3.4.5.     Value added tax (VAT)

LEGAL BASIS

Under Article 93 (99) EC, the Council is required to adopt measures for the harmonisation of "turnover taxes, excise duties and other indirect taxes" where this is "necessary to ensure the establishment and functioning of the Internal Market."

OBJECTIVES

1. Under the First VAT Directive of 11 April 1967 Member States replaced their general indirect taxes by a common system of value added tax. The purpose was to achieve transparency in the " de-taxing" of exports and "re-taxing" of imports in trade within the EEC (see below). All Member States had introduced a VAT by the early 1970s.

2. In April 1970 the decision was taken to finance the EEC Budget from the Communities' own resources. These were to include payments based on a proportion of Value Added Tax and "obtained by applying a common rate of tax on a basis of assessment determined in a uniform manner according to Community rules". The primary objective of Directive 77/388/EEC of 17 May 1977 - generally known as the Sixth VAT Directive - was therefore to ensure that each Member State had a broadly identical "VAT base": i.e. levied VAT on the same transactions. Numerous subsequent amending Directives have attempted to remove anomalies.

3. In 1985 the Commission published the Single Market White Paper, Part III of which covered the "removal of fiscal barriers". A substantial package of proposals for legislation was published between 1987 and 1990. The need for action in the field of VAT arose from the "destination principle" applied to transactions between Member States. The rates of VAT and excise applied are those of the country of final consumption; and the entire revenue accrues to that country's Exchequer. The method by which this system was then administered required physical frontier controls. As traded goods left one country, they were "de-taxed" (e.g. in the case of VAT, zero-rated); and were then "re-taxed" on entering another. Complex documentation was necessary for goods transiting Member States. The Cecchini Report concluded that the system was costing intra-Community traders around 8 billion ECU, or 2% of their turnover.

ACHIEVEMENTS

1.     The VAT System

a.     Initial proposals
The solution initially proposed (1987) by the Commission (COM(87)322) involved a change to the so-called "origin principle". Instead of being zero-rated, transactions between Member States liable to VAT would bear the tax already charged in the country of origin, which traders could then deduct as input tax in the normal way. In theory, this would have resulted in goods moving between, say, England and France, or France and Germany, being treated in exactly the same way as those moving between England and Scotland or Bavaria and Baden-Würtembourg. There would have remained, however, one big difference: VAT paid in England and Scotland goes into the same Treasury; that paid in England and France does not. Estimates showed that there would have been substantial transfers of tax revenues, notably to Germany and Benelux from the rest. Accordingly, the Commission proposed the establishment of a clearing system (COM(87)0323) to re-allocate the VAT collected in the countries of origin to the countries of consumption. This might have been based on VAT returns, on macro-economic statistics or on sampling techniques.

b.     The transitional system
The Commission proposals, however, proved unacceptable to Member State governments. In the second half of 1989, a high-level working party convened by the Council outlined an alternative which retained the destination principle for transactions involving VAT-registered traders. This became the basis of the transitional system proposed by the Commission in the following year, and which came into effect at the beginning of 1993 (Directives 91/680/EEC of 16 December 1991 and 92/111/EEC of 14 December 1992). However, the origin principle generally applies to all sales to final consumers: that is, once VAT has been paid on goods in one country, they can be moved within the Community without further control or liability to tax. At the beginning of 1993 the VAT-paid "travellers' allowance" was therefore abolished - or, rather, was increased to infinity. There are three "special regimes" where this principle does not apply:
-    Distance sales. Mail-order or similar companies having sales over a certain threshold to any Member State must levy VAT at the rate applied in that country (i.e. where the goods are delivered). If necessary, they must appoint "fiscal agents" to account for the tax.
-    Tax-exempt legal persons. (i.e. hospitals, banks, public authorities, etc.). Where these buy goods over a certain threshold from another Member State they are required to pay VAT on them at their domestic rate, despite the fact that the deliveries are theoretically zero-rated (i.e. the customer rather than the vendor is accountable for the tax).
-    New means of transport. Boats, aircraft and cars under 6 months old are taxable in the purchaser's country, even if acquired in another Member State.

The destination principle also continues to apply to most transactions between registered traders. Though tax controls at frontiers have been abolished, traders are required to keep detailed records of purchases from, and sales to, other countries, and the system is policed by administrative cooperation between Member States' tax authorities.

c.     Towards a "definitive" system
The original intention was that this transitional system should apply until the end of 1996. Under Article 35a of the amended 6th.VAT Directive, the Commission was required to "submit proposals for a definitive system" before the end of 1994, and for the Council to reach a decision on it before the end of 1995. However, no formal legislative proposals appeared. Instead, the Commission published two discussion documents:
-    "A Common System of VAT: a programme for the Single Market" (COM(96)328 final of 22 July 1996). This outlined a timetable, running from late 1996 to mid-1999, during which the new system would be introduced in stages.
-    "Description of the General Principles, Commission Services technical note" (XXI/1156/96), which was launched at a special conference on 4/5 November 1996. The essentials were:

.   the "place of taxation" would no longer be where goods are located, or services provided, but where the suppliers' business was established,
.   invoicing and deduction of input tax would be according to the origin system,
.   VAT rates would be harmonised "within a rather narrow band",
.   the allocation of VAT revenues would be separated from the VAT system itself, and be carried out according to national consumption statistics,
.   the 6th. Directive would be revised to make the system simpler, with fewer derogations, exemptions, options and special régimes,
.   steps would be taken to avoid differing national interpretations of VAT law; the role of the VAT Committee would be strengthened; and cooperation between tax authorities improved.

In pursuit of this final objective, a draft Directive was proposed to give the Committee on Value Added Tax, which consists of national representatives and is chaired by the Commission, more powers of decision (COM(97)325). New proposals to replace the 8th. VAT Directive with a system of deduction in the country of registration, together with a linked proposal on eligibility for deduction (COM/98/377); and a simplification of the "tax representative" system (COM(1998)660) were published in 1998. A decision on the taxation of gold (COM(92)441) was adopted by the Council on 12 October, 1998.

Meanwhile several other VAT issues have remained unresolved: tax-exemption thresholds for SMEs (COM(87)525); and the taxation of passenger transport (COM(92)416) and of various non-food agricultural products (wool, flowers, timber) (COM(94)584).

The growing importance of information technology has focused attention on the application of VAT in this area. The Commission proposed a Directive on value added tax arrangements applicable to telecommunications services (COM(97)0004), following a decision by Council to apply a temporary derogation from the normal provisions of the 6th Directive, and apply a "reverse charge" procedure (which remains in force). The Commission also published a Communication on Electronic Commerce and Indirect Taxation (COM(1998)374 final); and a draft Directive on VAT on e-commerce (COM(2000)349).

More generally, the Commission has now shifted its emphasis from a move to a "definitive" system towards measures to improve the present "transitional" arrangements. In June 2000 it published a Communication on a Strategy to Improve the Operation of the VAT System within the Context of the Internal Market (COM(2000)348), outlining a new list of priorities and timetable for decisions.

Source: Commission Communication COM(2000)348

2.     VAT Rates

The Commission's original proposals on VAT rates (COM(87)321) were for "approximation" within two tax bands: a standard rate between 14% and 20%; and a reduced rate between 5% and 9%. However, the main provisions of Directive 92/77/EEC of 19 October 1992 were:
-     a minimum standard rate of 15%, subject to review every two years;
-     the option for Member States to apply either a single or two reduced rates over 5% to any of the goods and services listed in Annex H of the amended 6th. VAT Directive;
-      derogations for certain Member States to apply a zero rate, a " super-reduced" rate or a " parking" (i.e. transitional) rate, pending the introduction of a definitive VAT system;
-     the abolition of "luxury" or higher rates.

The first Commission report (COM(94)584) on the results of this agreement concluded that it was working satisfactorily. There were no significant changes in cross-border purchasing patterns since 1 January 1993, nor any significant distortions of competition or deflections of trade through disparities in VAT rates. The Commission therefore proposed (COM(95)731) no change in the 15% minimum; but suggested a new maximum rate of 25%. The Council in December 1996 accepted the first of these proposals; but only agreed to make "every effort" not to widen the current 10% span. No new proposals on VAT rates were made in the Commission's 1997 Report on the working of the system (COM(97)559). However, a renewed proposal to fix VAT rates in a 15% to 25% band was made in 1998 (COM(1998)693) - though this was subsequently rejected by Council. A Communication was also published in November 1997 on "Job creation: Possibility of a reduced VAT rate on labour-intensive services for an experimental period and on an optional basis" (SEC(97)2089), and a formal proposal in 1999 (COM(1999)62). This was agreed by Council for a limited range of services and for an experimental period.

Much controversy has taken place concerning the continuing application of a zero VAT rate to certain goods and services, notably in the UK and Ireland. A specific derogation contained in Art. 28 of the 6th.Directive, refers back to Art. 17 of the Second VAT Directive of 11 April 1967. The zero rates already in force on 31 December 1975 can continue provided that:
-     they exist for clearly defined social reasons;
-     they benefit the final consumer; and
-     the "origin principle" is still not being generally applied.
Sweden and Finland have the right to continue applying a zero rate where another Member State already applies it to the same products or transactions.

ROLE OF THE EUROPEAN PARLIAMENT

1.     The VAT System
Parliament has pointed out that ending tax controls at frontiers is not the same thing as abolishing fiscal frontiers. For this to happen goods and services traded between Member States must be treated in the same way as those traded within Member States. In its resolution of 15 July1991, Parliament accepted the transitional regime "on the understanding that both Commission and Council are committed to the full abolition of fiscal frontiers at the earliest possible date". Following the publication of the Commission's programme for a Common System of VAT, Parliament supported an eventual move to the system proposed by the Commission, but gave higher priority to immediate improvements to the system currently in force.

Most recently, Parliament has demanded urgent action against fraud in the VAT system, following the publication of several disturbing reports from the Commission and the Court of Auditors.

2.     VAT Rates
The EP Committee on Economic and Monetary Affairs and Industrial Policy broadly supported the Commission's original 1987 proposals for VAT rates. But, as a result of the revisions that took place in the years that followed, Parliament was only able to give a final opinion on rates in June 1991. It supported a 15% minimum standard rate; but proposed that the application of a reduced rate to certain essential goods and services should be mandatory rather than optional. It also proposed that "no reduced rate may be more than 9%": i.e. that zero might be considered a legitimate reduced rate.

Parliament voted against the proposed 25% upper limit on the VAT standard rate in 1997, but in 1998 approved a 15-25 standard rate band under certain conditions. It also pressed for Member States to be given the option of applying a reduced rate to certain labour-intensive or environmentally-friendly activities - pressure which was eventually successful. In May 1998 Parliament also urged action to ensure a uniform application of rules on reduced VAT rates.

19/10/2000