New EU VAT Initiative Launched

The future of Value Added Tax (VAT) in Europe is set to be getting more attention at EU level in the coming months.

Although tax is predominantly a national policy area, the EU does have the prerogative to “harmonise” VAT (for example, the current minimum rate in the EU is set at 15%) and grant exemptions and derogations; also, a small part of Member States’ revenues that accrue from VAT receipts go toward the EU budget.

It is in this context that the Green Paper on the future of VAT in launched, which the European Commission says will aim at ensuring that the EU’s VAT system becomes simpler and more solid and efficient.

This week EU Issue Tracker looks at the main themes of the Commissions VAT Green Paper.

Transactions between Member States in the single market – the relevance of VAT.

Although the EU has from its very first piece of legislation on VAT in the EU conceived of its VAT system being applied in the same way as it is on national level in Member States, this has not materialised. Current EU law actually states that VAT has to be applied on goods and services in the state of origin and not, as it is today, in the country where the it is being sold. Attempts have been made to live up to the original text enshrined in EU law but these have all foundered and new pieces of legislation are more accommodating of the reality on the ground.

The Green Paper looks at different ways in which this problem can be resolved by focusing on different aspects through which the current VAT system can be changed:

One suggested model would be to have the VAT tax applied in the Member State of destination. This means that VAT would be paid in the country where it is consumed but this also entails the problem of ensuring that the treatment of domestic and intra-EU supplies is consistent.

Another suggestion is to not change the principles of the current system. This would however require a thorough review and enhancement of its application as regards legal certainty and bureaucratic burdens on cross EU transactions. 

A third suggestion elaborates upon applying a reverse charge mechanism on domestic business to business transactions so as to create consistency between intra-EU and domestic transactions. The aim of this would be to solve the current problems of fraud in the VAT system.

Taxing intra-EU supplies of services and goods (under the current rules and at the rate of the Member State of destination) is also suggested since this would also create consistency between intra-EU and domestic transactions.

The Commission’s question that it raises in regard to this concerns whether people think that the current VAT arrangements for intra-EU trade are tailored well enough for the functioning of the single market or whether they are better viewed as obstacles to the optimisation of the potential benefits of the single market. 

Ensuring the VAT system’s neutrality

In regard to the scope of VAT the Green Paper points out that since there are differences concerning the VAT rules that apply to different suppliers (an example of this would be instances where public bodies are exempt from paying VAT), different incentives relating to such things as outsourcing of activities will be affected. It is thus mentioned that the Commission has launched a study looking into this matter (and suggested solutions) and the questions asked in regard to this topic asks whether people think that the contemporary VAT rules for public institutions and holding companies can be viewed as acceptable, what other problems concerning the scope of VAT people have come across and what should be done to solve these problems.

The Green Paper touches upon the issue of exemptions of VAT that currently exists (this includes such thing as educational and cultural activities), which by definition go against the principles of VAT being applied as a broad based tax. The questions raised in relation to this therefore focus on what, if any, VAT exemptions should be kept intact, if the system of taxation of passenger transport creates particular problems (for example tax neutrality) and, if so, what should be done to resolve these problems. 

The importance of businesses being able to deduct VAT is strongly emphasised since VAT is meant to be a tax on consumption and nothing else. Issues relating to the extent VAT is deductible and when and how it should be deducted are thus of paramount importance. Questions concerning what people think are the main problems with the right to deduct and what changes people would like to see in order to improve the fairness and neutrality of the rules concerning deduction of input VAT are raised. 

International services have become more important over the decades as a result of changes to the world economy and the development of communication technologies. These changes have great implications for VAT since there are risks of double or non-taxation of the services in question. Questions relating to this hence ask what the main problems in regard to VAT and international services are in terms of issues such as tax neutrality and competition and what should be done to resolve these problems.

Required degree of single market harmonization

Concerning the legal process through which the rules on VAT in the EU are being set out the Commission states that the usage of Directives has given the Member states a bit too much room for manoeuvre, which has left the outcome of VAT in the Member States inconsistent in comparison to each other. The questions raised thus aim to elicit answers in regard to which provisions should be regulated by Council Regulations (instead of Directives), whether a Commission Decision might be more suitable or if non-legal instruments are more suitable if the two first alternatives are not achievable.  The issue of how to improve the legislative process more broadly (i.e. its transparency, stakeholder process etc.) is also raised. 

Due to the fact that Member States can seek (and be granted) derogations in order to address, for example, issues relating to the complexity of collecting VAT and tax evasion, a fragmented landscape has emerged. This adds to the complexity of VAT within the EU and the questions raised as a result focus on whether people have experienced any difficulties as a result of these derogations and whether the procedure used for granting these derogations is satisfactory. 

The Green Paper makes clear that the contemporary variation of the VAT rate in the EU does not seem to disrupt the single market. The reason for this has to with certain correction mechanisms relating to this but these do of course add to the complexity of the VAT system.  The questions thus raised focus on whether people think the current rates structure, for instance, impede the functioning of the single market and if people would prefer to have no reduced rates or a compulsory and uniformly applied reduced VAT rates list.

Reducing ‘red tape’

The EU has been committed since 2007 to reduce its administrative burdens by 25% by 2012. The way to achieve this was outlined in ‘the Commission Action Programme for Reducing Administrative Burdens and Streamlining VAT Obligations’. The Green Paper outlines a couple of scenarios to deal with red tape as concerns VAT (such as dealing with the fragmentation that has resulted as a consequence of differences in how Member States meet certain obligations set out in the VAT Directive). The Commission asks in relation to this what people’s main problem with the current rules on VAT obligations have been, what should be done at EU level to resolve these problems and what their views are on the ideas outlined by the Commission.

The Green Paper states that small businesses are allowed to get VAT exemptions as long as they remain below a certain threshold. There is however a number of problems relating to this that, for instance, concern the fact that there are different levels in the threshold in different Member States. The Commission hence states that an obvious solution to this would be to have an EU wide scheme that would set a uniform threshold and allow for a greater scope to limit compliance costs within the EU. It goes on to ask whether the contemporary exemption scheme for small business should be reviewed and, if so, what the main elements of such a review should be. Additional simplifications to be considered and if the small business schemes cover small farmers well enough are also issues people are asked to ponder.

A one-stop-shop mechanism (to deal with the problems that arise in business-to-customer transactions that are subject to VAT in a Member State other than that in which the supplier is located in) is proposed by the Commission. The Commission makes clear that it would like to know whether people see it as a relevant simplification measure.

Concerning the VAT system and large and pan-European businesses the Green Paper states that corporations usually complain that there is an absence of clear and consistent VAT rules whereas tax authorities are worried about the possibilities for VAT evasion schemes in complex business structures. The questions raised in relation to this ask whether contemporary VAT rules create problems for intra-company or intra-group cross-border transactions and, if so, how these can be resolved.

In line with a consultation regarding the possibilities to simplify VAT collection procedures as concerns centralised customs clearance the Commission asks in which areas of VAT legislation synergies with other tax or customs rules need to be promoted. 

Creating a more solid VAT system

The way tax is collected in the EU has barely changed over the last couple of decades. In regard to combating fraud the Commission has in an earlier feasibility study looked into different ways of simplifying and improving the way the collection of VAT is carried out. The result of the study included four models that were proposed to accomplish this feat. The different models aim to use modern technologies, financial intermediaries and other more modern solutions to come to grips with this problem. The question asked to the public is which of the four different models they prefer or if they would like to suggest another alternative.

Protecting legitimate traders against possible involvement in VAT fraud, and ensuring that they are not culpable, is a costly and administrative burdensome process. Thus the question about the feasibility and relevance of an optional split payment (which would mean that customers can protect themselves against culpability and save themselves from needing to check their suppliers’ compliance) is raised.

Administrating the VAT system in an efficient and modern manner

The Commission makes clear that, although tax administration is carried out on a Member State level, it has an impact on the single market as a whole. Different ways to ensure the reduction of the involvement of tax authorities and the administrative burden on corporations were proposed in the Commission’s Communication on ‘A coordinated strategy to improve the fight against VAT fraud in the EU’. The proposal focuses on such things as enhancing the dialogue between tax authorities and other stakeholders, pooling best practices etc. The questions raised in relation to this therefore concerns what people think about the Commission’s proposals and whether they have any suggestions of their own.

Other issues

The last question asked in the Green Paper asks whether there are any other issues, in relation to VAT, that people would like to be addressed.

Next steps

All answers to the questions raised in this Green Paper need to be submitted by 31 May. The result of the debate that will ensue, in addition to the issues brought up in the Commission Work Programme for 2011, will be the basis for a Communication that the Commission will present in late 2011, which will identify the priority areas in which further EU action is needed.