The dish on marshmallows and VAT — Wacky Tax Wednesday

Few experiences capture the spirit of summer quite like roasting marshmallows. Few events capture the attention of tax officials quite like taxability disputes. So with summer in sight, the time seems right to revisit a tax dispute centered on the taxability of mega marshmallows in the United Kingdom. There are new developments since we first tackled this topic in December 2022. 

This value-added tax dispute has been brewing since August 14, 2019, when HM Revenue & Customs (HMRC) issued a £472,928 VAT assessment against a wholesaler of “American sweets and treats.” The crux of the case boils down to this: Do mega marshmallows qualify as “confectionery” (candy) under value-added tax law? 

To understand how such a question could even come to be, you need to understand how the U.K. taxes food.

So.

The U.K. applies value-added tax (VAT), a consumption tax, to most goods and services. VAT might feel much like sales tax to an American shopping in London, but the two tax systems are actually quite different. 

The U.K. has three VAT rates:

• Standard rate (20%)
• Reduced rate (5%)
• Zero rate (0%)

The standard rate applies to most goods and services. 

The reduced rate applies to certain goods and services that are good for people to have, such as children’s car seats and home energy. 

The zero rate applies to specified items, including clothing for young children, women’s sanitary products, and most food. 

But not all items intended for ingestion are considered zero-rated “food” under VAT law. Some foods are subject to the standard rate of 20%, and the difference between 20% and 5% and 0% is, well, 15% or 20%. A lot, when it comes to tax. 

The zero rate applies to most food products intended for home consumption (catering, restaurant, and takeaway food is generally taxed at the standard rate). Examples of zero-rated food products include raw meat and fish, fruits and vegetables, and cereals and nuts.

For the most part, standard-rated food is the stuff your mom might keep hidden in a high cupboard. Does it taste good? Usually. Is it good for your health? Probably not. Examples of standard-rated (20%) foods include ice cream, potato chips, and some confectionery.

HMRC tries to provide clear guidance for taxpayers in the food business to help them determine whether the foods they sell are taxed at the standard or zero rate of VAT (foods generally aren’t subject to the 5% reduced rate). It offers numerous examples of standard-rated and zero-rated foods. 

But it isn’t easy. There are just too many nuances to include every possibility, so questions and controversies inevitably arise.

For example, if you had to guess, would you say a marshmallow is subject to the standard rate or the zero rate? What about an oversized marshmallow sold to be skewered and roasted over a fire?

The HMRC gives “marshmallow” as an example of “standard-rated confectionery” (subject to the 20% VAT). According to the agency’s guidance, “Standard-rated confectionery includes chocolates, sweets and candies, chocolate biscuits and any other ‘items of sweetened prepared food which is normally eaten with the fingers.’”

However, HMRC also notes that a product sold for use as an ingredient in home cooking or baking can, in some circumstances, be zero-rated.

So, what’s a business in the marshmallow industry to do? If there’s a chance their products could qualify for the 0% rate, many businesses will argue they should. That’s what happened here.

In the case at hand, the taxpayer treated its Mega Marshmallows as zero-rated. HMRC determined they were subject to the 20% VAT rate. Then, in August 2019, HMRC assessed the business £472,928 in value-added tax on supplies of Mega Marshmallows for the periods between June 2015 and June 2019. That’s about $590,000 today.

The company appealed, as companies often do, and in September 2022, the First-Tier Tribunal issued a nine-page ruling. This wasn’t an open-and-shut case.

The ruling acknowledges that a number of factors suggest the marshmallows be categorized as standard-rated confectionery. For example:

• The marshmallows can be eaten as a snack from the bag
• The packaging identifies the marshmallows as a product that may be consumed as a snack
• The marshmallows are generally eaten with the fingers, either without roasting or once roasted and allowed to cool down

Yet the ruling also lists factors suggesting the product “is not properly characterised as confectionery,” including:

• The preparation. Unlike confectionery, the marshmallows are intended to be subject to a further cooking process. 
• The packaging. The packaging suggests the marshmallows are intended to be roasted.
  
• The marketing. The marshmallows are typically displayed in the barbecue section of retail stores.
• The sales. The marshmallows are purchased more in the summer months than regular marshmallow products, suggesting customers tend to roast them.

The tribunal took these and other factors into account. And in the end, it decided that the product must be zero-rated.

This time, it was HMRC’s turn to appeal.

The Upper Tribunal issued its decision on April 4, 2024. At 25 pages, it’s even longer than the First Tier Tribunal’s ruling and is worth a read if you enjoy references to “legal fiction,” “perverse” facts, and doing “some violence to the words.” 

The Upper Tribunal ultimately agreed with the First Tier Tribunal that mega marshmallows are not “confectionery” under VAT law. Its reasons include the following: 

• The marshmallows are marketed, sold, and purchased as a product specifically for roasting
• The size of the marshmallows makes them particularly suitable for roasting 
• The marshmallows are kept in the barbecue section of supermarkets during the summer months, when most sales are made
• Outside of summer, the marshmallows are found in the world foods section

It’s unclear whether HMRC will appeal this decision.

There are a lot of tax disputes like this, and they’re interesting to follow. For the taxpayers involved, however, they’re usually a drag. One way to avoid them is to collect the proper amount of tax from the outset, no matter where or what you sell. Tax automation software can help.