The common Value Added Tax (VAT) system plays an important role in Europe’s Single Market. It was originally put in place to do away with turnover taxes which distorted competition, hindered free movement of goods and created fiscal checks/formalities at internal borders.

VAT is a major and growing source of revenue in the EU, raising almost € 1 trillion in 2014, corresponding to 7% of EU GDP. It is also one of the EU’s own resources; as a consumption tax, it is one of the most growth-friendly forms of taxation.

But the VAT system has been unable to keep pace with the challenges of today's global, digital and mobile economy. The current VAT system, which was intended to be a transitional system, is fragmented, complex for the growing number of businesses operating cross-border and leaves the door open to fraud: domestic and cross-border transactions are treated differently and goods or services can be bought free of VAT within the Single Market.

The Commission has consistently pressed for the reform of the VAT system; the European Parliament and the Council agreed that future VAT system should be based on the principle of destination, i.e.: where the goods or services are consumed.

Present Action Plan is part of the Commission's Better Regulation agenda.

Changing VAT system

European Commission has presented an Action Plan setting out ways to reboot/update the current EU VAT system to make it simpler, more fraud-proof and business-friendly.

The 'VAT gap', which is the difference between the expected VAT revenue and VAT actually collected in EU states, was almost €170 billion in 2013. Cross-border fraud in EU is estimated to be responsible for a VAT revenue loss of around €50 billion a year. At the same time, the current VAT system remains fragmented and creates significant administrative burdens, especially for SMEs and online companies.

Taxation rules on how VAT is collected from customers domestically will be extended to cross border sales. This change alone should help reduce cross-border VAT fraud by €40-50 billion per year.

The Action Plan sets out a pathway to modernise the current EU VAT rules, including four main aspects: - key principles for a future single European VAT system; - short term measures to tackle VAT fraud; - update the framework for VAT rates and set out options to grant member states greater flexibility in setting them; and - 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.

Vice-President Valdis Dombrovskis, responsible for the Euro and Social Dialogue informed that the Commission started a dialogue with the European Parliament and EU-28 states for a simpler and more fraud-proof VAT system.     

He also underlined that every year, cross-border VAT fraud costs EU states and tax payers about € 50 billion a year. At the same time, he noted, the administrative burden for small businesses was high and technical innovation posed new challenges for VAT collection.

Besides, the Commission has proposed clear measures to address corporate tax avoidance, and modernise existing VAT system in tackling fraud.

Pierre Moscovici, Commissioner for Economic and Financial Affairs, Taxation and Customs, added that VAT as a major source of tax revenue for EU states suffers some problems. For example, there is a staggering fiscal gap: the VAT revenues collected are €170 billion short of what they should be. This money could be invested on growth and jobs and the EU Action Plan will deliver on these points. He added that the EU wants to grant the member states more autonomy to define their VAT reduced rates. 

Action plan’s key elements:

1. Reducing opportunities for fraud in VAT system for cross-border EU trade 

The current VAT system needs to be modernised to keep pace with the challenges of today's global, digital and mobile economy. The current VAT system for cross-border trade which came into force in 1993 was intended to be a transitional system and leaves the door open to fraud. The Commission therefore intends to come forward in 2017 with a proposal to put in place definitive rules for a single European VAT area. Under the new rules, cross-border transactions would continue to be taxed at the rates of the member state of destination ('destination principle') as today, but the way taxes are collected would be gradually changed towards a more fraud-proof system. At the same time, an EU-wide web portal would be implemented to ensure a simple VAT collection system for businesses and a more robust system for the states to gather revenue.

2. Immediate measures to tackle VAT fraud under the current rules

Cross-border VAT fraud deprives member states of vast sums of revenue. Estimates show that the future VAT system could reduce cross-border fraud by around € 40-50 billion (or by 80%) a year.

Later in 2016, the Commission will propose measures to reinforce current tools used by the EU states to exchange information related to VAT fraud, fraud schemes and good practices. Commission will continue to closely monitor the performance of tax administrations in collecting and controlling VAT.

3. More states’ autonomy to choose their own rates policy

Under the current rules, the EU states need to stick to a pre-defined list of goods and services when it comes to applying zero or reduced VAT rates. The Commission plans to modernise the framework for rates and to give states more flexibility in future.

It proposes two options: one option would be to maintain the minimum standard rate of 15% and to review regularly the list of goods and services which can benefit from reduced rates, based on a member states' input.

The second option would abolish the list of goods and services that can benefit from reduced rates. This would, however, require safeguards to prevent fraud, avoid unfair tax competition within the Single Market and it could also increase compliance costs for businesses. Under both options, the currently applicable zero and reduced rates would be maintained.

4. Support for e-commerce and SMEs

The current VAT system for cross-border e-commerce is complex and costly for the EU states and businesses alike: they are at a competitive disadvantage because certain non-EU traders can import VAT-free goods to the EU. The complexity of the system also makes it difficult for the states to ensure compliance.

The Commission will come forward by the end of 2016 with a legislative proposal to modernise and simplify VAT for cross-border e-commerce as part of the Digital Single Market strategy. This will include a proposal to ensure that e-publications can benefit from the same reduced rates as physical publications.

As a second step, Commission will present in 2017 a VAT simplification package designed to support the growth of SMEs and to make it easier for them to trade across borders.

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 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.

See more in the following web links: =Information on the Action Plan on VAT; = Memo on the Action Plan on VAT; = Communication on the Action Plan on VAT; and

= http://europa.eu/rapid/press-release_IP-16-1022_en.htm.  

Action Plan on VAT: Present & Future

= Commission’s Action Plan on VAT. 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 states date back to 1993. At that time, they were meant to be transitional. However, they do not take into account technological developments, changes in business models or the globalisation of the economy. They need to be rebooted, said the Commission (using web-term meaning shut-up & restart) not just to make the VAT system simpler and fraud-proof, but so that businesses can reap all the benefits of the Single Market.

= Future Single EU VAT area. The VAT system is a major and growing source of revenue in the EU, raising almost € 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.

= VAT collection in future. New 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.

= 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 the EU 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.

Thus, the Commission will propose to make the VAT system simpler, fairer and more fraud proof, as well as taking immediate measures to improve VAT collection.  

Immediate measures would cover three directions: = enhancing cooperation among EU states by supporting the sharing and joint analysis of information; = improving tax compliance by cooperating with businesses to address fraud; and = supporting the modernisation of tax administrations to prevent and fight fraud.

Table: Expected timings for planned initiatives in improving VAT collection

2016	Measures to improve cooperation between tax administrations and with customs and law enforcement bodies and to strengthen tax administrations' capacity;
2016	Evaluation report of the Directive on the mutual assistance for the recovery of tax debts;
2017	Proposal to enhance VAT administrative cooperation and Eurofisc;
2017	Proposal for the definitive VAT system for cross-border trade (single European VAT area, part of REFIT program).

= Changes in 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 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 EU states, while preventing the erosion of VAT revenues, and shrinking 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 EU states to ensure rapid inclusion of these conclusions into legislative proposals.

The Commission will propose to modernise the framework and give greater flexibility to the EU states as regards VAT rates. This can be done in one of two ways:

Option 1. 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 EU states to ensure equal treatment. The minimum standard VAT rate of 15% would be maintained.

Option 2. Adopt the principle that EU 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, e.g. limits on the number of different rates that 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.

Present proposal aims to modernise VAT rates policy and give more flexibility to the states on VAT rates; it is not about scrapping existing reduced (or zero) rates. As for increasing rates, the proposals change nothing: currently, states generally have the discretion to increase their VAT rates.

= Lowering rates for specific products (e-books, tampons, energy-saving material, etc.).

If an agreement is found on either of the Commission's options for VAT rates, the states would have more freedom to apply reduced VAT rates to certain additional sets of products. In particular, under Option 1, all 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, states would not be able to introduce completely new zero rates. Under Option 2, the basic principle would be that EU 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.

= Some EU 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.

= Reverse charge introduced in some EU states. 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 EU states, which 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 states, because goods could be bought VAT-free and sold on the black market.

= VAT-fraud issues in the Action Plan. VAT fraud does not affect all EU countries equally; however, there is a 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; in June 2016 Commission will report to the Council with the acquired findings.

Commission’s proposal on VAT in the area of the Digital Single Market

= VAT for e-commerce.  In order to change the rules in digital era, a level playing field for business shall be created; it should be easier for online companies to trade within the EU.

Presently, 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. Finally, 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.

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 micro-businesses;

- 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.

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. Legal constraints often result in the VAT rate on e-publications being higher than the one on the corresponding printed version. Present proposal will attempt to align VAT rates policy for e-publications across the EU.

Action Plan also intends 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.

The Commission intends to ease the VAT burdens on SMEs too: work has already started on a comprehensive simplification package for SMEs. It involves a review of the SME scheme for VAT, including easing VAT obligations for SMEs. 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.

Besides, VAT’s 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.

Reference: Action Plan on VAT: Questions and Answers, 7.04.2016, in:

http://europa.eu/rapid/press-release_MEMO-16-1024_en.htm?locale=en