European Commission releases proposal on more flexible VAT rates
On 18 January 2018, the European Commission published details of two more initiatives that are part of the proposed reform of the EU VAT system. One proposal allows Member States more freedom on applying VAT rates, the other proposal discusses new simplification rules for SME’s. In this alert we discuss the proposal that grants Member States more flexibility in setting their reduced VAT rates.
19 January 2018
In its 2016 VAT Action Plan, the European Commission outlined immediate and urgent actions to tackle the VAT gap and combat VAT fraud. In order to do so, the Commission proposed to replace the current transitional VAT system by a definitive VAT system based on the principle of taxation in the Member State of destination.
According to the Commission, the shift towards taxation of goods and services according to the destination principle results in suppliers deriving no longer significant benefits from being established in Member States applying much lower reduced VAT rates and enhances the functioning of the single market. A proposal for a reform of VAT rates therefore would be consistent with the definitive arrangements based on the destination principle that will gradually replace the current transitional arrangements.
Currently, Member States are allowed to apply one or two reduced VAT rates at a minimum of 5%, next to the standard VAT rate of at least 15%. The application of the reduced VAT rate is limited to certain specified listed goods and services. However, in addition to this list a series of individual derogations and stand still measures exist, allowing Member States to apply rates below 5% or even zero rates on specific products.
The European Commission proposal
The purpose of the current proposal is to introduce the application of the same rules in and to grant equal freedom in setting VAT rates to all Member States.
To that purpose, in addition to a standard VAT rate at a minimum of 15% (a proposal to make this rate of 15% minimum permanent was published on 19 December 2017), the Commission proposes to give the Member States more flexibility to put in place:
- A maximum of two separate reduced rates of at least 5%;
- One extra reduced rate lower than the minimum of 5%; and
- One exemption with right to deduct or 'zero rate'.
The current, complex list of goods and services to which reduced rates can be applied, would be abolished and replaced by a new, so-called negative list of products on which the reduced rate or zero rate cannot be applied by Member States. This limitative (short) list includes the following supplies:
- Services subject to the tour operator margin scheme (TOMS);
- Goods subject to VAT under the margin scheme for second-hand goods;
- Goods subject to VAT in accordance with the special arrangements for sales by public auctions;
- Precious metals, jewelry and bijouterie;
- Alcoholic beverages;
- Tobacco products;
- Supply, hire, maintenance and repair of means of transport;
- Fuel oil, gas and lubricating oils;
- Weapons and ammunition;
- Computer, electronic and optical products and watches;
- Electrical equipment;
- Musical instruments;
- Works of art;
- Financial and insurance services;
- Gambling and betting services.
In the Netherlands the reduced VAT rate is currently conditionally applied to the supply of works of art. When the proposal is adopted this will have to end.
To maintain some rate harmonization under the new rules, reduced rates (or zero rates) can only be implemented by Member States if they benefit the final consumer and shall be applied to pursue an objective of general interest. Furthermore, to safeguard public revenues, Member States will also have to ensure that the weighted average VAT rate of all applied VAT rates is at least 12%.
The proposal will be forwarded to the European Parliament and the European Economic and Social Committee for consultation, and to the Council for their agreement. It will require unanimous agreement from all Member States in the Council before the proposal can enter into force.
The entry into force of the new provisions on VAT rates has been linked to the introduction of the definitive VAT regime, which is intended for 2022, although this will still need to be confirmed in the detailed proposals on that regime which are expected in the course of 2018.
This link is somewhat surprising, as the destination-principle is already to a large extent realized for cross border services and will be achieved for cross border B2C goods supplies through the e-commerce VAT changes recently approved with effect from 1 January 2021.
VAT rates for e-publications
The entry into force is also disappointing from the viewpoint of the much awaited modernization of the reduced VAT rate product list, for example with respect to e-books and other e-publications. On 1 December 2016 the European Commission released a proposal that allowed Member State to apply reduced VAT rates on the supply of e-books and other e-publications that qualify as electronic services (i.e. e-books and other e-publications that are downloaded or streamed via the internet). It also allowed Member States to apply lower VAT rates than 5% on both e-publications and their physical equivalents (i.e. paper books, books on USB sticks, paper magazines and newspapers etc.).
To date, the Member States have failed to reach an agreement on the proposal for VAT rates on e-publications. Unfortunately, the proposal released on 18 January does not explicitly mention this pending proposal. We assume that the prohibition to apply the reduced VAT rate on electronic services will be abolished by the proposal released on 18 January, while Member States get the option to set reduced VAT rates at a lower level than 5%. Furthermore, in its proposal the Commission also commits to conducting a review of the existing list of goods and services prior to the entry into force of these new rules, to take account of specific requests by Member States.
This proposal will be the basis for further discussion in legislative bodies of the EU, which ultimately might lead to changes in the EU VAT legislation. In the longer term, the definitive VAT regime constitutes a major overhaul of the EU VAT system for businesses, with a drastic impact on systems and processes. The ultimate impact will depend upon the detailed proposals announced on 4 October 2017.
We will keep you updated with the developments regarding the proposals for a definitive VAT system.