Beat the VAT hike!

The most painful measure in this week's emergency Budget was the hike in the level of VAT to 20% - adding an extra £425 to the average family's annual outgoings. The tax hits basic and higher-rate taxpayers equally hard - but there are ways to beat it. Find out how to protect your finances against the VAT hike

Chancellor George Osborne unveiled his emergency Budget this week, which saw him promise to cut the £155bn black hole in Britain’s finances to zero over the next six years. An array of spending cuts and welfare reforms were announced to help bring down the UK’s economic deficit - but the biggest measure unveiled was the increase in VAT to 20%.

Value Added Tax will climb from its current level of 17.5% to 20% on January 4, 2011, in an attempt to cut the deficit. The measure is expected to raise more than £13bn a year by the end of the current parliament - equivalent to nearly 1% of GDP. Everyone will be hit as the measure will add 2.5% to the cost of most goods and services.

Estimates from price comparison website Kelkoo suggest the move will cost most households some £425 a year. In real terms, the measure will put 11p on the cost of a £5 bottle of wine, 2.5p on a litre of petrol and 7p on a pint of lager - but it’s in the cost of big ticket items where the pain will really be felt.

For example, Britain’s best-selling car - the Ford Fiesta 1.25 model, which currently sells for £11,536 - will be over £300 more expensive come January. What’s more, a parallel rise in insurance premium tax from 5% to 6% will see further price increases on goods and services such as domestic electricity and gas payments and motor parts.

Today’s measure could have been worse - most “essential items” such as food, books, newspapers, magazines and children's clothes will continue to be exempt from VAT.

Be a smarter shopper

Fortunately, there are ways to soften the blow of rising prices. The first is to know exactly what goods are exempt from VAT - and to change your shopping habits accordingly. Goods usually fall into three VAT categories: zero rate “essential” items: items charged at the “reduced rate” of 5%: and those that are charged at the full rate. There are also goods fully exempt from the VAT system.

You can find a full list of the VAT classifications on the HMRC website - and there are some interesting differences in the classification of everyday items you can exploit. For example, items including Jaffa cakes, milkshakes and tortilla chips are all classified at the zero rate - yet biscuits and crisps are classified as luxuries and incur the full VAT tariff.

Similarly, so-called “luxury items” such as sanitary towels and maternity pads incur the 5% reduced rate - but medical essentials incur no charge. Get to know your non-VAT items and change your shopping habits accordingly - you could claw back a significant chunk of that £425.

Bring forward big purchases

The most obvious move to beat the VAT hike is to bring forward any major purchases you’re planning to make ahead of the January deadline. Be aware that any goods you order will need to have any VAT receipt raised before January 4.

In theory, this means you could in theory pay a deposit now and the balance in 2011 - but it’s safest to pay off any items in full well in advance. Holidays booked and paid for ahead of the VAT deadline will go through on the 17.5% rate – although any overseas charges, such as accommodation, will of course be exempt from UK measures.

So, if you’re looking to make a major purchase of a non-portable item - for example, a car, washing machine, kitchen installation or flat-screen TV - it’s best to get it done this side of Christmas at the cheapest rate possible.

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Duty free and foreign purchases

Surprisingly, the UK currently enjoys one of the lowest rates of VAT within the EU - Spain’s VAT rate of 16% is set to climb to 18% on July 1, while Germany and the Netherlands currently have domestic VAT rates of 19%. In theory, you could make VAT savings by purchasing abroad – but it’s a risky business. Any savings you make could be eaten up by import duties and shipping charges, while you won’t enjoy the same level of consumer protection you do on UK items.

It’s best to only consider purchasing small, portable items with full guarantees, such as mobile phones and MP3 players - perhaps from duty free outlets when you next go on holiday.

To help save even more on everyday spending take charge of your daily expenditure with our exclusive online banking service or make it your goal to cut your food bills.

More: The Budget: Winners and losers | History won't judge this budget kindly