should be treated - for VAT purposes - the same as the chocolate flavour powder as they are, in essence, the same. Both HMRC and Nestlé accept that chocolate Nesquik should be zero rated on the grounds that the product contains cocoa which allows it to fall within the list of “exceptions to the exempted items” within the UK’s zero-rating provisions for food.

So, when it comes to VAT and food, it's important not to assume anything. The rules are complex and not necessarily rational. Always double check with your accountant...