The most significant issue identified in the report is the VAT registration threshold, which at £85,000 is one of the highest levels in the world.

The OTS concedes that by enabling many small businesses to stay out of the VAT system the high threshold is a form of simplification, but says it is an expensive relief, costing around £2bn per annum, and evidence strongly suggests that many growing businesses are discouraged from expanding beyond this point.

The £2bn cost for the threshold is an estimation based on the difference between the current threshold of £85,000 and the EU minimum threshold of €10,000 (£8,852).

The report looks at options for reducing the current ‘cliff edge’ effect resulting in a very visible bunching of businesses just before the VAT threshold, and an equally large drop off in the number of businesses with turnovers just above the threshold. Also examined are the advantages and disadvantages of lowering or increasing the threshold.

The report’s core recommendations will include calling for the government to examine the current approach to the level and design of the VAT registration threshold, with a view to setting out a future direction of travel for the threshold, including consideration of the potential benefits of a smoothing mechanism.

The OTS says HMRC should maintain a programme for further improving the clarity of its guidance and its responsiveness to requests for rulings in areas of uncertainty, and wants the Treasury and HMRC to undertake a comprehensive review of the reduced rate, zero-rate and exemption schedules.

In addition, the report makes recommendations for improving the day to day administration of the tax, including better and more accessible guidance and a less uncertain penalty system. This would particularly benefit small businesses.

The OTS also considers specific areas of technical difficulty, including the partial exemption regime, the capital goods scheme, the option to tax and other special schemes.

The report highlights a number of VAT quirks, pointing out that while children’s clothes are zero-rated, including many items made from fur skin, items made from Tibetan goat skin are standard-rated. A ginger bread man with chocolate eyes is zero-rated but if it has chocolate trousers it would be standard rated.

VAT zero rates cost over £45bn per annum to maintain. EU law limits options to make changes in this area but there is a longer-term opportunity to significantly improve the efficiency, simplicity and fairness of the UK VAT system, the OTS says.

Angela Knight, chair of the OTS board, said: ‘This report presents an opportunity to start addressing the many anomalies of VAT. The tax is awash with layers of complexity reflecting both its evolution over the last 45 years and aspects of the purchase tax that VAT replaced.

‘For small businesses, this report will propose ways of simplifying many irritating administrative technicalities and kick off a debate about the registration threshold.’

The OTS report: Value added tax - routes to simplification is now available and was published on 7 November.

Report by Pat Sweet