You might think that the Kafka-esque world of HMRC and VAT is a bit of an arcane subject for a blog post. And it is. But when clients ask me questions about VAT on postage, I sometimes struggle to give a straight answer. Which is a source of angst, as Brightsource proclaim some expertise in the area of VAT and direct marketing. And although you may think it a dull topic… it’s an important one for financial services companies and charities (who can’t recover VAT). For high volume users of direct mail, postage will be the biggest single cost element of the campaign.

So this blog is expiation for my inability to give clients the information they need to make longer-term decisions about how they mail their customers or supporters. The potential audience for this stuff may be small compared to other marketing blogs – but if you’re one of the select few, I hope you’ll find it interesting and useful.

If you’ve read this far, I’m assuming you understand the basics of VAT (input/output tax, standard and zero-rated services, exempt services, and why getting charged VAT is a problem for financial services and charities).  If not, this link may help http://bit.ly/gKnCGX

Right – on with our convoluted tale of government and regulatory muddle. Bulk mail postage used to be simple for banks and charities. They didn’t get charged VAT, because Royal Mail was VAT exempt, and Royal Mail was the only postal supplier. And then deregulation happened.

• Jan 2006 – A European directive leads to the UK postal market being deregulated. But new downstream access (DSA) operators aren’t exempt from VAT. This is clearly an anomaly, as Royal Mail is providing the ‘final mile’ delivery, which accounts for 90% of the cost. The HMRC interpretation is that if this cost is billed through Royal Mail, it is exempt, but if it is billed through TNT or UK Mail, then it becomes standard-rated. DSA operators lobby the government for a ‘level playing field’, but to no avail.

• June 2006 – Brightsource launches an integrated print and postal management service, which gets round the problem for charities and financial services, as long as the postage can be linked to a zero-rated direct mail product, (which it generally can).

• March 2007 – The major DSA operators and Royal Mail Wholesale negotiate ‘agency agreements’. These use ‘disbursement’ VAT rules to allow DSA operators to avoid charging VAT on the Royal Mail ‘final mile’ cost, as long as a contract is signed specifying that the DSA operator is acting as an agent for Royal Mail Wholesale and is passing on Royal Mail’s charges without mark-up. The DSA operator still has to charge VAT on their own upstream distribution costs, however.

• April 2009 – This still wasn’t a level playing field for the DSA operators. TNT decided to go to the European Court and challenge the Royal Mail’s exemption from VAT – on the grounds that following deregulation, Royal Mail should not have a competitive advantage in the two biggest sectors of the UK postal market. The court delivered its ruling in April 2009. Basically, TNT lost. The Court noted that the supply of ‘public postal services’ was exempt under the European Sixth VAT Directive. A public postal service is a universal service to all citizens of a country, delivered every working day. The Court ruled that as the UK’s only ‘universal service provider’, the Royal Mail’s exemption was legally sound.

• 2009 to 2010 – But the ruling triggered more confusion. As well as the headline decision above, the European Court also said that only universal postal services are exempt from VAT. Services that were dissociable from the public interest service… and whose terms had been individually negotiated, were not exempt.

So if a postal service falls within the ‘universal service obligation’, it remains exempt from VAT.
If a postal service is on ‘individually negotiated terms’ then it is not exempt.
Expressed another way (and I quote from the European Court’s own summary of the judgement):
The universal postal service provided by the Royal Mail is exempt from VAT
The Royal Mail is subject to VAT where it supplies services on terms which have been individually negotiated.

Nobody could work out the implications. Postcomm had defined Mailsort 1 and 2 as part of the universal service obligation (USO)… but Mailsort 3 sat outside of the USO. So presumably Royal Mail should start charging VAT on the third class Mailsort service? The European Court did not address which services are part of the universal service, and which are on individually negotiated terms. What is within the USO and what is not, is decided by Postcomm. To add to the uncertainty, Postcomm are about to be abolished, with their regulatory powers transferred to Ofcom in spring 2012.

• Jan 2011 – the government and Royal Mail accept that unaddressed services (i.e. doordrops) and some other specialist services, clearly don’t fall within the USO exemption. VAT is to be charged on doordrop distribution from 31 January 2011

• Feb 2011 – the government lets it be known that it intends to amend the Finance Bill 2011 to include a VAT exemption for postage from DSA operators. The idea is that this will finally create a level playing field on VAT between Royal Mail and new competitors.

• May 2011 – Postcomm decides it wants to remove all bulk mail products from the universal service obligation. Given the EC ruling in April 2009, this would mean that Royal Mail Retail would now definitely have to charge VAT on all bulk mail services such as Mailsort. But in a delicious irony, this might coincide with the government giving the advantage to DSA operators – by making their services exempt through the amendment to the Finance Bill!

I’ve heard that HMRC “is aware of the potential distortion” and is thinking of cleaning up this whole area after the Postal Services Act 2011 has been passed. (This is the bill to restructure Royal Mail Group – which also contains a new framework for how Ofcom will regulate other postal operators besides Royal Mail. Given that privatisation of Royal Mail cuts right across party lines, the final legislation may be quite different from the draft bill).

So you can see why it is hard to give a straight answer to many questions on VAT and postage…  It depends on:

• how you interpret the 2009 EC ruling
• what’s in the Finance Bill when it is approved
• what the Postal Services Act contains when finally passed by Parliament
• how Ofcom implements a new regulatory framework, and approaches the universal service obligation
• … and then you have to wait and see what specific VAT guidelines that HMRC decides to overlay on all of this.

So unfortunately, I don’t expect anyone will be able to offer any greater clarity until the back end of 2012.  And if anyone from the government or Postcomm is reading this, please stop bemoaning the fact that deregulation has not resulted in someone like DHL or TNT investing in their own end-to-end network to compete directly with Royal Mail. Their reluctance to do so is hardly surprising in the face of such a shambolic regulatory and legislative environment.