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VAT Review: The End of Reduced Rates in the EU?


By Tax-News.com Editorial
April 9, 2013


This feature highlights the European Commission’s ongoing attacks against the way European Union (EU) Member States are applying reduced rates of value-added tax (VAT) to certain goods and services as it battles to simplify the European VAT system.

Under the EU VAT Directive, member states must apply a standard VAT rate of at least 15%, but have the option of applying one or two reduced VAT rates, with a minimum of 5%, to goods and services included on a restrictive list annexed to the Directive. However, that simple structure is complicated by a multitude of derogations which are included in the Directive or were granted to certain member states, for example, in Acts of Accession.

As part of wider work being done to fundamentally reform the EU value-added tax landscape, the European Commission launched a public consultation in October 2012 to ascertain opinions on certain reduced tax rates, and what a change in European rules in that area might imply.

The consultation was a follow-up to the EU VAT Strategy setting out the priority actions needed to create, a simpler, more efficient and more robust VAT system in the EU, which the Commission presented in December 2011. A review of reduced VAT rates was then highlighted as a priority. The three principles which should guide this review were listed as the abolition of those reduced rates which constitute a distortion to competition, and an obstacle to the proper functioning of the internal market; the removal of reduced rates on goods and services, the consumption of which is discouraged by other EU policies; and the subjection of similar goods and services to the same VAT rate, with progress in technology being taken into account in that respect.

As the list of goods and services which can benefit from a reduced rate was agreed by member states many years ago, respondents to the consultation were asked whether certain reduced VAT rates now contradict EU policy objectives, with answers being concentrated on the reduced rates for water, energy, waste management and housing. The consultation was part of an assessment process, and the Commission stressed that is not proposing the abolition or introduction of any reduced VAT rate yet, and that the results of the public consultation, which ran until January 4, 2013, will feed into the preparation of new proposals on VAT rates, which the EC will present in 2013.

Commenting at the time of the consultation launch, Algirdas Šemeta, Commissioner for Taxation, Customs, Anti-Fraud and Audit, said: “It is high time that we take a fresh look at reduced VAT rates. Member states need new revenue sources, while businesses need simpler tax systems with fewer compliance costs. We are asking whether certain reduced VAT rates are delivering what they seem to promise, or whether they pose more problems than they are worth.”

As if to emphasise Semeta’s last point, the Commission has continued to highlight examples where Member States are seemingly not applying the VAT Directive correctly.

The most important case in terms of how VAT should be applied to new types of digital services and products is the e-books dispute involving France and Luxembourg. In letters of formal notice (the first stage of infringement proceedings) sent to both Governments in July 2012, the Commission pointed out that the downloading of digital books is regarded as a service supplied electronically, which is not included in the list of goods and services to which Member States are permitted to levy reduced VAT rates under the VAT Directive and therefore cannot be taxed at the reduced rate. France and Luxembourg nevertheless decided to apply reduced rates to digital books as of January 1, 2012, thereby infringing EU law. The rates are 7% for France and 3% for Luxembourg.

The Commission warned that the situation is creating serious distortions of competition that are damaging to economic operators in the other 25 member states since digital books can easily be purchased in a state other than the one where the consumer resides and, under the current rules, the VAT rate that applies is that of the provider’s, not the customer’s, member state. The Commission noted that local actors in the electronic book market have complained that some of the dominant players in this market have reorganized their distribution channels to benefit from these reduced rates, which has apparently had a serious effect on the sale of books (both digital and traditional) in the other member states in the first quarter of 2012.

However, after the French and Luxembourgish Governments refused to furnish the Commission with an adequate explanation of their respective positions on this issue, or commit to bring their VAT legislation in line with the VAT Directive, both countries were referred to the European Court of Justice in February 2013. Commenting on the case, Semeta observed at the time that: "Questions concerning the tax treatment of physical books and e-books must certainly be tackled. And this is exactly what the Commission is doing as part of the wider review of reduced VAT rates. However, in the meantime, the Member States must play fair. Infringement of the VAT rules for e-books distorts the single market and runs counter to the fundamental EU principle of fair tax competition."

Since it launched the consultation back in October, the Commission has won a significant legal victory in the Court of Justice regarding the way Spain applied reduced rates of VAT to pharmaceutical products.

The VAT Directive lists the categories of supplies of goods and services to which member states may apply a reduced rate of VAT. Those categories include pharmaceutical products normally used for health care, prevention of illnesses and as treatment for medical and veterinary purposes and medical equipment, aids and other appliances normally intended to alleviate or treat disability, for the exclusive personal use of the disabled.

However, according to the Court of Justice, Spain applies a reduced VAT rate to a broader range of goods than provided for under the VAT Directive in the field of pharmaceutical products and medical equipment.

Firstly, the Court considered that the application of a reduced rate of VAT to medicinal substances, "which can be used habitually and suitably in the production of medicine is contrary to the VAT Directive."

Secondly, the Court considered that the VAT Directive does not authorize a reduced rate of VAT to be applied to "medical devices, material, equipment and appliances used only to prevent, diagnose, treat, alleviate or cure human or animal illnesses or ailments."

Thirdly, the Court declared that the application of a reduced rate of VAT to aids and equipment, which may be used to treat physical disabilities to animals is contrary to the VAT Directive.

Lastly, the Court affirmed that a reduced rate of VAT cannot be applied to apparatus and accessories used essentially or primarily to alleviate physical disability in humans, but which are not intended for the exclusive personal use of the disabled.

The Commission issued a reasoned opinion on November 25, 2010, inviting Spain to comply with the VAT Directive, to which Spain reiterated its position that the Spanish VAT legislation is in line with the provisions of the VAT Directive.

Spain was ordered to comply with the Court’s judgment without delay.

Buoyed by its legal success, Brussels has since escalated infringement proceedings against two other member states with regards their application of reduced rates of VAT.

In January, the Commission formally requested that Poland amend legislation giving a reduced VAT rate to medical equipment and pharmaceutical products beyond what it says is allowed under EU law, in a case with many similarities to that of the ruling against Spain.

The Commission argues that Poland goes beyond the scope of the Directive by granting a reduced VAT rate to medical equipment for general use, and to certain non-medicinal pharmaceutical products, such as disinfectants and spa products.

The Commission's request takes the form of a written "Reasoned Opinion," which forms the second step of EU infringement proceedings. In the absence of a satisfactory response within two months, the Commission may refer Poland to the European Court of Justice.

In February, the Commission announced that it has referred the United Kingdom to the Court of Justice for its reduced VAT rate on the supply and installation of energy-saving materials.

According to the Commission, the UK's measure goes beyond what is allowed under the VAT Directive. The EU's rules specify that individual Member States can apply reduced VAT rates to the supply of goods and services used in the housing sector, provided that this is part of a social policy.

However, the VAT Directive does not make any provision for the introduction of a reduced VAT rate on "energy-saving materials" specifically. The universal application of a reduced rate for energy-saving materials is therefore not allowed.

The Commission also notes that the UK's reduced rate is linked to the Government’s "Green Deal", which is designed to improve the energy efficiency of buildings. Nonetheless, the Commission stresses that while it supports the Deal's objectives, it does not believe that breaking EU VAT rules will help the UK in achieving these objectives.

The European Commission sent a reasoned opinion to the UK on the matter in June, 2012. It did not deem the reply received in August to be satisfactory, hence its decision to refer the case to the Court of Justice. This referral is the last step in the Commission's infringement procedure.

The Commission emphasised when it launched the consultation back in October that, if an abolition of reduced rates was the preferred policy option at the end of the process, this would not automatically mean that it would trigger an increase in the overall VAT/tax burden, or would jeopardize the social or other policy goals which are at the basis of the reduced rates currently applied. Additional revenues from abolishing reduced rates could also be used to provide more targeted financial support for pursuing those policy goals and to reduce the standard VAT rate accordingly, it suggested.

However, is it realistic to expect Europe’s revenue-hungry governments to begin reducing standard rates of VAT in the current economic and fiscal environment, especially so soon after many EU Member States have increased standard rates of VAT during the economic crisis to help plug budgetary gaps?

The abolition of reduced rates could certainly be beneficial for businesses buying and selling goods in more than one Member States who must navigate a complex maze of VAT rates, derogations and exemptions. However, while this exercise has the potential to simplify the EU’s nightmarish VAT rules and lower the compliance burden on companies, it is hard to believe the Commission’s assertion that this would not result in a higher tax burden overall.

The Commission’s new proposals on VAT rates will be eagerly awaited this year, but changes to EU fiscal laws tend to move at a snail’s pace, so it might be some years yet before the VAT landscape actually changes. A judgment in favour of the Commission in the e-books case could lend additional weight to any proposal to abolish reduced rates. However, given it took the Court 18 months to reach a decision on Spain’s pharmaceutical VAT, the outcome of the e-books case might not be known until 2015. On the other hand, the Commission might want to move on this issue before the e-books case is determined. Either way, this is a situation that will have to be watched closely by companies operating across Member States, or selling into the EU.


 

Tags: tax rates | health care | budget | environment | United Kingdom | European Union (EU) | business | compliance | legislation | law | European Commission | Poland | France | energy | Luxembourg | services | Spain | tax

 

 

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