VAT is a major and growing source of tax revenue in the EU. The current VAT system is, however, too burdensome and complex for businesses that wish to expand beyond the Member State in which they are established. This is a particular problem for small businesses, because cross-border trade costs are on average 11% higher than domestic.
The current VAT system is also too vulnerable to fraud when it comes to cross-border trade. Cross-border VAT fraud is estimated to be responsible for revenue losses of around €50 billion annually in the EU.
The current VAT rules for cross-border trade between businesses in EU Member States date back to 1993. At that time, they were meant to be transitional. They do not take into account technological developments, changes in business models or the globalisation of the economy. They need to be rebooted, not just to make the VAT system simpler and fraud-proof, but so that businesses can reap all the benefits of the Single Market.
2. What is in the VAT Action Plan?
The Action Plan sets out:
- key principles for a future single European VAT system;
- short term measures to tackle VAT fraud;
- options to modernise the EU framework for Member States setting VAT rates;
- plans to simplify VAT rules for e-commerce in the context of the Digital Single Market (DSM) Strategy and for a comprehensive VAT package to make life easier for SMEs.
The Commission's proposed future VAT system is based on the principle that goods and services should be taxed in the country where they are consumed. Taxation rules on how VAT is collected from customers domestically will be extended to cross border sales [see question 6]. This change alone should help reduce cross-border VAT fraud by €40 billion per year.
3. What are the next steps for the Action Plan?
The Action Plan aims to trigger a debate with EU Member States and with the European Parliament. Agreement on the way forward would allow the Commission to present legislative proposals on each of the issues raised in the Action Plan.
Forthcoming measures in 2016 include proposals to adapt the VAT system to the digital economy, removing VAT obstacles to cross-border e-commerce, and specific measures for e-publications. In order to simplify VAT for smaller businesses, a VAT package for SMEs will be proposed in 2017.
As a pre-cursor to setting up a single European VAT area, different initiatives which aim to improve cooperation and mutual assistance between Member States’ tax administrations will already be tabled in 2016. A specific proposal to enhance VAT administrative cooperation, including Eurofisc, the network for Member States to enhance administrative cooperation for combating organised VAT fraud, is envisaged for 2017.
In 2017, the Commission expects to make a proposal for the definitive VAT system for EU cross-border trade together with a reform of the VAT rates.
4. Who has the Commission consulted?
Member States have already been consulted and have participated in discussions since we announced our intention to review the current VAT rules in 2011. They will continue to be consulted throughout the entire process until a legislative proposal is tabled by the Commission. Other parties (businesses, tax practitioners and academics) have also been involved through a VAT expert group.
A FUTURE SINGLE EU VAT AREA
5. Why do we need a single VAT area and how will it work in practice?
The VAT system is a major and growing source of revenue in the EU, raising almost EUR 1 trillion in 2014. But the VAT system has been unable to keep pace with the challenges of today's global, digital and mobile economy. It needs to be modernised because it is too complex for the growing number of EU businesses operating cross-border and leaves the door open to fraud.
The current system splits every sale across EU borders into a VAT exempt transaction in the country of origin, and a taxable purchase in the country of destination. It is like a customs system, but lacks equivalent controls and is therefore the root of a significant amount of cross-border fraud [see factsheet]. For example, missing trader fraud can occur when the importing company sells the VAT exempted imported goods, collects VAT, but disappears before passing on the VAT collected to tax authorities.
A robust single European VAT area would treat cross-border transactions in the same way as domestic transactions (i.e. cross-border trade will no longer be exempt from VAT), putting an end to the inbuilt weaknesses of the system. The current system is too fragmented and not in line with the needs of the Internal Market. It is no longer viable or realistic to base the EU system on 28 different VAT procedures. The current rules can discourage businesses from expanding their businesses across borders.
The creation of an EU-wide VAT system would support a deeper and fairer Single Market. It would also help to boost jobs, growth, and investment and competitiveness.
6. How would VAT be collected in future?
Today's Action Plan proposes a future VAT system where VAT is charged under the rules of the originating country on sales that are made across borders to another country in the EU, at the rate applicable in the country of consumption. The VAT on a cross-border sale (goods or services) would be collected by the tax authority of the originating country and transferred to the country where the goods or services are ultimately consumed.
Businesses that trade within the EU will be able to sort out their VAT far more simply and easily, via an online web portal in their home country. Otherwise, traders would have to register for VAT, file returns and make payments in every EU country where they operate. The online portal would also allow VAT to be collected by the country where the sale is made and transferred to the country where the goods are consumed.
In order to allow for a gradual transition, trustworthy businesses that are certified by their tax administrations, including SMEs, could initially continue to purchase goods free of VAT in another Member State and pay VAT in their own country.
7. How big a problem is VAT fraud?
VAT fraud results from weaknesses in the current VAT system and the way in which tax administrations manage the VAT system. As VAT is a major revenue source for Member States, VAT losses have a big impact on the State budget. The VAT gap study indicated a VAT loss of €168 billion at EU-level in 2013, much of which was caused by VAT fraud.
However, not all Member States are affected by VAT losses to the same extent (the VAT gap ranges between 4% and 41%. A recent study [see here] suggests that on average 36% of the VAT gap is due to VAT fraud.VAT fraud results from the weaknesses in the current VAT system and the way in which tax administrations manage the VAT system.
8. What actions does the Commission envisage to fight against VAT fraud?
The Commission will propose to make the VAT system simpler, fairer and more fraud proof. We also plan to take immediate measures to improve VAT collection.
Immediate measures would cover three headings:
i. enhancing cooperation between Member States by supporting the sharing and joint analysis of information;
ii. improving tax compliance by cooperating with businesses to address fraud;
iii. supporting the modernisation of tax administrations to prevent and fight fraud.
The table below provides an outline of expected timings for planned initiatives in this area:
Measures to improve cooperation between tax administrations and with customs and law enforcement bodies and to strengthen tax administrations' capacity
Evaluation report of the Directive on the mutual assistance for the recovery of tax debts
Proposal to enhance VAT administrative cooperation and Eurofisc
Proposal for the definitive VAT system for cross-border trade (single European VAT area, part of REFIT program)
9. What needs to be changed on VAT rates?
Current rules are set out in the VAT Directive and date back to the 1990s, when it was envisaged that the VAT system would evolve in a different direction than the one it has taken. At the time, EU Member States agreed to set a minimum standard VAT rate of 15% for all goods and services. In addition, they agreed that a reduced rate of 5% or higher could be applied to a pre-defined list of certain goods and services. Moreover, a number of further reduced rates are allowed only in certain Member States according to ‘standstill derogations’, agreed when they joined the EU.
The current rules have not been updated to reflect new developments and new sectors, such as digital products. Updates are difficult because all decisions in this area have to be taken unanimously. The Commission intends to modernise the rules, removing outdated legal restrictions for Member States, while preventing the erosion of VAT revenues, and a shrinking of the tax base.
The Commission takes note of the European Council conclusions of March 17, 2016, which welcomes a review of the rules on VAT reduced rates. The Commission will be working closely with all Member States to ensure that it can rapidly translate these conclusions into a legislative proposal.
10. What are your plans for rates?
The Commission will propose to modernise the framework and give greater flexibility to Member States as regards VAT rates. This can be done in one of two ways:
Extend the possibility to grant reduced rates and regularly review the list of goods and services. Under this option, all currently existing reduced rates, including derogations (e.g. zero rates) already legally granted to certain countries would be maintained and could be extended to all Member States to ensure equal treatment. The minimum standard VAT rate of 15% would be maintained.
Adopt the principle that Member States are free to follow the reduced rates policy they wish, so long as it does not generate tax distortions. Safeguards would be needed to avoid unfair competition and to prevent fraud, such as limits on the number of different rates that Member States could adopt and a prohibition on reduced rates for easily transportable, high value items. Member States would also have to continue to abide by general Single Market and competition rules.
11. Will you scrap zero or reduced rates?
No. This proposal aims to modernise VAT rates policy and give more flexibility to Member States on VAT rates. It is not about scrapping existing reduced (or zero) rates. As for increasing rates, the proposals change nothing. Currently, Member States generally have the discretion to increase their VAT rates.
12. What about lowering rates for specific products like e-books, tampons, energy-saving material, etc.?
If an agreement is found on either of the Commission's options for VAT rates, Member States would have more freedom to apply reduced VAT rates to certain additional sets of products. In particular, under Option 1, all Member States will be able to cut rates on goods or services that are already included in the list. This would address the problem of unequal treatment. However, Member States would not be able to introduce completely new zero rates.
Under Option 2, the basic principle would be that Member States are free to adopt the rates level they want on their choice of goods and services, provided this does not create risks of unfair tax competition or unduly complicate the VAT system.
The case of e-publications will be addressed separately in the context of the Digital Single Market strategy [see question 18].
13. Will you still make the distinction between essential, non-essential and luxury goods?
The idea that EU rules distinguish between essential, non-essential and luxury goods is a myth. The so-called luxury rate was abolished decades ago and it is not true that goods are listed as essential or non-essential. At the moment, there is simply a list of goods for which reduced rates, super-reduced or zero rates can apply.
14. How will the Commission handle requests from some countries to have derogations for the VAT system?
Some Member States have asked to apply rules which derogate from the main principles of the EU VAT system (the current system whereby VAT is collected throughout the chain of production) by applying a generalised 'reverse charge' system.
Derogations can be granted under the current rules in order to simplify tax collection or fight VAT fraud. But this type of derogation has to be limited in scope. General derogations to the principles of the EU VAT system are not possible under the current VAT rules. The Commission therefore rejected these requests on legal grounds.
This time, we will discuss whether the VAT rules themselves should be changed so that some Member States would in future be able to introduce certain derogating measures.
15. What is the reverse charge and why do some Member States want to introduce it?
The reverse charge mechanism closely resembles a sales tax. In practice, it means the various transactions between businesses can be invoiced free of tax. It is only the final consumer who pays VAT at the very end. For instance, for a table produced in country A and then sold in country B, the final VAT bill would be paid only by the person buying the table, not by the various firms involved in the making, transport and distribution of the table.
Those Member States who have argued in favour of such a system believe that such a scheme would stop one specific type of cross-border tax fraud, known as carousel fraud [see VAT factsheet].
However, this has to be carefully assessed since such a system also has disadvantages. It can be exploited and open to abuse, which is why this system imposes substantial reporting obligations on business. A recent study has demonstrated that it could increase administrative costs by around 40%.
Reverse charge would also risk shifting fraud to the retail level or to other Member States, because goods could be bought VAT-free and sold on the black market.
16. How will you address the concerns about fraud that some countries have?
It is true that VAT fraud does not affect all EU countries equally and we recognise the need to find practical and short-term solutions to tackle VAT fraud.
We will therefore assess these requests for derogations, taking into account potential political, legal and economic implications. It is critical to assess the impact on businesses and tax administrations, as well as address concerns about fraud potentially shifting to neighbouring countries and to the retail level.
In parallel, we will help those Member States concerned about VAT fraud to improve their tax collection and inspection capacity. Eurofisc will also be mobilised to help carry out risk analyses and joint audits. We plan to report to the Council by June 2016 with our findings.
VAT FOR E-COMMERCE
17. How will you change rules to keep pace with the digital era?
First, we need to create a level playing field for business. It should be made easier for online companies to trade within the EU.
Second, it is costly for businesses to comply with cross-border VAT obligations: a company selling goods or services cross-border pays around €8,000 per year per country where it makes its sales in VAT compliance costs. Businesses cite VAT obligations as one of the biggest barriers to cross-border e-commerce.
Third, the amount of VAT lost, including by non-compliance and fraud for the digital sector is very high: Member States can lose up to €5 billion annually according to a recent study.
18. What will the Commission propose in the area of the Digital Single Market?
The Commission will, as part of its Digital Single Market strategy, make legislative proposals by the end of 2016 to reduce the administrative burden on businesses caused by different VAT regimes. The proposals will aim to:
- extend the current single web portal concept, whereby a seller is able to declare and pay all VAT for both domestic and EU sales in its own Member State. The tax authority then transfers VAT revenues to other Member States where VAT is due. This concept already exists today for electronic services but not for goods sold on the Internet, for which sellers have to register for VAT in each Member State where they have clients;
- introduce a VAT-free threshold to help start-ups and microbusinesses;
- streamline audits in this sector (home country audits): ensure that businesses are audited only by the tax administration of their home country;
- remove the VAT exemption that applies for the import of small consignments from suppliers in third countries: this is becoming highly distortive against EU businesses and the system is widely abused. In future, VAT on imports of small consignments will to a large extent be collected through the single web portal, by sellers or intermediaries acting on their behalf.
19. What about e-publications?
The Commission will make a proposal in the context of the Digital Single Market to address the unequal treatment of paper versus e-publications for VAT purposes. Indeed, legal constraints often result in the VAT rate on e-publications being higher than the one on the corresponding printed version. Our proposal will attempt to align VAT rates policy for e-publications across the EU.
20. What will you do about VAT free small consignments from third countries that are currently swamping the EU market?
The VAT Action Plan also sets out plans to remove the VAT exemption for the import of small consignments from suppliers in third countries. With around 150 million parcels imported free of VAT into the EU each year, this system is open to massive fraud and abuse and creates major distortions against EU business. In future, VAT on imports of small consignments will to a large extent be collected through the single web portal, by sellers or intermediaries acting on their behalf.
21. How does the Commission propose to ease the VAT burdens on SMEs?
Work has already started on a comprehensive simplification package for SMEs. It involves a review of the SME scheme for VAT, including looking at how to ease VAT obligations for small and medium-sized enterprises.
The Commission will make legislative proposals by the end of 2017. While it is too early to say which elements this package will include, the proposal will aim to reduce administrative burdens and to contribute to a favourable environment to the growth and cross-border EU trade of SMEs.
22. How does this Action Plan fit with the Commission's REFIT programme?
The VAT Action Plan is part of the Commission’s REFIT programme, which aims to make EU law simpler and reduce regulatory costs, thereby contributing to a clear, stable and predictable regulatory framework to support growth and jobs.