Why multinationals need to know about a UK VAT ruling on big marshmallows

Unfortunately for multinational organisations, managing VAT obligations can be difficult and carries risk. These risks — including potential penalties as a result of errors, fraud or for other reasons — are on the rise as tax authorities across the globe try to close the VAT gap. This gap is the amount of indirect tax that authorities believe they should have been paid versus the amount they actually collected.

VAT is a complex area of taxation; the OECD’s international VAT/GST guidelines run to over 100 closely printed pages. One aspect of the tax that’s perhaps underappreciated is that its application varies across transactions because of factors such as social considerations, economic dynamics, political imperatives and other influences. As a result, VAT systems often feature a diverse range of applicable rates.

Country-specific legislation governing VAT categorises specific activities and assigns them tax rates. Certain activities, however, remain ambiguous, which can make it difficult for multinational organisations to determine the VAT rates of certain products or services — or indeed if VAT applies at all.

A recent UK judgement involving the food company Innovative Bites Limited illustrates the challenges of understanding if and to what extent VAT applies to goods or services. This article summarises the case as a real-life example of the kinds of challenges multinational organisations face when interpreting VAT rules.

The marshmallow case: Background

Innovative Bites is a wholesaler of American sweets and treats. One of their products is Mega Marshmallows, which are approximately two inches in height and have a similar diameter. Mega Marshmallows are designed to be roasted over a campfire or barbecue and then eaten or used as an ingredient in making s’mores.

From 2015 to 2019, Innovative Bites treated UK sales of Mega Marshmallows as zero-rated for VAT purposes. It reasoned that the marshmallows should be classified as “food,” which is zero-rated for VAT. HMRC, however, argued that Mega Marshmallows should fall under the classification of “confectionery,” which is excluded from zero-rating for food and subject to VAT at the standard rate of 20 percent. HMRC issued a VAT assessment to Innovative Bites for £472,928.

Innovative Bites appealed the assessment to the UK’s First-tier Tribunal. The tribunal deliberated on whether to categorise the marshmallows as a food or a confectionery. Innovative Bites contended that Mega Marshmallows are intended for roasting or as an ingredient, rather than for raw consumption, unlike other similar products. The company emphasised that the marketing, packaging and size of the product all indicated this intended use. The First-tier Tribunal ultimately sided with Innovative Bites.

HMRC challenged the decision in the Upper Tribunal, arguing that Mega Marshmallows align with the general perception of marshmallows and share similarities with other traditional sweets and should be considered a confectionery.

Upper Tribunal decision

In April 2024, the UK Upper Tribunal upheld the First-tier Tribunal decision and ruled in favour of Innovative Bites. It considered the following factors to be key: 

Marketing and packaging. Mega Marshmallows were marketed as unique products for outdoor activities, such as camping and barbecues, rather than regular sweets. The packaging prominently featured families enjoying the marshmallows over a fire, a use not typical for ordinary sweets. This message in marketing and packaging indicated that Mega Marshmallows were distinct from regular sweets and meant for a specific cooking experience rather than just eating.

Size. Mega Marshmallows stood out because they were larger than regular marshmallows, making them ideal for roasting over a fire and setting them apart in the market.

Supermarket placement. Innovative Bites requested that Mega Marshmallows be placed in supermarkets alongside barbecue essentials such as charcoal and skewers. This was a clever move that demonstrated their intended use and established a connection with outdoor cooking, as distinct from typical confectioneries.

Seasonal sales. Mega Marshmallows sell more during the summer than in other seasons, indicating consumers associate the product with outdoor barbecues and camping.

Implications

While obviously an important decision for Innovative Bites, the Upper Tribunal’s decision has implications for the taxation and categorisation of similar products sold in the UK. Presumably, food producers in the UK and other jurisdictions will take a closer look at their products to determine if some of them might be re-categorised as food for VAT purposes. Producers in other sectors may also find they have opportunities to re-categorise their products to lower their VAT exposure.

More generally, the case illustrates the complex nature of indirect taxation and emphasises the importance of conducting a thorough, case-specific assessment of products to determine the correct VAT, GST or equivalent status. The case also highlights that the distinction between different tax treatments can be subtle and depend on factors that are often overlooked and may not immediately appear relevant to tax considerations.

Most organisations will want to engage third-party VAT experts to help them navigate these complexities and lower their VAT-related risks.