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EU Seeks Debate On VAT Simplification

by Ulrika Lomas,, Brussels

09 July 2007

The European Commission has launched a political debate on how the EU's disparate value-added tax systems can be simplified across the union.

"The application of VAT reduced rates is a very sensitive issue in an area where the unanimity principle forces all stakeholders to be inclined to compromise. Today I am very happy to launch a broad political debate between Member States; we need their views before defining a coherent and achievable long term policy," László Kovács, the Commissioner for Taxation and Customs Union, stated last Thursday. "We consider that a new framework for reduced rates is needed, more rational, more transparent and more flexible for the Member States".

The EC's announcement is based on, and presents the results of, an economic study conducted by an independent think-tank, as well as on other reflections on the possible way forward in the field of reduced rates.

The main conclusion of this study is that from an economic perspective a single uniform VAT rate per Member State is the best policy choice. The Commission believes that it would slightly improve consumer welfare in comparison with the current situation, reduce distortions in the functioning of the Internal Market, simplify the rules, and thus reduce compliance costs for business.

Supplies of goods and services subject to VAT are normally subject to a rate of at least 15%, but Member States may apply reduced rates of not less than 5% to goods and services set out in a restricted list. However, these simple rules are complicated by a multitude of derogations granted to certain Member States – and not to others – during the negotiations preceding the introduction of the VAT rates Directive (1992) or in Acts of Accession.

However, EC said there may be specific economic benefits from operating a reduced rate in carefully targeted sectors. According to the study, lower VAT rates could contribute to economic growth if they can induce consumers to spend more on bought–in goods and services. Such a change in consumption habits often also allows more time to be spent on leisure activities, with an associated increase in expenditure. There are also arguments for introducing VAT reduced rates in sectors employing many low skilled workers in order to permanently create new jobs, although the EC said that overall net gains in this area seem to be minor.

The study also stresses that other economic instruments (such as subsidies) might often be more efficient than reduced VAT rates to achieve environmental, social, cultural and economical policies.

The Commission says that there is a place for more flexibility to be given to Member States to apply VAT reduced rates. However, it believes that the room for manoeuvre is narrow. Indeed, the internal market requires that goods and services can be traded within the EU without giving rise to unacceptable distortions of competition for companies or for Member States. These distortions could arise when consumers buy in other Member States in order to benefit from reduced prices. Locally supplied services (which cannot be delivered from a remote location) could be a candidate for reduced rates, as they do not pose any major risk to the internal market. However, the Commission wants political input to determine what distortions can be deemed to be acceptable.

The EC warned that there is a danger that introducing additional reduced VAT rates may lead to increased costs, making single market access more difficult for traders. Having to deal with different VAT rates in different Member States creates a cost which becomes particularly burdensome where the variation of rates concerns not just a few goods or services but hundreds, with different definitions for the scope of each reduced rate. Again, the Commission suggested that political input is needed to find the appropriate balance between flexibility and the risk of increasing compliance costs.

Derogations for reduced rates granted to Member States which joined the EU before 1 January 1995 are valid until the adoption of the definitive VAT system. However, many reduced rate derogations granted to the other Member States expire at the end of 2007 or in 2008. This difference in treatment creates inequality between Member States without any substantial justification. This could prejudge the outcome of the future discussions on the use of reduced rates.

The Commission has proposed to extend until the end of 2010 these last mentioned derogations, providing they do not conflict with the smooth functioning of the internal market, with other Community policies, or became obsolete. This planned prolonging of the measures aims at allowing an in-depth debate, without undue time pressure, in order to design new common rules to apply after 2010.

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