Government plans to clamp down on tax avoidance have missed out a Channel Islands VAT loophole costing the Treasury hundreds of millions of pounds per year and devastating independent traders.

Many large retailers have set up shop in Guernsey and Jersey and benefit from Low Value Consignment Relief (LVCR), which allows goods worth up to £18 to be imported into the UK VAT-free.

While some consumers buying items such as online DVDs have seen prices fall, many small shops and UK mainland based internet retailersare unable to compete or move off-shore themselves and are being forced to close.

Following its pledge to address tax avoidance in the June Budget, and October’s Comprehensive Spending Review (CSR), the Government has announced legislative changes aimed at clawing back some of the £7 billion of tax revenue that is lost annually.

Immediate measures include preventing groups of companies using intra-group loans or derivatives to reduce their tax bill and reviewing schemes in which companies do not fully recognise loan and derivative monies in their accounts. In addition, ministers have commissioned a feasibility study into a potential ‘Government General Anti Avoidance Rule’ (GAAR).

Further details are to be announced on plans to address the practice of ‘disguised remuneration’, prevent investment companies retrospectively changing the currency they prepare their accounts in for tax purposes and tackle businesses which artificially split the supply of services to reduce VAT.

However, the plans do not include addressing LVCR through the Channel Islands which, while a legitimate tax relief, must not be exploited if it leads to unfair competition or VAT abuse.

This inaction is despite repeated calls from independent retailers. In 2005 the business support organisation gave evidence to the All-Party Parliamentary Small Shops Group on the impact of LVCR abuse. This group’s 2006 report ‘High Street Britain 2015’ – which stated that, based on the then rate of closures, the UK’s privately-owned shops would disappear completely by 2015 – recommended that:

“The UK Government should immediately apply the lowest threshold applicable for the relief of low value consignments permissible in the directive, which is currently 10 Euros, (approximately £7) – this would eliminate the vast majority of exploiting trade almost immediately.”

And that:

“The enforcement, by government bodies like Customs and Excise, of VAT should be reviewed to ensure a level playing field.”

In the 2006 Budget the previous government said it was aware the loophole, originally an administrative relief, was “being exploited” and that it would consider changes to prevent this. However, since then even more retailers have set up in the Channel Islands and no action has been taken to protect small, independent shops and internet retailers.

Richard Allen was forced to close his mainland-based online music retail businesses, Delerium Mail Order, as a direct result of LVCR on goods imported via the Channel Islands. Mr Allen, along with a group of UK internet and high street retailers, has formed a pressure groupcalled Retailers Against VAT Abuse Schemes (RAVAS) and has filed a complaint with the European Commission, arguing that LVCR is being used in a way that distorts competition and amounts to VAT abuse.

The complaint argues that the UK Government has failed to prevent LVCR from being used in a way that distorts competition and amounts to VAT abuse. The Commission’s final decision will be announced in the New Year.

“It’s utterly incredible that HMRC and The Treasury have allowed this abusive industry to grow to the size that it is now – particularly given the many warnings they have had since 1998,” said Mr Allen. “Goods are being round tripped from the UK to the Channel Islands for no purpose other than to avoid VAT, in direct contravention of the basic principles of EU law. Our Government just watches idly as this trade continues to grow.”

He added: “My own business was unable to compete when offshore traders started to compete within the VAT margin and now over 90% of music retail is offshore. You just cannot match the prices if you have to charge VAT, yet the 20% VAT saving is big enough to be a decent margin if you can move to the Chanel Islands.

“While this also affects shops, I was an internet retailer and this abuse has completely distorted the market and created a barrier to entry. You have to buy your way offshore to trade. Do we want to see jobs sent offshore, along with all the tax it generates for our country?

“It’s madness – the UK could act immediately by lowering the threshold at which this relief operates to 10 Euros, exclude certain types of mail order goods on a product and territory basis and by taking anti-avoidance legal action using existing case law. Doing nothing is not an option the UK has the right to exercise.”

I believe the LVCR loophole should be addressed as a priority as part of a shake-up of the UK’s complex tax system. Last year a member survey found that tax administration is one of costliest bureaucratic burdens faced by small firms, leaving them with a bill of £1.8 billion per year. Only employment law and health and safety legislation cost more, at £2.4 billion and £2.1 billion respectively.

More recently, research earlier this year found that 68% of small employers believe the tax system is ‘unfair’, with 52% believing that larger firms have the resources to invest in tax loopholes where they cannot afford to do so themselves.

The Channel Islands VAT loophole distorts competition and leads to VAT abuse – clearly it was not created to allow large retailers to undercut their smaller, mainland competitors, which is what is happening now on a worrying scale, forcing many to close.

For small firms to be able to grow and create jobs as part of a private sector-led recovery, and in order to preserve the very existence of independent retailers across the country, LVCR must be removed without delay in addition to addressing other tax avoidance schemes.

If the Government is serious about achieving rapid small business growth this should happen as part of a major re-think of the operation of the UK’s tax system, which is currently one of the most complex in the world.

According to a statement, on 9 December the Government will publish a draft protocol setting out the circumstances in which it will consider changing tax legislation with immediate effect.

In the CSR the Chancellor invested £900 million in tackling tax evasion and avoidance. The Government expects to raise £2 billion in additional tax revenue during the course of the next Parliament, and protect forecast revenues of up to £5 billion over the next four years.