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European Union VAT Reform - Reshaping The EU VAT Regime

By Editorial
November 29, 2017

In October 2017, the European Commission released plans for what it has said will be the biggest reform of EU VAT rules in a quarter of a century. These proposals, and the reasons why the Commission sees the need for such major changes, are explored in this special feature.

Context – The VAT Gap

According to data released by the European Commission just days before the VAT reforms were announced, the EU value-added tax gap – the overall difference between expected VAT revenue and actual EU member state collections – was EUR152bn in 2015.

Breaking down the VAT gap figures by member state, the largest VAT Gaps were reported in Romania (37.2 percent), Slovakia (29.4 percent) and Greece (28.3 percent). The smallest gaps were observed in Spain (3.5 percent) and Croatia (3.9 percent). In absolute terms, the highest VAT Gap of EUR35bn was in Italy. The VAT Gap decreased in most member states, with the strongest improvements in Malta, Romania, and Spain. Seven member states saw small increases: Belgium, Denmark, Ireland, Greece, Luxembourg, Finland, and the UK.

The VAT Gap was nevertheless down in 2015 on the 2014 level of EUR160bn. And the Commission attributes this to key reforms introduced from January 1, 2015. Under these changes, the EU introduced enhanced rules on business-to-consumer supplies of telecommunications, broadcasting, and electronic services, requiring that these be subject to VAT in the location of the consumer, with strengthened rules to boost business compliance rates. Given that the VAT gap study includes data from taxpayers' compliance with these rules, these results are therefore likely to strengthen its arguments that further reforms to the EU VAT regime are needed.

Indeed, at the time the VAT gap figures were released, the Commission said the scale of the tax gap "demonstrates the need for serious reform so that member states can make full use of VAT revenues for their budgets."

"While the collection of VAT revenues shows some signs of improvement, the missing amounts remain unacceptably high," it said.

Towards A Definitive Tax Regime

In the Commission's view, the fact that the EU VAT regime is incomplete is a major reason for the extent of the VAT gap.

Under the current "transitional VAT system," goods sold cross border between businesses established in different member states are exempt from VAT in the member state of departure of the goods (an exempt intra-EU supply) and the customer has to self-assess and pay the VAT due in the member state of arrival on his intra-EU acquisition.

This system leads to complex and fragmented VAT rules and results in high compliance costs for businesses trading across the EU, as well as a significant administrative burden for companies and tax administrations. It also generates important risks of cross-border fraud in the trade of goods and hampers the functioning of the Single Market.

Therefore, since 2016, the Commission has been working towards tabling proposals for a "Definitive VAT system for Business to Business (B2B) intra-EU transactions on goods." This, it says, would be a simpler and fraud-proof definitive VAT system, focusing on taxing supplies under the destination principle.

The VAT Reform Plan

The new VAT reform plan follows up on the Commission's multi-pronged "VAT Action Plan," first outlined in 2016. The primary purpose of the new proposals is to reduce levels of VAT fraud, but the Commission also believes they will help to simplify the pan-EU VAT system and reduce compliance costs for traders, especially for those making supplies across internal EU borders – compliance costs are estimated to be 11 percent higher for cross-border traders than for businesses trading only within a single member state's domestic market. The plan would therefore reduce businesses' compliance costs by a cumulative EUR1bn while modernizing the regime, according to the Commission.

The Commission proposes to fundamentally change the current VAT system by taxing sales of goods from one EU country to another in the same way as goods are sold within individual member states.

With a legislative proposal next year, the Commission will ask member states to agree to four fundamental principles, or "cornerstones," of a definitive single EU VAT area:

  • To tackle fraud, VAT should be charged on cross-border trade between businesses. Currently, this type of trade is exempt from VAT, providing an easy loophole for unscrupulous companies to collect VAT and then vanish without remitting the money to the relevant country's government;
  • The "One Stop Shop" should be expanded. A smaller version – the Mini One Stop Shop – was introduced in 2015 to support the Commission's efforts that year to require the collection by registered persons of value-added tax on business-to-consumer supplies of broadcasting, telecommunications, and electronic services to consumers in the place of consumption. Under the plans, it will be simpler for companies that sell cross-border to deal with their VAT obligations; traders will be able to make declarations and payments using a single online portal in their own language and according to the same rules and administrative templates as in their home country. Member states will pay VAT to each other directly, as is currently the case for electronic services.
  • EU VAT law should follow the destination principle, requiring that the final amount of VAT should always be paid to the member state of the final consumer and charged at that member state's effective rate;
  • Invoicing rules should be simplified to allow sellers to prepare invoices according to the rules of their own country even when trading across borders. Companies would no longer have to prepare a list of cross-border transactions for their tax authority (the so-called "recapitulative statement").

The plan also introduces the notion of a Certified Taxable Person – a category of trusted business that will benefit from much simpler and time-saving rules. Provided that companies – small or big – meet a set of criteria, they can get a certificate allowing them to be considered throughout the EU to be a reliable VAT taxpayer. A business can become a Certified Taxable Person by applying to their national tax authorities and proving compliance with a set of sufficiently harmonized and standardized pre-defined criteria including: regular payment of taxes, reliable internal control systems, and proof of solvency. The status of Certified Taxable Person will be mutually recognized by all EU member states.

This legislative proposal will be sent to the member states in the Council for agreement and to the European Parliament for consultation. The Commission will follow this initiative in 2018 with a detailed legal proposal to amend the EU VAT Directive at technical level so that the proposals set out for the definitive VAT regime can be smoothly implemented.

Four "quick fixes" have also been proposed, to come into force by 2019. These short-term measures were explicitly requested by member states to improve the day-to-day functioning of the current VAT system until the definitive regime has been fully agreed and implemented. These will include:

  • Simplification of VAT rules for companies in one member state storing goods in another member state to be sold directly to customers there. This simplification is limited to Certified Taxable Persons who will no longer need to register and pay VAT in another member state when they store goods there.
  • Simplification for those elements of a chain transaction which do not involve the physical movement of goods, for example when goods are sold via several traders, but physically the goods move directly from the original seller to the final buyer. This simplification is also limited to Certified Taxable Persons.
  • New harmonized and uniform rules for Certified Taxable Persons to enable them to more easily provide proof that goods have been transported from one EU country to another.
  • Clarification that, in addition to proof of transport, the VAT number of the commercial partners recorded in the electronic EU VAT-number verification system (VIES) is required for the cross-border VAT exemption to be applied under the current rules.

Additionally, the Commission confirmed that in November 2017, it would release its: proposal for a modernized system of setting VAT rates, to give greater flexibility to member states as regards VAT rates; proposal to reinforce administrative cooperation between member states; and its proposal to simplify VAT for SMEs, which will look at how to ease VAT obligations for small- and medium-sized enterprises.

However, at the time of writing, these additional proposals have yet to materialize.

The Next Steps

This legislative proposal will be sent to the member states in the Council for agreement and to the European Parliament for consultation. The Commission will follow this initiative in 2018 with a detailed legal proposal to amend the EU VAT Directive at technical level so that the proposals set out for the definitive VAT regime can be smoothly implemented. It is intended that the transitional measures and so-called "quick fixes" will take effect in January 2019. The definitive VAT regime is expected to apply from 2022.

Weighing Up The Reforms

In justifying the need for these changes, Pierre Moscovici, European Commission for Taxation, said that the old regime was no longer fit for purpose in the age of the Single Market, and that the proposals were vital, both to thwart the activities of tax evaders and criminals, and to provide a more seamless EU VAT system.

"25 years after the creation of the Single Market, companies and consumers still face 28 different VAT regimes when operating cross-border. Criminals and possibly terrorists have been exploiting these loopholes for too long… this anachronistic system based on national borders must end!," he declared.

"Member states should consider cross-border VAT transactions as domestic operations in our internal market by 2022. Today's proposal is expected to reduce cross-border VAT fraud by around 80 percent. At the same time, it will make life easier for EU companies trading across borders, slashing red tape, and simplifying VAT-related procedures. In short: good news for business, consumers, and national budgets, bad news for fraudsters," he added.

However, Moscovici's words don't disguise the fact that whichever way one views the proposals, they still represent a far-reaching overhaul to the EU VAT system, and the new system, based on the destination principle, is likely to take some getting used to for many taxpayers, especially SMEs and small traders.

Indeed, the reforms themselves are complex, and as such any gains for taxpayers in terms of simplification may well be compromised. The Certified Taxable Persons proposal, to name one of the more controversial elements of the reforms, could potentially add to the compliance burden of taxpayers.

Political compromises are also expected. Indeed, there is no guarantee that these reforms will be put in place according to the schedule outlined by the Commission, and it is likely that they could look quite different to those outlined above once the member states have had their say. Given that the plan is likely to be debated intensively in the Council, the current timetable looks quite ambitious.

Nevertheless, this isn't to say that taxpayers shouldn't prepare for major changes to the VAT system, even if they could be some way off. These VAT reforms are one of the Commission's highest priorities, and they are therefore likely to remain high on the EU agenda.


Tags: tax | business | Tax | compliance | trade | Europe | European Commission | services | budget | Greece | VAT rates | Romania | Spain | Luxembourg | Malta | Belgium | Slovakia | Croatia | Denmark | Finland | tax authority



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