One of the key outstanding uncertainties with Scotland's deposit return scheme (DRS), of interest to both producers and retailers, has been the VAT treatment of the refundable 20p deposit that is to be added to the price of a drink at each stage of its supply chain.

Why does the DRS need specific VAT rules?

Under current VAT legislation, VAT is chargeable on the price paid for goods including any deposit added to the price. If the deposit is refunded to the customer, the VAT is then adjusted to ensure that the VAT paid to HMRC reflects the price actually paid.

Applying the current VAT rules to the DRS would be very complicated indeed, and so a much simpler approach is being taken to ensure the DRS operates effectively. HM Treasury issued a factsheet in February outlining the way VAT will apply to the DRS, which explained that:

  • no business will have to charge VAT on the deposit amount when a drink is sold;
  • VAT will only be due on unredeemed deposits (i.e. the deposit paid on a DRS container that is not returned);
  • only the producer of the unredeemed drink will be liable for the VAT (see our previous post to understand who qualifies as the producer).

The necessary changes to the VAT rules are included in the Spring Finance Bill 2023 (at clause 314, which introduces new sections 55B, 55C and 55D to the Value Added Tax Act 1994). HMRC has also issued a technical consultation on amendments to the VAT regulations, which is open until 17 May 2023. HMRC is also preparing a VAT Notice to give more detailed guidance on the new rules, but this has not yet been published.

No VAT to be charged by any business on deposits at the point of sale

The new VAT rules provide that a deposit amount under a DRS scheme is excluded from the consideration for VAT purposes (in line with what the DRS Regulations themselves say). This means VAT is only chargeable on the price excluding the 20p deposit, and not on the deposit amount.

Even where the deposit on an item goes unredeemed, there will still be no VAT payable at any stage by anyone in the supply chain after the producer – i.e. distributors, wholesalers and retailers will not have to charge VAT on the deposit amount in any circumstance.

However, there will still be some complexities for those other parties in the supply chain, who will need to ensure that their accounting systems are ready to deal with the VAT treatment of DRS sales. Where an in-scope drink is subject to a discount or is part of a "meal deal" or "buy one get one free" arrangement, the deposit amount will need to be taken into account in any apportionment calculations to arrive at the VAT chargeable.

Producers to pay VAT on unredeemed deposits

The Bill places the liability to pay VAT on unredeemed deposits on the person who makes the first supply of goods in the supply chain (which should equate to the producer under the DRS Regulations), provided their supply was standard rated.

Producers will have to include a DRS VAT adjustment in each quarterly VAT return. This will be calculated based on their DRS supplies less DRS returns in that VAT quarter, and over time, on a rolling basis, will ensure that VAT is only paid on deposits relating to containers which were not returned by consumers.

For example, in a particular VAT quarter:

  • if a producer sells 1,000 drinks in within-scope containers;
  • and 900 of the containers are returned, so there are 100 unreturned containers / unredeemed deposits;
  • then the producer has to pay VAT on the 100 unredeemed 20p deposits (i.e. £20 in total), and so would include the VAT payable on that £20 in their VAT return;
  • HMRC have confirmed that when accounting for the VAT on unreturned drinks containers, drinks producers should treat the deposit amount as inclusive of VAT. So for a deposit amount of 20p, the VAT would be 3.33p. The VAT on 100 unredeemed deposits would therefore be £3.33.

To assist cash flow, if the number of containers returned is less than 80% of the number of containers the producer supplied in any VAT quarter, producers have the option of accounting for all or part of the VAT in their next VAT return.

How will producers know how many of their containers have been returned?

Scheme administrator Circularity Scotland Limited ("CSL") will be responsible for collating this information and communicating it to producers, as part of its role of collecting returned packaging from return point operators.

However, if for some reason producers do not receive the necessary information from CSL then (unless the lack of information is only temporary) the draft regulations on which HMRC are consulting provide that VAT will be payable as if 80% of deposits had been redeemed. That is equivalent to the 80% minimum collection target set out in the DRS Regulations (at Schedule 3) for 2024, although that target does then rise to 90% for subsequent years – whether the VAT assumption follows suit may depend on the collection rates that can be achieved in practice.

The VAT notice to be published by HMRC will also deal with situations where producers cannot distinguish between returned containers relating to products some of which were sold with VAT and some without VAT for example because some sales were made within a tax warehouse.

It remains to be seen whether the UK Government will agree to exempt the DRS from the operation of the UK Internal Market Act. If not, it is debatable whether Scotland's DRS scheme will be able to go ahead as planned. Either way, however, England, Wales and Northern Ireland are expected to introduce a DRS in 2025 (and if Internal Market Act approval is not forthcoming for the current scheme then Scotland will presumably join that UK-wide approach). The new VAT regime will apply equally to DRS schemes introduced anywhere in the UK, so sooner or later producers, retailers and others will need to get to grips with the new rules.


Isobel d'Inverno

Director of Corporate Tax

Scott Bell

Senior Solicitor