The Member States involved have been given two months to reply to the letters of formal notice, which are the first step of the infringement procedure laid down in Article 226 of the EC Treaty.

Under the VAT Directive (article 132), certain activities which are in the public interest are VAT exempt.

That provision does not, however, provide exemption from VAT for every activity performed in the public interest, but only for those which are listed and described in great detail in it.

The EC explained that: "In its settled case-law, the Court of Justice has underlined that all exemptions have to be interpreted restrictively, since they are exceptions to the general rule which requires that VAT be levied on any economic activity."

"Furthermore, exemptions applied by one Member State with no basis in the VAT Directive could lead to distortions of competition and would make it impossible to ensure that Member States contribute on an equal basis to the Community's own resources."

The EC revealed that it has taken issue with exemptions provided for under the Danish VAT regime. Denmark exempts all supplies carried out by charitable or otherwise non-profit-making associations and the like in connection with their running business.

The Commission considers that such a generalized exemption goes beyond what is allowed under Article 132 of the VAT Directive, which contains a detailed restrictive description of the exempt activities, and in some cases also conditions the exemption to the status of the person who is to carry them out.

Denmark also applies a general exemption for goods supplied by second-hand shops, if the surplus is used entirely for charitable purposes or otherwise for purposes of public interest, provided that the shop only sells second-hand goods which it has received free of consideration, and that the shop only employs voluntary unpaid staff. None of the exemptions in Article 132 cover such supplies.

The Austrian VAT regime is also under EC scrutiny, as the Commission considers that Austria should broaden the scope of its VAT exemption rules so as to encompass certain supplies by certain non-profit organisations to their members, as well as the above-mentioned supplies, in connection with certain fund-raising events.

Moreover, an exemption under the VAT Directive for supplies of services by independent groups of persons has generally not been implemented, except with regard to certain professional activities.

Furthermore, the Austrian implementation of the exemption under the VAT Directive for supplies of certain services closely linked to sport or physical education by non-profit-making organisations to persons taking part in sport or physical education is too wide, according to the Commission, since it is valid without restrictions for all transactions by associations of public interest whose aim is to exercise or to promote sports.

Finally, the VAT Directive contains an exemption for supplies of certain cultural services, and the supply of goods closely linked thereto.

However, Austria appears to exempt all the running business of theatres, museums, zoos, natural preserves and botanical gardens, which goes beyond what is allowed under the VAT Directive.

With regard to exemptions in place in Sweden and Finland, meanwhile, the European Commission observed that:

"Under the VAT Directive, any economic activity carried out by a VAT taxable person must be subject to VAT, except where an exemption is explicitly allowed."

"However, under Swedish VAT law, the definition of "economic activity" does not refer to the criteria under the VAT Directive, but is directly linked to the definition and criteria of economic activity under national income tax law. These criteria are irrelevant and potentially misleading from the point of view of VAT. The Commission considers this to be an infringement of the VAT Directive."

"More specifically, as a consequence of the divergence in the definition of economic activity, there is discrimination between non-profit making organisations."

"The Commission however underlines that the activities carried out by non-profit making associations and religious congregations would in most cases be exempt under Article 132 of the VAT Directive. Shouldn't this be the case, Sweden could also opt to implement a special scheme for small enterprises, which is allowed under the VAT Directive. Entities under this scheme would not be obliged to apply VAT on their supplies of goods or services."

It continued: "A similar situation arises in Finland, where, under the national Income Tax Act, only those entities of public interest that are liable for income tax for commercial activities are considered taxable persons for VAT purposes. Other entities of public interest are excluded from VAT."

And concluded: "Moreover, several of the exemptions listed in Article 132.1 of the VAT Directive have not been implemented into Finnish legislation."