Your author is displeased with the state of global affairs, but I’m not here to discuss the concerns you might imagine. There are troubles in the Middle East and Eastern Europe, not to mention discord here at home. At times our world seems like a mess. Amid this strife, I choose to fixate on consumption taxes. There’s a problem with VAT, and it’s driving me nuts. Admittedly that’s a peculiar fascination, as I live in the sole industrialized nation that doesn’t have VAT.
This is what happens when you spend too much time reading academic literature — and Tax Notes. Aspirational thinking sets in. Before you know it, you’re paraphrasing Len Burman (VAT could pay for universal healthcare) or Michael Graetz (VAT could remove 100 million households from the income tax). You might even embarrass yourself at cocktail parties, wanting to debate other guests on the superiority of VAT relative to state-level retail sales taxes. No, the nice lady at the bar does not want to be lectured on the virtues of the credit-invoice mechanism.
Call it an idée fixe. I want our consumption tax regimes to be elegant in their simplicity, a feature the income tax struggles with. I want VAT to be efficient, raising revenue with minimal economic distortions. I want the VAT burden to fall exclusively on the final consumers of goods and services, never on business inputs. I especially want the VAT base to be neutral among different categories of consumption, never dictating winners and losers in the marketplace.
Above all, I want VAT to be free of the carveouts, preferences, and gimmickry that plague income tax codes the world over. That’s to say, I want VAT to be immune to tax politics, to the greatest extent possible. In short, I ask too much of VAT. Mea culpa.
Imagine, then, my discontent on learning of a recent U.K. court decision that underscores our glum reality. Real-world VAT regimes seldom possess the venerable traits we purists want them to have. The case is HM Revenue & Customs v. Innovative Bites Limited, decided March 21. You may have heard of Innovative Bites by a different moniker: the great British marshmallow decision of 2025. Reality also bites.
The issue on appeal was whether oversized, fluffy marshmallows should be classified as edible confectionaries, thereby subject to the standard U.K. VAT rate of 20 percent, or classified as a culinary ingredient that qualifies for VAT exemption.
Make no mistake: Lawsuits like this are why you studied so diligently in school and took out those student loans. This is why you admired Atticus Finch as a youth, and why we appreciate the courtroom skills of Clarence Darrow. We became members of an esteemed profession to brawl over junk food.
I’m sorry to report that society has not progressed beyond the tedious Jaffa Cake affair. That VAT dispute, now preserved in infamy, turned on whether food items were properly classified as cakes (exempt from VAT) or biscuits (fully taxable). To that end the learned jurists took notice of the fact cake-like substances are naturally soft and harden over time as they go stale, whereas biscuit-like substances are naturally stiff and gradually soften when allowed to stale. That Jaffa Cakes morph into hockey pucks when left out too long foretold the taxpayer’s triumph.
If your patience with VAT preferences has gone stale, you are not alone. Within the tax community the term “Jaffa Cake” has become synonymous with legislative fecklessness. Especially for VAT preferences that waste our time, resources, and intellectual energy while serving no identifiable policy objective.
I harp on the U.K. tax rules, but the same criticism applies elsewhere. This flaw with VAT is nearly universal. Just look at India’s VAT if you want a more recent example of rate preferences run amok. The prevalence of multiple VAT rates inevitably leads to conflict and litigation, with taxpayers chasing discounted rates and revenue bodies pushing back. As a tax publication we’re driven to cover these developments; they’re bound to be important to somebody. It’s challenging to report on them without smirking.
First Jaffa Cakes, now behemoth marshmallows. I’m reminded of what a professor once told me years ago: There are no foolish tax cases, just foolish tax laws. A disproportionate number of them involve VAT rates. So, we ask ourselves: What lasting good do these multiple rates serve? Little to none, I’d say.
They don’t fuel growth. They don’t foster investment. They don’t create jobs. Nor do they raise revenue for the fisc, quite the opposite. The more you ponder it, a single-rate VAT is exactly what the doctor ordered. Too bad such things are nearly impossible to find.
Alas, we’ve reached the point where it’s hard to distinguish serious legal analysis from biting satire. What follows is bit of both.
See You in (Food) Court
The taxpayer, Innovative Bites Ltd., is a wholesaler. It does not produce the snack food in question, which is branded as “Mega Marshmallows.” The company distributes a range of food products across the U.K. grocery and convenience store sector. It specializes in American-style snack food.
A conflict developed between the taxpayer and HMRC regarding the treatment of non-retail sales activity occurring between June 2015 and June 2019. The taxpayer claims the marshmallows are merely a food ingredient. That is, one component used in the making of a separate food product and therefore zero-rated for VAT purposes under Schedule 8 to the U.K. VAT Act 1994.
The government regards the zero-rating as unwarranted. It contends that Mega Marshmallows are a distinct confectionary snack on their own, thereby fully taxable at the standard VAT rate applicable during the years at issue. This resulted in an August 2019 assessment for unpaid VAT of £473,000. The case progressed through the First-Tier Tribunal (Tax Chamber) and the Upper Tribunal (Tax and Chancery Chamber), before landing in the U.K. Court of Appeals (Civil Division). Each of the lower courts ruled in the taxpayer’s favor.
How are marshmallows (of any variety) something other than a confectionary delight, you ask? The taxpayer draws our attention to the size of these tasty tidbits, which is unique. As the name implies, Mega Marshmallows are oversized. At room temperature an individual piece can measure a stout 5 centimeters when stood upright on its end. That’s about double the height of standard offerings.
Size matters, the taxpayer insists. Oversized morsels are primarily intended to be skewered through the middle, say, with a lengthy stick or pronged instrument with an extended handle. That’s so they can be roasted over a nearby heating source, preferably a campfire. Once warmed, the marshmallow turns gloriously gooey, allowing it to be compressed between two cinnamon-encrusted crackers. Toss in a wedge of chocolate softened by the heat, and you have the sandwich treat affectionately known as a s’more (as in, “Give me some more, please!”).
The taxpayer contends these insights are relevant to the legal challenge. It argues that the finished food product is the s’more, not the Mega Marshmallow itself. The taxpayer noted that these items were typically sold in the same grocery aisle as outdoor barbecue equipment (matches, charcoal, lighter fluid, and so forth). Retail product placement is not a random thing. Conventional marshmallows are stocked elsewhere in stores, usually in the same aisle as other candy, cookies, and licorice — all of which are classifiable as finished snacks and ineligible for zero-rating.
The court considered other relevant facts. For instance, the product’s plastic packaging contains images of a campfire under the caption “Extra Tasty, Extra Fluffy, and Extra Large — Perfect for roasting, s’mores, or just snacking.” Some of the packaging included “instructions for use” to guide newbies through their initial s’mores experience. It featured the following tips: “Keep the stick approx. 20 cm above the heat. Do not hold the mallows in the flames, to avoid burning.”
HMRC had rebuttals for each of the taxpayer’s arguments. It pointed out, for example, that s’mores have been made with conventional-size marshmallows for generations. The size of the marshmallow, it argues, is irrelevant. There’s nothing preventing the oversized pieces from being eaten by hand, directly out of the bag, just as you would with a run-of-the-mill snack.
Old Sins, Long Shadows
The Court of Appeals dove deep into the VAT exemption, offering a miniature history of consumption taxation in the United Kingdom. It noted that long before the nation’s entry into the EU, these matters were governed by the Purchase Tax Act 1963. That was the U.K. version of a national retail sales tax. It had none of the features of a modern VAT.
Food was generally exempt under the Purchase Tax Act, with Parliament regarding it as a necessity. An exception was permitted for certain food items thought to be indulgences. These included “chocolates, sweets and similar confectionery,” which were all taxable.
Even then, lawmakers couldn’t resist the compulsion to split hairs. Most chocolate items were taxable but certain “chocolate couverture” were exempt. Drained candy fruits were taxable; drained candy cherries were exempt. Glazed or crystalized fruits were taxable; candied fruit peels were exempt. Bizarrely, biscuits coated in a chocolate casing were taxable but not cakes coated in a chocolate casing. (Behold, the demon seed of our Jaffa Cake madness!) Dear reader: If you’re able to find a noble endeavor in the drawing of these differences, then you’re a better sleuth than I.
Years later the United Kingdom joined the European Economic Community (EEC). The accession process required conforming domestic U.K. law to various EU (or EEC) directives, including those pertaining to consumption tax. The Purchase Tax Act 1963 was effectively superseded by Directive 67/228/EEC. This was during the era when retail sales tax regimes across Europe were replaced with VAT.
Conveniently, article 17 of the directive allowed member states to provide for reduced rates, exemptions, and zero-rating on a selective basis. That meant the familiar carveouts from preaccession domestic law could carry over with the transition to VAT, provided the exceptions were “taken for clearly defined social reasons.”
Thus, when Parliament enacted the Finance Act 1972 to usher in the country’s EEC-compliant VAT, the general exemption for food items survived. Schedule 4 of the 1972 act provides that food “of a kind used in human consumption” was to be zero-rated for VAT purposes. Exceptions were again made for chocolates, sweets, and confectionary, as under earlier law.
The U.K. VAT rules were amended several times over the ensuing decades. Most notably in the early 1980s, under the Thatcher government, with the VAT Act 1983. Schedule 5 of the act added a new twist, providing that “any item of sweetened prepared food which is normally eaten with the fingers” was no longer eligible for the zero-rating. This was the first primordial whiff of our marshmallow dispute.
From 1983 onward, U.K. tax authorities have been obliged to consider whether a sweet was normally eaten straight out of the package using fingers, or by other means like a fork, skewer, or tongs. Fingers imply a VAT exemption; utensils imply taxability. Why these things should matter is beyond my cognitive bandwidth.
By the time we got to the VAT Act 1994, the technical distinction was still there, though it’s articulated slightly differently. Confectionaries are subject to the standard VAT rate, while food ingredients are zero-rated.
That, itself, is a baffling policy decision. It sounds as though lawmakers wanted to prevent cascading tax charges to the food preparation cycle, similar to how it aims to prevent the cascading of business inputs generally. However, the U.K. VAT requires no such special rule for intermediate food ingredients because the regime already includes a credit-invoice mechanism. Cascading is sufficiently addressed without the need for further product categories.
The result is that marshmallows eaten out of the bag, with fingers, are presumptive confectionaries, while those toasted over a heat source and used in the making of s’mores receive a dubious VAT exemption. The interchangeability of all marshmallows created by humankind never occurred to the people who wrote the VAT rules. Lord, help us.
La Dolce Vita
Can we blame Innovation Bites, or any other taxpayer, for trying to claim a VAT preference that’s written into domestic law? I don’t. Three courts heard the case and ruled in the taxpayer’s favor — for what it’s worth.
Can we blame HMRC for bringing an assessment and trying to subject the sale of bloated marshmallows to the standard VAT rate? I don’t. The argument that marshmallows are a confectionary item hardly seems unreasonable.
We can, however, blame the legislative mentality that enables these VAT disputes to arise. Some lawmakers may believe it’s their prerogative to lessen regressivity by offering discounted rates on assorted necessities. This doesn’t work. In part because it’s impossible to accurately draw lines between real and perceived necessities, and partly because affluent households consume necessities as much (if not more) than poorer households. Numerous scholars have studied the issue and reached the same conclusion. Providing a range of multiple VAT rates doesn’t provide the intended relief. VAT rate preferences are poorly targeted. In some cases they are completely backwards.
We have better ways of taxing rich folks. The progressive income tax comes to mind. It’s hubris to think we can turn VAT into a progressive fiscal instrument; that’s not what it’s for. The basic task of any broad-based consumption tax is to be purposefully blind to a consumer’s identity and personal attributes, including their economic standing. For instance, the VAT charged on a cup of tea must be the same, regardless of whether the purchaser is a hedge fund manager or retired pensioner. That is not a defect of VAT; that’s an essential design element.
I have no grievance with progressive taxation in the appropriate settings. Policymakers should accept that consumption taxes are inevitably regressive. Our fiscal systems can (and should) compensate for the regressivity in other ways, through other taxes.
Lawmakers blunder in another way regarding VAT rate preferences. They pretend that VAT is a de facto luxury tax or sin tax. There are other ways to penalize consumers who purchase items that are either too posh or socially undesirable. For sure, there are ways other than VAT to deal with externalities.
Nobody should conflate VAT with a Pigouvian scheme. VAT is not how the state should discourage people from indulging in tobacco, alcohol, cannabis, or fizzy drinks. Besides, does anybody really think there are major externalities behind the purchase of Jaffa Cakes or overgrown marshmallows?
At some level this is the story of legislative tinkering for its own sake. U.K. tax attorney and blogger Dan Neidle recently had some choice words on the matter, declaring that “Jaffa Cakes is the price of political cowardice.” I don’t disagree.
Read the full article here
