Cake or biscuit? Case of the Jaffa Cakes shows the many layers of VAT law

Today I want to highlight how fiendishly open to interpretation value added tax (VAT) rules can be, such slights of syntax being an expensive construct purveyed by the legal profession.

If that opening sentence felt like a mouthful, sit down and make yourself a cup of tea. Pick up a biscuit or maybe a cake. This agreeable digression brings us to the infamous case of the ubiquitous family teatime treat, which would become Jaffagate.

McVitie’s in 1991 brought a case in the United Kingdom against Her Majesty’s Revenue and Customs (HMRC) for the right not to charge VAT on the billion-plus Jaffa Cakes that roll off their production line annually. The product is price sensitive and removing VAT would have a material effect on turnover.

Everything from the production process to the act of consumption itself was analysed comparatively to create a weighting that would demonstrate whether the product was a cake or a luxury biscuit.

In the UK, while cakes and plain biscuits are zero rated, chocolate biscuits are standard rated. Why? When the rules were formulated, cakes were perceived as generally made in homes by hardworking families whereas chocolate biscuits were factory-produced luxury treats.

McVitie’s agreed that Jaffa Cakes had biscuit tendencies but had more cake elements. As part of its evidence the company baked for the court an example that was one foot (30 centimetres) in diameter. The courts concurred and Jaffa Cakes and VAT at standard rate were, by order of court, divorced.

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At a glance

■ What: The UAE implements its value added tax on January 1.

■ Why: Decisions are about to be made about what will attract VAT.

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One more twist in this tale. Ireland has different rules relating to Jaffa Cakes, the definition there is based on moisture content so it attracts a reduced VAT rate. I didn’t investigate each of the other 26 EU countries but I would expect to find some more differences in its treatment.

Peter Whatley, the chief executive of Argent Gulf Consulting, said: “The Judiciary had unintendedly served HMRC a Dickensian bleak biscuit as copycat cases sought to exploit the judgement. Traditional teacake makers argued in 1994 that their biscuit-sized thin chocolate sheltered marshmallow domes sitting atop a biscuit base, was also a cake.

“The courts agreed and 22 years of VAT became refundable by the government. Was 22 years appropriate or would a shorter period from the date of the challenge be a more equitable remedy? Common in many jurisdictions is a prescription period before which no claim would be entertained.

“Why refund the business in any case, surely this money should be handed back to the consuming customers who had paid it? Even if there was the will, how could you identify and prove each sale?”

It is not all cake or biscuit either. I could regale you with tales of Tibetan goat skin versus gazelle skin in children’s clothes, or printed versus e-books, but I believe you probably now grasp the unexpected underlying uncertainties that can arise.

If the world of luxury changed why didn’t the rules for VAT? Changes are restrained within a greater EU framework and common sense has taken flight in fear of competitive advantage being sought. In this environment anomalies get left lingering. Wondering about the regional relevance of this? For UK insert the UAE and for EU insert GCC.

What you do need to understand is that decisions are about to be made in the GCC regarding which goods and services will attract VAT and that these will be informed by the social norms and politics of today. We can only try to imagine tomorrow’s woes that will be unintentionally born on “V day” – January 1.

Could GCC governments do anything to prevent expensive and lengthy challenges? The simplest possible rules would help but the agreed framework will allow for variable approaches by each constituent country, so we can discount that happening.

A collective pledge not to tinker with the rules would be heartening but special-interest petitioning is inevitable.

One approach might be for the supporting legislation to specify that its interpretation should read in the tradition of the law of equity rather than contract law, ie, the spirit rather than interpretation of its cold ink, although this might be seen as too controversial.

The words of Lord Justice Sedley, late of the UK Court of Appeal, should act as a rallying cry for those who would seek to prevent a commencing tribulation. He bemoaned the idiosyncrasies of VAT for having created a “fiscal theme park” where “factual and legal realities were suspended”.

Having considered various angles, I regretfully recommend overkill. The supporting legislation should be an exhaustive Gordian knot of a document, closing out attempts to undermine its intent. While this will not prevent our wily learned friends from seeping dampness into it, the scope for nuisance challenges should be reduced.

The workload pressures that the UAE courts are under have been widely reported. Given the specialist nature of VAT regulation, can we expect to see either a separate branch created or at the least a two-tiered tribunal structure to adjudicate?

Beyond that, where will individual GCC countries go to when they feel aggrieved with a national decision of another member that in their view undermines the agreed GCC framework? This suggests a requirement to create a GCC-wide court of final appeal to maintain its coherence.

To reduce a caseload confluence, it might only sit to consider Government-lodged challenges measured against the GCC framework.

I’ll leave you with this concluding example of the madness of VAT granularity.

In the UK, gingerbread men with two chocolate drops for eyes are zero rated, standard rated if they have similar sized chocolate buttons on their torsos. Those buttons add up to an additional 20 per cent on the selling price.

David Daly is a chartered accountant (Cima) typically serving in chief financial officer or finance director roles.

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More Value Added Tax coverage

■ New UAE taxes not likely to change consumer behaviour, experts say

■ Analysis: Who should worry most about VAT in the UAE?

■ Analysis: All in the details for value added tax in the GCC

■ VAT to generate Dh20 billion in second year for UAE, Minister of Economy says

■ Q&A: Sultan Al Mansouri, the UAE Minister of Economy, and his views on VAT, infrastructure spending and the investment law

■ Comment: The basics of value added tax

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