"Do I have to pass on the VAT cut to my customers?"

by Martin Dunne - Thursday, 27th November 2008 -

Real Business agony uncle Martin Dunne is the answer to all your accounting woes. Each week he will tackle another problem faced by entrepreneurs. This week: the 2.5 per cent VAT cut: should you pass it on to your customers?

Q: “Do I have to pass on the 2.5 per cent cut in the VAT rate to my customers?”

This is a very good question and one which I have already been asked by a number of clients.

In the vast majority of cases, the reduction in the standard rate of VAT from 17.5 per cent to 15 per cent must be applied to all sales from 1 December 2008.

If your customers are businesses, however, they are probably VAT registered anyway and therefore able to reclaim the VAT you charge them. This means that the change in the VAT rate will make no difference to them at all.

If your customers aren't VAT registered, for example you are a retailer selling to consumers, then they will be expecting your prices to fall by 2.5 per cent.

Of course, where customers are used to seeing only the VAT-inclusive price, it would be relatively easy for you to keep your prices at the same level as they were before the VAT reduction, meaning an extra 2.5 per cent of profit added straight to your bottom line.

This is not what the Chancellor intended but it is perfectly legal and, in these difficult times, is likely to be a course of action taken by many businesses.

Ultimately, it comes down to what your customers will accept, the added cost to you of changing your prices (both now and then again in 13 months' time), and how your competitors act. If they pass on the saving in the form of lower prices, then you may have little choice but to do the same.

Perhaps an easier, and less expensive, way to pass on the VAT savings to your customers would be to keep your prices the same but to offer discounts if customers purchase above a certain level. This has the added advantage of incentivising customers to spend more of their money with you, in return for slightly lower prices.

Of course, those businesses that differentiate themselves on non-price factors (eg. quality or service) will be better placed to leave their prices unchanged.

Martin Dunne is a partner at Sayers Butterworth LLP. He previously worked in the entrepreneurial services division of Ernst & Young, and has over 15 years of experience working with fast-growing, entrepreneurial businesses. He provides practical and commercial advice to clients ranging from start-up stage to AIM-listers in a variety of sectors including retail, property, manufacturing, technology and media.