Water, VAT and the new retail market

Ok, I admit this doesn't sound that exciting, but its an interesting story with big implications for the new market so bear with me. Most water supplies in the UK are zero rated for VAT. In 1990 after an EU ruling the UK charged VAT for those companies falling into categories 1-5 of the 1980 SIC code, basically industry and utilities. Which means that prior to market opening water companies asked their customers their SIC code and charged them VAT if they were in categories 1-5. This meant that only a small percentage of customers paid VAT on their water.

However, in April this year the English market opened to competition and now wholesalers sell water to retailers who then sell water to their customers. But retailers are being charged VAT on the water they buy from the wholesaler. According to HMRC and the wholesalers the retailers are water suppliers and therefore sit in categories 1-5 of the SIC codes. This is disputed by a number retailers who believe that they are service providers who supply retail services such as billing and customer contact rather than physically supplying the water.

The current situation means that wholesalers have moved from getting VAT on a small portion of their sales to receiving VAT on all the water they sell. This is great for wholesalers cash flow, but terrible for retailers cash flow and leaves HMRC out of pocket too. What it means in practice is that retailers will have 10% of their operating capital tied up each month and this cost will be passed onto customers making the market less efficient to the tune of serval million pounds a year. It also throws up some anomalies for those companies looking at moving to self serve, would a restaurant or chain of clothes shops deciding to go self serve suddenly move from zero rating to 20% VAT just by becoming their own retailer?

Clearly this was not the intention of Parliament who during the passage of the Water Act 2014 defined retailers as providing retail services including billing, reading meters, customer services etc., rather than as water suppliers. Water retailers are not physical suppliers of water, we don't handle the water and we don't have water as an asset on our books, we provide the customer services associated with the water supply. This was the intention of the Act, and the current VAT position is reducing the efficiency of the market and effectively increasing prices for end customers.

It is clearly up to HMRC to determine and interpret the VAT code, but there is a very strong argument for the water sold to retailers to be zero rated. There is now a good dialogue taking place at the moment on this issue involving HMRC, MOSL, Ofwat, retailers and wholesalers. But unfortunately, like many aspects of the market, the current position was in effect decided before market opening by the incumbent water companies and they seem to be the only ones who benefit from this approach.