The end of LVCR?

With the government reducing the VAT threshold on low-value exports, just how catastrophic could the impact be for legitimate business in the Channel Islands? Dave Waller investigates.

Tax avoidance is a beloved hobby horse of the UK press, but coverage tends to centre on the idea of high rollers such as Philip Green sunning themselves on an island while offshore trusts get busy maximising their wealth – with the taxpayer supposedly being the one who suffers. These days, however, the public coffers are so tight that nothing can escape the spotlight, which has shifted momentarily away from Champagne and super-yachts towards more everyday items, like Lady Gaga albums and box-sets of Glee.

In this year's Budget, George Osborne set his sights on Low Value Consignment Relief (LVCR), the legal technicality that allows companies in the Channel Islands to export items like CDs, DVDs and memory cards to the UK free of VAT, and which has spawned a mail-order industry said to be worth around £750 million a year to the islands. Osborne vowed to root out those organisations exploiting LVCR “for a purpose it was not intended for” – suggesting he'd spotted another means of sewing holes in the Treasury pocket and scoring points with a cash-conscious public.

But it doesn't end there. Inspired by gung-ho lobbying from UK retailers (and the likes of Tory Peer Lord Lucas, who described the use of LVCR as a destructive “smuggling exercise”), the European Commission warned the UK Government in April that if it failed to curb the ‘exploitation' it would be in breach of EU law, which states that under the principle of fiscal neutrality, no VAT relief can benefit one state over another.

So LVCR looks like it's on the way out – good for the UK Treasury, which stands both to placate its European peers and recover £130 million a year in lost VAT. But if the Channel Islands fail to protect this important industry it could affect everything from the islands' income to their job markets and postal rates.

Playing the game

LVCR was introduced by the EU in 1983 to solve a problem common to all member states: how to approach the costly process of taking VAT from small-value items. Under LVC R, low-value imports from outside the EU would be exempt from VAT (the UK Government set its cap at £18, reduced by Osborne in his Budget to £15). One of the first to realise the opportunity was Guernseybased Derek Coates: in 1996 he launched Healthspan, offering VAT-free vitamins from full-page adverts in national newspapers.

With the rise of the internet in the late 1990s, the likes of music and DVD online retailer Play.com formed to benefit from LVCR, using the efficient postal system to flood the UK market with goods at very appealing prices. The low-cost trend has since spread to a range of other products, such as memory cards and printer cartridges.

It's a very effective retail model, but it soon turned controversial as UK distribution companies started operations – with Scottishbased Indigo Lighthouse setting up a Jersey ‘fulfilment centre' to ship contact lenses for Dolland and Aitchison in 1998. Similarly, Cheshire-based The Hut Group started warehousing DVDs and CDs in Guernsey for Tesco, Asda and other large retailers in 2005, all using circular shipping – where retailers send their stuff from the UK to the Channel Islands in bulk, then unpack it for separate customer orders and ship it back to the UK free of VAT – essentially giving them a 20 per cent cost advantage over onshore rivals. Critics of LVCR argue it's a green light for market distortion.

“George Osborne said in the budget that LVCR is ‘being used for something it's not intended for', which basically means ‘abuse',” says Richard Allen, a UK retailer who has waged a one-man crusade against LVCR, blaming it for the collapse of his online record business. “The message to trusts and the lawyers is: ‘This is finished'.” Indeed, with the EU on the Government's back, it seems the recent adjustment to LVCR is only the beginning. The next step may well be to reduce its reach only to items under £8, or to exclude mail-order items entirely. “Now the EU has threatened the UK with infraction proceedings if they don't fix it, LVC R will be removed in a year,” says Allen.

Allen, who runs the pressure group Retailers Against VAT Avoidance Schemes, recently faced off in a Radio 4 debate on the subject against Phil Balderson, CEO of Healthspark, a Channel Islands health company which exports to the UK. Balderson's argument is that, used properly, LVC R is beneficial to both the UK and the Channel Islands, and its loss would have severe ramifications.

“At least 1,000 jobs would be lost across the islands,” he says. “Plus there are related jobs in telecoms, financial services and the internet that may go as a result, taking it to perhaps 2,000 to 3,000 jobs lost in total. The cost of data-hosting would soar if e-commerce players moved away from the islands, and we wouldn't enjoy the postal rates we've got now if it wasn't subsidised by the fulfilment industry.”

This is serious stuff indeed. Aside from the direct job losses, the islands' postal operators have long utilised the profits generated by LVCR shipments to subsidise their Universal Service Obligations, which will inevitably lead to question marks surrounding the future of their collection/delivery services. And with the lack of freight heading back to the UK, operators will have to increase carriage charges to compensate for loss of revenue, and this will impact every islander.

On the move

While the Channel Islands tend to receive the bulk of flak in discussions of LVCR, this is simply because of their relationship with the UK and those aforementioned postage rates, which mean it's the biggest beneficiary. But other jurisdictions such as Switzerland – a major LVCR player – would also stand to lose out if the EU decided to further clamp down on this ‘exploitation'. Yet what's the alternative? Member governments may find the cost of low-value VAT outweighing the savings, and those fulfilment businesses simply heading to other places with low corporation tax and low VAT rates, such as Hong Kong or China.

So is the fate of LVC R already decided? Balderson doesn't think so. He believes that there should be no ground for the EU's new position, especially as LVCR is a directive that the EU itself created. The trick is for the islands to identify what could be deemed exploitative and stamp it out.

To its credit, Jersey has done this already. In 2007, the island ejected the fulfilment operations of 17 major UK retailers, including Tesco and Sainsbury's, having declared that e-commerce companies would require Jersey owners, and a physical base there employing locals. It was a good strong move. The problem being that Guernsey opted not to follow its lead.

“Guernsey's been reprehensible through all this,” proclaims Balderson. “When Jersey kicked out UK companies, Guernsey ignored the opportunity and just let them get on with it. Osborne talks of the abuse of LVCR, but it isn't abuse when it's indigenous Channel Islands companies. What is abuse is HMV and Sainsbury's moving to Guernsey, or Tesco moving to Jersey, then to Switzerland and back to Guernsey. This letter-boxing has to stop.” He adds: “The biggest loser with the end of LVC R will be the UK taxpayer. The solution is for Jersey and Guernsey, perhaps with Switzerland, to go to the UK and the EU saying they will boot out letter-boxers and cap shipment size if they can keep the £18 cut-off.”

The Government is set to review its position on LVCR in its next Budget, and in the current climate the Channel Islands can't expect an easy ride. Ominously, when asked by the Jersey Chamber of Commerce about the role of LVC R, Osborne said: “I don't think you should allow an industry just to spring up on the back of a kink in the tax system.” And so the islands' politicians have only one option: to package their argument and ship it to the mainland ASAP.