EU VAT – No single market added value

Editor’s Blog: Produced in collaboration with the EU Buzz team 

VAT (Value Added Tax) is an important revenue source for the Member States of the European Union. VAT is a general consumption tax applicable to most goods and services bought and sold for use or consumption in the EU. It is an indirect tax applied when buyers of goods or services pay value added tax to the sellers, who then transfer these tax receipts to their national revenue authorities. VAT revenues represented between 13% (in Italy) and 28% (in Croatia) of general government revenues in 2019. However, the VAT gap, the difference between the amount of value added tax that is theoretically collectable and the amount that is collected in reality – was estimated at €117 billion in the EU27 for 2018. With budget deficits worrying all governments, collecting the missing VAT to reimburse the public purse will be essential in addressing the impacts of the Covid-19 pandemic.

Since the 1960s, European Union law makers have lobbied for harmonising the application of rules and procedures related to VAT. The opportunity arose to establish a transitional EU VAT system for intra-EU trade in goods with the creation of the EU single market in 1993. In this transitional system for goods, each Member State became responsible for the administration, control and collection of its own VAT. However, since then, developing a definitive EU VAT system for goods, from what was supposed to be a transitional system, has never been accomplished despite most supplies of services being taxed according to the destination principle.

Today, the main framework of VAT legislation in the EU is the VAT Directive, adopted in 2006 and subsequently amended numerous times. The VAT Directive sets a standard VAT rate for goods and services of, at least, 15 % but Member States are allowed to apply reduced VAT rates of at least 5 % to specific goods or services. Exceptions to these rates apply under certain conditions including super-reduced rates at less than 5% and zero rates. Hence, there are now large differences in VAT rates between Member States, and in some cases even different rates within Member States. 

Reducing the complexity of the existing system by abolishing the reduced rates applicable to goods and services has been an ambition of the Commission and EU legislators but the Member States have failed to reach any such agreement despite proposals for both “positive lists” and “negative lists” of exceptions to be included. 

Of course the impact is not just on government revenues. Challenges on business, and especially small and medium-sized enterprises (SMEs), result from different rules applying in the different EU Member States, and the compliance costs associated with collecting the taxes. SMEs are disproportionately burdened and overall VAT compliance costs are substantial, ranging from 1% to 4% of company turnover within the EU Member States. 

At the end of the day, the diversification of VAT rates across the Member States distorts the functioning of the EU internal market which only adds to the frustrations whilst highlighting the inability of the Union to create a fully functioning and efficient single market as foreseen in 1993!  

Variations in standard and reduced rates, exemptions and VAT registration thresholds across the states leads to distorted competition in the internal market as goods and businesses are de facto subsidised through a lack of standard taxation. Furthermore, compliance costs increase prices to consumers and distort competition in the internal market, especially where the diversification of VAT rates creates an incentive to exploit tax differences. Such irregularities have now lead to a phenomena of tax competition among Member States – something some countries, and corporates, are unwilling to backdown on.

Tax has always been taxing, but whilst it will always be complex, without some form of standardisation across the European Union there can never be a fair, fully functioning single market – Governments, businesses, consumers and a desperate financial situation after the pandemic, will all be the losers. 

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