The end of the Retail Export Scheme and post-Brexit tax-free shopping in the UK
Following the end of the Brexit transition period on 31 December 2020, the UK Government has made the decision to extend VAT-free shopping to all overseas tourists, including EU nationals, and terminate the VAT Retail Export Scheme (VAT RES) in Great Britain. The previous tax-free shopping rules will continue to apply in Northern Ireland only. This article offers Airvat’s interpretations of the Government’s decision and future policy recommendations.
In preparation for Brexit, HMRC performed a consultation to review the tax-free shopping scheme, or Retail Export Scheme, as it is formally known. The consultation highlighted two issues related to the scheme.
Firstly, tourists are typically charged high fees by the incumbent refund operators, such as Global Blue and Planet. The fees can range between 30-50% of the VAT amount and may include hidden payment charges and poor exchange conversion rates by partner companies involved in the commercial chain. This means that tourists do not fully benefit from the VAT refund incentive, as was originally intended by the scheme.
Secondly, the operation of the scheme is heavily concentrated among luxury retailers and large department stores in London's West End and Bicester Village outlet park. Most independent and regional stores are effectively excluded due to high friction costs of participating in the scheme, or they are not adequately serviced by the established refund operators due to a low turnover. According to Airvat’s internal data it is estimated that the top 5 participating retailers account for around 40% of the RES turnover.
VAT RES expansion and modernisation
We believe another major determining factor in the decision to end the scheme was the prospect of the increase in VAT refund claims from the EU nationals following the end of the Brexit transition period. Without having a working digital solution to manage this expansion the administrative costs and risks would have been too high.
The Retail Export Scheme historically existed in a paper format as a silo outside of the national export procedures and accounting, making the supervision of the scheme by HMRC more difficult. Unlike all other exporters having to file standardised declarations, RES retailers and refund operators were able to issue their own simplified export documentation, known as VAT407 forms.
Despite HMRC’s efforts for several years to digitise RES, there was no plan to achieve this in time for the end of the Brexit transition period when transaction volumes were expected to have tripled due to the inclusion of the EU nationals.
Prior to Brexit, over 95% of all VAT refund claims were validated at just two UK airports, Heathrow and Gatwick, which had a functioning customs process in place. Post Brexit, at least another four major international airports servicing mainly short haul European destinations would have required improved customs processes to adequately handle the scheme expansion.
Whilst we are disappointed to see the Retail Export Scheme being terminated in Great Britain, we are sympathetic to the Government’s concerns of not having an easily scalable digital system in place to cope with the prospect of more administration. We can therefore understand how this unpopular, but pragmatic decision had to be taken in the context of other more pressing Brexit and Covid related issues.
Changes to the VAT Retail Export Scheme in Northern Ireland
As part of the Northern Ireland Protocol, the trading relationships for goods between the EU and Northern Ireland will largely remain unchanged. This means that VAT RES will continue to apply in Northern Ireland for visitors from non-EU countries (excluding GB).
Airvat welcomes the latest update to the VAT RES guidance for Northern Ireland, published just before the end of the transition period, which is forward looking and shows appetite for reform. HMRC has acknowledged alternative operating models for refund companies and accepted the use of digital eligibility verification by retailers.
These progressive changes to the operating rule book will encourage greater competition from new technology startups and prepare the scheme to eventually become paperless. We hope that this new framework will eventually become the basis for any future digital VAT RES in the rest of the UK if the scheme is reinstated.
VAT-free shopping as an alternative to RES in Great Britain (England, Wales, and Scotland)
From 1 January 2021, VAT-free shopping was extended to all visitors to the UK, including EU nationals, allowing tourists to avoid paying UK VAT on their personal shopping shipped directly to their home address overseas. We welcome the Government's intention to allow all visitors to the UK to benefit from a VAT reduction on their purchases but do not believe that the new rules are an equivalent replacement for RES.
Importing goods in person has a substantially higher de minimis amount threshold for paying a destination county’s taxes and duties, see here for more details. This incentivises tourists to carry the merchandise in their baggage instead of having the same goods shipped to their home address. The average de minimis amount threshold for goods carried in tourists’ baggage for Airvat’s top 5 export countries is £690. This value drops to only £215 if the same goods are shipped directly to the tourist’s home address overseas.
Given that Airvat’s average export value per traveller was around £500 in 2020, it is clear that tourists would have a strong preference to carry the tax-free goods in their baggage with them instead of having them shipped. Additionally, there are associated shipping and insurance costs, which would limit the adoption of the new VAT-free shopping rules.
Public costs and benefits
There are definite public benefits of having a well-functioning tax-free shopping scheme. A number of large countries that strive to encourage tourism, namely China, Russia, and the UAE, have recently adopted schemes that facilitate tax-free shopping for visitors. Other established tourist destinations, such France and Italy, have long ago digitised their tax-free shopping schemes.
Even in the previous VAT RES consultation in 2013, HMRC itself acknowledged that VAT RES “plays a key part in the shopping experience for our visitors and positively influences their views on Britain as a value for money shopping destination”. As recently as 8 years ago it seems the scheme benefits were clear and the work focused on how to make improvements instead of questioning its viability.
40.9 million overseas visitors came to the UK in 2019 and spent a total of £28.4 billion. According to VisitBritain 58% of all visits to the UK involve shopping and 25% of the total tourist expenditure is on shopping. Tourist retail expenditure is estimated to have a 1.8 GDP multiplier effect. Any decision to change tax-free shopping incentives will significantly impact the immediate tourist expenditure and also take many years to be felt in the wider tourist industry through the multiplier effect.
Therefore, a more detailed budgetary review is required to quantify how the removal of RES, or an introduction of a modernised replacement scheme, would impact future net tax collection.
Retail Export Scheme 2.0
Instead of completely removing this tourist incentive, Airvat believes that the UK deserves a modern well-functioning RES that addresses the previous scheme’s shortcomings and builds on the latest changes in Northern Ireland. In order to achieve this, any future reformed scheme must be both competitive and digital.
Any new scheme must facilitate a competitive environment to ensure that tourists have a real choice of selecting from a multitude of refund operators for the best and cheapest service instead of being limited to each retailer’s affiliated providers.
The traditional way of commercially operating RES, known as Direct Reclaim Service (DRS), functions through bilateral arrangements between individual retailers and refund agents, who administer the RES on their behalf. Once a retailer has chosen a refund operator for its store, it is difficult for a new alternative refund company to displace or co-exist with this existing provider. Over time this has led to a lack of competition and fewer providers as the incumbents enjoy a more extensive network of retailers, which has reinforced their market position further.
This arrangement has led to a very concentrated market structure with only two dominant refund operators, which explains the high fees charged to tourists and lack of innovation to enable smaller and regional retailers to effectively participate in the scheme.
When RES was first introduced, the right technology did not exist to permit any alternative arrangements. However, just like with other large industries recently, such as taxies and retail banking, given a favourable regulatory framework, the latest technology has the potential to bring competition, better solutions, and lower costs.
There are three potential paths to digitisation. First, the Government could commission a bespoke IT infrastructure to be developed specifically for RES. This option would be a great solution in an ideal world, however, in reality it is costly and would have a long lead time.
Second, one of the established tax refund operators could license its technology for “free”. This option may seem like a quick and an easy fix but it is likely to limit the competitiveness and innovation going forward, making the new digital RES continue to deliver a poor outcome for tourists.
Third, the new morden Customs Declaration Service (CDS), which is being gradually rolled out by HMRC as a replacement for CHIEF, could be adopted as the operating platform. This would be the most pragmatic solution that could achieve RES digitisation relatively quickly and without much extra public expenditure or planning. Consolidating all retail exports into a single national export system would also ensure that all VAT claims are electronically monitored for enforcement purposes by HMRC.
If the CDS infrastructure is to be adopted for RES, the cost of doing the heavy lifting of connecting retailers and travellers to the scheme would be borne by private technology companies. This would eliminate the need for the Government to further develop new IT infrastructure or budget for extra expenditure.
The only additional cost of adopting the existing CDS infrastructure would be the implementation of a digital validation process at airports. This would eventually be required anyway for commercial exports, hence, the addition of RES is unlikely to add much additional expenditure.
Electronic self-validation procedure by tourists at airport customs is already a widely accepted practice in other digital RES schemes around the world. Similar to airport passport e-gates, it will reduce the burden on the Border Force agents of managing VAT refund claims. The technology typically works by selecting passengers for inspection based on a risk-weighted algorithm. The right combination of automation, inspections, and heavier penalties for misrepresentation would be the ultimate solution for reducing both airport queues at customs and fraudulent claims.
We hope Airvat’s experience and observations expressed in this article positively influence the quality of the public debate on the subject and help inform public policy decisions. The Government has already made steps in the right direction when updating the guidance on the VAT RES for Northern Ireland, which shows appetite for reform. We would like to see the radical changes brought about by Brexit become a catalyst for a fully digital and modernised RES in the UK.