House of Commons - European Scrutiny

Select Committee on European Scrutiny First Report

1 Value added tax

(24978)

13853/03

COM(03) 614

Commission Communication: review and update of VAT strategy priorities.

Legal base —

Document originated 20 October 2003

Deposited in Parliament 28 October 2003

Department Customs and Excise

Basis of consideration Minister's letter of 7 November and EM of 12 November 2003

Previous Committee Report None; but see (21355) 9337/00: HC 23-xxiv (1999-2000), paragraph 11 (12 July 2000)

To be discussed in Council Not known

Committee's assessment Politically important

Committee's decision For debate in European Standing Committee B

Background

1.1 When the First and Second VAT Directives were adopted in 1967, the Community committed itself to establishing in due course a common VAT system under which, in intra-Community trade, the VAT on imports and non-taxation of exports would be abolished. Proposals to that end were put forward in 1987, in connection with establishing the internal market by January 1993, and were designed to achieve the application of VAT in the country of origin. These did not make progress and in 1989 the Council adopted a so-called transitional system which enabled VAT to continue to be collected in the Member State of destination whilst abolishing internal tax borders. At the same time, the Council reaffirmed its 1967 commitment to introduce a definitive VAT system in which goods and services would be subject to VAT in the Member State of origin and set a new target date of 1996.

1.2 However, Commission proposals made in 1996 did not make progress and in June 2000 the Commission proposed improving the transitional VAT system in a "New VAT strategy" based on three main objectives:

simplification and modernisation of existing rules;
more standardised application of the existing provisions; and
reinforcement of co-operation between Member States tax administrations.[1]

The document

1.3 After three years of action to implement the "New VAT strategy", this Communication from the Commission reviews progress on meeting the objectives, sets out a legislative work plan for the next two years, updates the Commission's priorities for the VAT system and draws particular attention to the increasing problem of VAT fraud.

1.4 The document reports on four legislative proposals that were on the table when the Commission launched the "New VAT strategy":

a draft Directive on improving mutual assistance between administrations for the recovery of tax debts (adopted as Council Directive 2001/44/EC);[2]
a draft Directive to allow businesses to trade in other Member States without needing to use a tax representative (adopted as Council Directive 2000/65/EC);[3]
a proposal to change the status of the VAT (advisory) Committee, which has not progressed;[4] and
a proposal on the right to deduct VAT, which has not progressed.[5]

1.5 The document also reports on the adoption of seven proposals made under the "New VAT strategy":

Directive 2002/38/EC which introduced provisions to improve the competitiveness of EU businesses providing electronically-delivered services;[6]
Directive 2001/41/EC which set an agreed minimum standard rate of VAT of 15%;[7]
Directive 2001/115/EC which enabled the use of electronic invoices for VAT purposes;[8]
Regulation (EC) 1798/2003 which laid down clearer rules for administrative co-operation for VAT purposes between tax administrations and provided for enhanced exchange of information;[9]
Decision 2235/2002/EC which extended for a further five years the Fiscalis programme to provide funding for electronic systems for exchanging information and a range of activities for enhancing co-operation between tax administrations on both direct and indirect taxes;[10]
Directive 2002/93/EC which extended the experimental scheme allowing Member States to apply reduced rates of VAT to certain labour-intensive services;[11]
Directive 2003/92/EC which updated the rules for the VAT treatment of supplies of gas and electricity.[12]

1.6 The report notes four proposals made under the "New VAT strategy" which are still under consideration. These are to:

change the VAT treatment of postal services;[13]
amend the scope of reduced rates of VAT;[14]
introduce a new scheme for travel agencies;[15] and
provide for new procedures for adopting derogations and conferring implementing powers on the Council.[16]

1.7 In the Communication the Commission sets out its short-term legislative programme, under which it hopes to bring forward eleven proposals in the next two years, and its plans for what it describes as a crucial aspect of the common system of VAT — the place of taxation. It says it is working on this in accordance with two guidelines: reaffirming the principle of taxation at the place of consumption, and simplifying traders' obligations.

The Government's view

1.8 The Paymaster General (Dawn Primarolo) tells us:

"The Communication is an extensive document that reviews progress over the past three years and sets the direction of future work.

"The key section on guidelines for future work closely matches UK interests by:

— giving priority to removing distortions in cross-border trade, and to do this by moving to taxation in the place of consumption,

— recognising the need to avoid undue burdens on business, and planning work for technological solutions to VAT compliance following the UK ideas for e-commerce,

— accepting that harmonisation is not the way ahead."

1.9 In considering various documents on VAT over recent months we have become conscious that we were not getting a clear overall view of the direction of VAT reorganisation and of the Government's approach to it. To that end we asked the Minister to let us have an account of where matters stand on modernisation of the VAT system. With our agreement she has delayed a response to our request until this present document was available. In addition to her Explanatory Memorandum the Minister now gives us a paper which helpfully provides "an overview of the European VAT agenda, including the key themes of the Commission strategy and the Government's approach to them". We annex that paper.

Conclusion

1.10 This is an important document which not only usefully summarises where matters stand on modernisation of the VAT system but also raises important questions of principle and practice. We believe Members would wish to have an opportunity to explore these questions and accordingly recommend that the document be debated in European Standing Committee B.

1.11 The Minister's paper helpfully highlights some of the issues. Amongst questions Members might like to examine are:

attitudes to tax harmonisation and the Government's and the Commission's approaches to taxation;
taxation at the point of consumption;
the impact of information technology in the taxation of businesses;
the increasing amount of fraud.

Annex (paper by HM Customs and Excise)

The modernisation of the VAT system

THE UK APPROACH TO TAX IN EUROPE

1. Tax is a key aspect of national identity. Within the European Union Member States make different choices about their level of social provision and the size of their public sector and they have different preferences for one type of tax over another as a means of funding them. These are national choices and should remain so. Successive UK governments have recognised that the operation of the internal market should not suffer from distortions arising from differing national systems for taxing consumption as at the extremes this can result in double taxation or in no tax at all being paid. However, the Treaties provide that VAT and other indirect taxes are, and may be, revised only to the extent necessary for the effective operation of the internal market, and that fiscal measures may only be decided by the unanimous agreement of all Member States.

THE NEED FOR CHANGE

2. The priority for Europe is to promote growth, prosperity and jobs. Many of the present VAT rules are still largely those agreed in 1977, and patterns of both supply and consumption have changed significantly over the quarter-century since then. The pace of change is accelerating, and the VAT system needs to reflect new business models, new products, and the growth in international trade. The successful introduction of the Single Market in 1992 was a major step in the right direction, but proposals made by the Commission for wholesale change since then have been neither realistic nor satisfactory, and the UK has consistently opposed them. Nevertheless, the UK has continued with a strategy of positive engagement, and with the support of other Member States successfully pressed for a change in direction that led to the publication in June 2000 of a welcome new strategy by the Commission. This set out four main objectives, all of which the UK shared: simplification, modernisation, more uniform application of the current rules and closer administrative cooperation.

3. Throughout this programme, the UK has played a significant role in ensuring that the proposals adopted are both practical and sensible, and appropriate to the needs of business and administrations. The progress of the programme is set out in this paper.

4. In the Explanatory Memorandum[17]on the 2000 Commission strategy,[18] the Government stated its objective to:

simplify and modernise in ways which would reduce costs and burdens for businesses
prepare the system for new developments, especially e-commerce, and
support improvements in administrative cooperation, particularly in order to counter fraud.

5. The Commission has now published a report[19]on progress that also outlines its plans for the future. This shows a clear advance of the UK agenda over the past three years. More importantly, the Commission's updated priorities show a continued acceptance that wholesale and harmonising change is not the way forward, and that the original objectives should continue to be pursued. This further embeds the shift in thinking in a positive direction for the UK.

6. Taking the plans for the future together what has been achieved so far, three areas are of particular significance to the Government:

the legal base for Commission proposals — this is of fundamental importance because unanimity is necessary to retain national control of taxes and as a bulwark against bad law.
the treatment of cross-border supplies — simplification and modernisation here are at the centre of the Commission's plans for further work.
the fight against fraud — the Government is committed to tackling fraud and the major international dimension to VAT fraud requires concerted action between Member States.

THE LEGAL BASE FOR COMMISSION PROPOSALS

7. The Government believes that the right of Member States to determine their own tax policies is a fundamental one. Tax matters are a key component of national sovereignty and vital to the social and economic wellbeing of the country. It is for this reason that the Government made a manifesto commitment to maintain the UK's tax veto. And that is why, in the IGC, the Government will insist that tax measures continue to be decided by unanimity. Any change to unanimity on tax can only be made itself by unanimity, and the Prime Minister makes clear in his foreword to the White Paper on the IGC that tax must remain the province of the nation state.[20]

8. Unanimity voting has secured more robust and effective European legislation on tax, enabling the UK to resist badly thought out, inappropriate or complicated and ineffective proposals.

9. While the UK has led the way in proposing greater co-operation and exchange of information on tax between Member States in line with the strategy, the Commission has consistently brought forward proposals in these areas on a legal base providing for QMV. The UK has made the case strongly for unanimity in all its negotiations on each dossier that contained any provisions for the collection and administration of taxes as well as pushing its negotiating objectives for the content of the proposals.

10. The Commission has taken legal action in the European Court of Justice on this issue, but the Government is pleased to note that in the lead case[21] the Advocate General's Opinion, which is usually followed by the Court, recommends dismissing the Commission's challenge.

CROSS-BORDER SUPPLIES

11. VAT is a tax on consumption that is paid by the final consumer of goods or services.

12. The long-established basic rule for services — that VAT is charged at the supplier's rate and benefits the supplier's government — dates from a period of relatively little cross-border trade. As technology and globalisation enable increasing international business, so this rule increasingly distorts competition because final consumers can pay less than their share of tax by buying from a EU supplier in a country with a lower rate of VAT, or from someone outside the EU charging no VAT at all. And because no tax accrues to the country where consumption takes place, the national government's decisions on tax are undermined, and national tax revenues are eroded. In addition, many EU suppliers are handicapped in world markets by having to charge VAT even on services they supply outside the EU.

13. Previous Commission proposals have sought to address this through harmonisation of VAT rates and/or tax authorities redistributing VAT collected on cross-border supplies back to the country where consumption takes place. The UK has consistently opposed them because they would have removed key areas of taxation from national competence. In its report, the Commission for the first time concedes the strength of the argument that progress is only possible on the basis that for a consumption tax, like VAT, individuals should pay tax at the rate decided by their national government and that the national government should get the benefit of the payment of that amount.

14. This can be done simply in principle by changing the basic rule for VAT to taxation in the place of consumption, but this would make suppliers liable to register for VAT in each Member State where they made their supplies and declare and pay the tax in accordance with the local compliance regime. This can be avoided for business customers by having them account for the tax on their own VAT returns and so the tax is declared and paid to the Member State of consumption without the supplier in fact having to register there. But that solution is not practical for supplies to private individuals (B2C) and so changing just the place of taxation would increase both complexity and burdens on businesses making supplies to ordinary consumers. This is demonstrated by the trade in goods, where the basic rule for distance selling already provides for taxation where the customer is located.

15. The Commission proposes to deal with this by introducing a 'single place of compliance' allowing businesses to fulfil all of their pan-European VAT obligations in one Member State. This embodies key elements of the solution proposed by the UK for the taxation of e-commerce that ECOFIN agreed should be developed by 2006: non-discriminatory, using electronic systems, and based on taxation in the place of consumption.

16. This shift in thinking by the Commission represents a real breakthrough after years of pressure by the UK. The present complicated and outdated rules discourage businesses seeking to expand abroad, distort competition between Member States and handicap EU businesses in world markets. Much work will need to be done for an effective system to be developed. It would be a very significant modernisation of the VAT system and the Government agrees that this should be the Commission's priority for future work.

THE FIGHT AGAINST FRAUD

17. The Government is committed to collecting the tax it is owed and cracking down on fraud. This applies as much to VAT as other taxes. Since 1993, intra-Community supplies of goods are sold VAT free by a supplier in one Member State to a purchaser in another Member State, and the tax is declared on the purchaser's VAT return. Although this makes for a simple system, it is open to exploitation by fraudsters purchasing goods VAT-free, selling them on with VAT, and then disappearing with the VAT they have charged. 'Carousel fraud' is a more complex version that routes the goods through a series of transactions to establish credibility, before one party disappears with the VAT payment. These Missing Trader Intra-Community (MTIC) frauds were estimated to have amounted to between £1.7 - £2.75 billion in lost UK revenue in 2001/02.

18. The Government believes that the response to this requires targeted regulatory control and enhanced enforcement and has deployed increased resources accordingly in the UK, but the cross-border nature of the problem means that effective enforcement requires co-operation between the tax authorities in different Member States. Although these frauds involve large sums of revenue, the number of fraudsters is relatively low and the UK experience is that they can be effectively countered by concerted action built upon exchange of information and adoption of best practice. The UK has demonstrated that existing legal structures can underpin this activity, for example leading the drafting of a "good practice guide to tackling missing traders" which has been taken up Europe-wide, and getting agreement to allowing legitimate businesses to determine the validity of possible trading partners through Community information systems.

19. The Communication outlines options for legislation that clearly risk turning out to be disproportionate by imposing too great a burden on legitimate businesses, or simply opening the door to different frauds. The results in this area that we are achieving in the UK suggest that there is unlikely to be a need for legislation at EU level here, let alone radical change to the VAT system. The Government is pleased to see that the Commission shares this view, and believes the example the UK sets is a persuasive argument against any unnecessary and intrusive action here.

CONCLUSION

20. The Government endorsed the European Commission's change in approach to VAT in 2000, away from simplistic analysis and towards more credible and focussed activity of the kind that we have suggested as the only proper basis for robust and sustainable policy. Significant progress has been made since then on a range of discrete dossiers, resulting in better arrangements for business together with greater assurance for tax authorities. Looking forward, the new strategy envisages advancing on a broader front, with the intention of making systemic changes to enable VAT to keep up with rapid economic developments both within the Community and worldwide. The Government believes that these are key components of the structures necessary for growth in line with the Lisbon agenda. The Commission's stated agenda for the future appears to reflect an increasing realism and a positive approach to reducing burdens for businesses and streamlining the collection of tax. However, the Government is not complacent. The Commission's proposal for reduced rates of VAT, for example, is presented as both simplifying and leading to more consistent application of the current rules when it does neither. The Government will be vigilant in ensuring that the agenda is properly followed and the criteria properly applied. And to safeguard its aims, the Government is equally determined to stamp out the exploitation of simplification and modernisation by organised crime and the bending of the rules for the purpose of tax avoidance. The Government is committed to working in Europe to ensure a fair tax burden for all.

7 November 2003

1 See headnote. Back

2 See (19265) 9877/98: HC 155-xxxvi (1997-98), paragraph 8 (29 July 1998) and (20169) 8809/99: HC 34-xxvii (1998-99), paragraph 16 (21 July 1999). Back

3 See (19681) 13408/98: HC 34-vi (1998-99), paragraph 7 (20 January 1999). Back

4 See (18259) 9118/97: HC 63-xxix (2002-03), paragraph 3 (10 July 2003). Back

5 See (19251) 9741/98: HC 63-xxxii (2002-03), paragraph 19 (17 September 2003). Back

6 See (21374) 9366/00: HC 23-xxv (1999-2000), paragraph 2 (19 July 2000) and HC 152-xxxviii (2001-02), paragraph 37 (16 October 2002). Back

7 See (21649) 11624/00: HC 23-xxviii (1999-2000), paragraph 28 (1 November 2000). Back

8 See (21880) 13562/00: HC 152-vii (2001-02), paragraph 19 (21 November 2001). Back

9 See (22537) 10510/01: HC 152-xxxix (2001-02), paragraph 9 (23 October 2002). Back

10 See (23182) 5520/02: HC 63-i (2002-03), paragraph 12 (20 November 2002). Back

11 See (23812) 12416/02 and 12416/02 ADD 1: HC 152-xxxix (2001-02), paragraph19 (23 October 2002). Back