Rishi Sunak has announced the temporary cut, first introduced in July, will now be in place until well into the new year.
It had been set to finish in January but this date has been pushed back as businesses again grapple with restrictions due to the worsening pandemic.
Pubs and restaurants will have to close early from 10pm tonight and people are limited to gathering in groups of no more than six.
Announcing the extension as part of a raft of new measures in the House of Commons, Mr Sunak said: ‘The final step I’m taking today will support two of the most affected sectors, hospitality and tourism.
‘On current plans, their VAT rates will increase from 5% back to the standard rate of 20% on January 13.
‘So to support more than 150,000 businesses and help protect 2.4 million jobs through the winter, I’m announcing today that we are cancelling the planned increase and will keep the lower 5% VAT rate until March 31 next year.’
Businesses who have deferred their VAT during the pandemic will no longer have to pay a lump sum at the end of March, the chancellor also announced.
They will have the option of splitting it into smaller, interest free payments over the course of 11 months. This is expected to benefit nearly half a million businesses who deferred £30 billion, according to the Government.
VAT changes were first introduced by Mr Sunak in his summer statement on July 8 as a way of supporting businesses that had to close during the lockdown.
The cut applies to places that sell food and non-alcoholic drinks as well as hotels, holiday accommodation and tourist attractions.
Some chose to pass on the saving to customers while others used it as a boost for dwindling sales.
KFC, Nando’s and Pret all decided to slash prices to reflect the tax reduction. A meal out costing around £45 is more than £5 cheaper because of the cut, but only if the restaurant agrees to change their prices.
Around 150,000 businesses, with 2.4 million staff, are eligible for the cut.
The chief executive of trade association UK Hospitality, Kate Nicholls, welcomed the news and said it would help relieve some of the damage caused by the incoming 10pm curfew.
But she said although the plans were a ‘move in the right direction’, she wants to see more targeted efforts as well.
‘We need Government to go further in hospitality, recognising the greater restrictions imposed upon us, and pick up the full cost of unworked hours,’ she said.
‘Full support to sustain people in their jobs during what could be a pretty bleak winter for hospitality would be a great step forward.
‘The Chancellor has given us some reason to be positive again, but we urge him to engage with the trade on specific measures to keep people in work.
‘While some of these measures announced today will give businesses a future to shoot for, and hope that they can begin to rebuild, we are still not out of the woods.’
Full list of businesses entitled to VAT cut
* Restaurants, cafes and pubs
* Hotels, inns and hostels
* Holiday and caravan parks and other holiday accommodation businesses charging fees for tent pitches or camping facilities
* Amusement parks