Public finance in theory and practice
Virtually every reference VAT manual recommends a single rate. A single VAT rate saves both the administration and the taxpayers significant costs, prevents fraud and litigation, and is the only solution that can ensure tax neutrality. Along with the rationalisation of exemptions, this is one of the main tenets of modern VAT doctrine.
A single VAT rate can arguably be set in places where international agencies use their leverage to impose orthodoxy. For the EU, however, this was never an option. At the time the EU VAT system was built, national practice was much diverse, each state singling out different goods and services with reduced rates in the pursuit of their public policies.
In the 1960s and 1970s VAT directives left member states completely free to set their own rates. In the 1990s, with the advent of the internal market, member states discretion was limited to setting two reduced rates to a given list of goods and services, while some states were allowed by means of special derogations to retain ‘super-reduced’ rates or ‘zero rates’ for different items.
In the context of a VAT system oriented towards the principle of origin, limiting the use of reduced rates seemed crucial to prevent the distortion of cross-border trade.
That was then, this is now
This is how we got to the point we are now. With the exception of Denmark, all member states apply some form of reduced rates to goods and services that are not always identical, never easy to define and subject to changes dictated by the political process. Take hotels for instance. In Belgium, the rate is 6%, in Finland 10%, and in Denmark 25%. Hairdressers for their part, have a 5% rate in Cyprus, 8% Poland and 23% in Portugal. Each member state has its own list of foodstuffs with a reduced rate, contemplating wildly different protein, vegetables, drinks, dairy products, pastries, and snacks.
It should come as no surprise, then, if the European Commission wanted to simplify all of this. The proposal tabled in 2018, however, went in the opposite direction. As the EU VAT system shifted to the destination principle, the risk of cross-border trade distortion was removed and the Commission felt member states should be afforded greater discretion in setting rates. Its initial proposal allowed every member state to adopt a super-reduced rate and a zero-rate in addition to two reduced rates of at least 5%. The positive list of goods to which such rates could apply was replaced by a negative list excluding the application of reduced rates to items such as weapons or works of art.
After three years of discussion, the original proposal changed significantly. The agreement approved by the Economic and Financial Affairs Council (ECOFIN) on December 7 keeps a positive list of goods and services to which two reduced rates of at least 5% may be applied. The list is larger than the current one, though, and member states will thus enjoy more discretion on the matter. Plus, every state will now be able to apply super-reduced rates under 5% or zero rates to the most essential of listed goods, such as foodstuffs or medicines. Many existing derogations will also be kept in place, subject to generous sunset clauses.
Brussels, we have a problem
One could say member states will now be better equipped to pursue their policy goals. The benefits resulting from this reform, however, do not seem to outweigh its costs.
The VAT gap in the EU has been steadily closing but it is still an impressive share of the potential revenue. The portion of the taxable base subject to the standard rate is 71% across the EU but only 47% in Spain and 52% in Italy. A study recently published by the European Parliament shows that removing the reduced rates would bring about an average drop of seven points to the standard rate in the EU.
Relaxing the use of reduced rates will certainly harm the member states’ ability to resist the pressure of economic operators. This is bad news for the preservation of national budgets, in particular at a time every government is trying to cope with the effects of the pandemic.
The new proposal is bad news when it comes to management costs. Companies engaging in cross-border operations will incur additional costs in dealing with further differentiated rates, and small businesses will have a very harder time expanding abroad.
The multiplying of reduced rates will also fuel litigation with tax authorities as reduced rates account for many VAT-related proceedings pending before national courts and the CJEU. There’s much waste of time, money and energy in discussing which rate should apply to croissants with a sell-by date greater than 45 days (AZ C-499/17), to camping sites vis-a-vis boat moorings (Segler‑Vereinigung Cuxhaven, C-715/18), or to natural aphrodisiacs consumed orally (Staatssecretaris van Financiën, C-331/19).
VAT case law may get more interesting. There’s very little else to celebrate though.
Sérgio Vasques
Founding partner, Lobo Vasques
E: sergio.vasques@lobovasques.com
