20 VALUE ADDED TAXATION
(a)
(28778)
11635/07
+ ADD 1
COM(07) 381
(b)
(28782)
11695/07
+ ADD 1
COM(07) 380
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Draft Directive amending Directive 2006/112/EEC with regard to certain
temporary provisions concerning rates of value added tax
Commission Communication: VAT rates other than standard VAT rates
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| Legal base | (a) Article 93 EC; consultation; unanimity
(b) —
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| Documents originated | 5 July 2007
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| Deposited in Parliament |
(a) 11 July 2007
(b) 12 July 2007 |
| Department | HM Treasury
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| Basis of consideration |
EM of 23 July 2007 |
| Previous Committee Report |
None |
| To be discussed in Council
| 13 November 2007 |
| Committee's assessment | Politically important
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| Committee's decision | Cleared, but further information requested
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Background
20.1 The Community has a common system of value added taxation
(VAT) which includes rules about permissible rates of VAT and
under which:
- supplies of goods and services are normally subject
to a standard rate of at least 15%;
- Member States may apply one or two reduced rates
of not less than 5% to a limited number of goods and services;
- Member States may, under certain conditions,
apply a reduced rate to certain labour intensive services; and
- individual Member States have a variety of temporary
derogations from the general rates rules allowing them to apply
additional reduced rates.
20.2 These derogations were granted during the negotiations
preceding adoption of the VAT rates Directive of 1992 and in the
Acts of Accession since then. The duration of these derogations
varies according to when a Member State joined the Community.
Those which joined before 1 January 1995 are allowed to maintain
their derogations until the entry into force of a "definitive
system". However, those Member States which joined after
1 January 1995 received precise deadlines for their derogations
to expire, if the introduction of the definitive system did not
occur first.
The documents
20.3 The draft Directive, document (a), would extend
until 31 December 2010 some of the temporary derogations of Member
States which joined the Community after 1 January 1995. The Commission
proposes this because the definitive system is unlikely to be
adopted in the foreseeable future and the first of the post-1994
temporary derogations are due to expire in 2007, thus creating
an imbalance of treatment between newer and older Member States.
It has chosen the date of 31 December 2010 on the basis that a
new political agreement on VAT reduced rates will be necessary
before that date, as the minimum 15% standard rate of VAT and
the experiment on the application of reduced VAT rates to labour-intensive
services are due to expire then. This issue could therefore be
reconsidered at the time of these broader discussions.
20.4 The draft Directive would prolong derogations
for:
- reduced rates applied in the Czech Republic,
Cyprus, Poland and Slovenia relating to the restaurant and housing
sector; and
- zero or super reduced rates (of less than 5%)
in Cyprus, Malta and Poland for food, books and pharmaceuticals.
20.5 The draft Directive would allow some derogations
to lapse. This is largely an administrative exercise removing
those which are either not necessary because the reduced rates
in question can be applied under the general rules or are no longer
used by the Member State. Czech and Estonian derogations allowing
a reduced rate for natural gas, electricity, district heating
and firewood are examples of the former; a Hungarian derogation
for restaurant services and energy supplies and a Slovakian derogation
for construction and heat energy supplied to private homes are
examples of the latter. But two derogations are allowed to lapse
on the basis that they conflict with the proper functioning of
the internal market or other Community policies. These concern
terminating Estonia's derogation regarding coal, coke, fuel and
oil, which is considered to be in conflict with Community energy
and environment policies, and Poland's derogation allowing a super
reduced rate for agricultural inputs, on the basis that this is
in conflict with the internal market. However, Poland could continue
to apply a regular reduced rate (of no less than 5%) to such supplies
under the general rules.
20.6 In its Communication, document (b), the Commission
summarises briefly the findings of a study into the economic impacts
of reduced VAT rates undertaken for it by Copenhagen Economics[85]
and sets out some possible ways to apply these to reforming the
VAT rules. The Commission's intention is to foster a "fundamental
debate" on VAT rates and it seeks initial views from Member
States, the European Parliament and the European Economic and
Social Committee by the end of 2007, with a view to presenting
a broad legislative proposal on VAT rates in late 2008 or early
2009, for agreement before the end of 2010.
20.7 In the Communication the Commission focuses
on how in its view the current system might be simplified and
rationalised and highlights the business compliance costs associated
with different levels and scopes of VAT reduced rates. It does
not make any formal proposals but it does identify possible overarching
objectives for future changes to the VAT rates structure:
- ensuring equal treatment of all Member States,
which the Commission argues would require terminating country
specific derogations;
- recognising that there is a strong political
will in most Member States to apply very low reduced rates including
zero rates, particularly for social purposes;
- recognising the increased economic and budgetary
difficulties in moving a product from one rate to another, because
of the often very huge difference between the standard rate and
a reduced rate;
- establishing a clear and logical purpose for
reduced rates; and
- balancing any increase in the flexibility allowed
to Member States against compliance costs.
20.8 The Commission suggests one way, but not the
only one, that these objectives could be translated into a structure
composed of three VAT rates (which might accommodate reduced rates
currently allowed by the temporary derogations):
- a very low rate of 0-5% for products of prime
necessity, such as food;
- an optional second rate of 10-12% for other purposes,
which were felt to merit preferential treatment for other reasons,
such as cultural, educational, public transport or employment
considerations; and
- a standard rate.
20.9 The draft Directive and the Commission Communication
are each accompanied by a copy of a staff working document which
more fully describes the findings of the study by Copenhagen Economics
and reproduces the consultant's own executive summary. The consultant
says:
- the study argues that there is a strong general
argument for having uniform VAT rates — they are a better
instrument to maintain a high degree of economic efficiency, to
minimise otherwise substantial compliance costs and to smooth
the functioning of the single market; but
- it also argues that there are exceptions —
there is a case for extending lower rates to some sectors in Member
States characterised by specific economic structures.
20.10 The consultant continues that the study examines
the theoretical and empirical merits of four different arguments
for reduced rates — reduced VAT can increase efficiency
by increasing productivity or by reducing structural unemployment
and reduced VAT can enhance equity by improving income distribution
or by making particular products more accessible to an entire
population. It says there is:
- a theoretical and empirical argument for extending
reduced rates (or other subsidies) to sectors whose services are
easily substituted for do-it-yourself or black economy work, for
example locally supplied services and some parts of the hospitality
sector;
- a theoretical argument for extending reduced
rates to sectors employing many low skill workers in order to
boost low skill demand, for example hotels, restaurants and locally
supplied services;
- a limited and contingent argument for extending
reduced rates (or other subsidies) to sectors particularly favoured
by low income households in order to improve post consumption
income distribution; and
- a limited and contingent argument for extending
reduced rates (or other subsidies) to sectors that for some good
reason are under-consumed.
20.11 The consultant says also that the study identifies
a number of concerns to be carefully evaluated in each case:
"most arguments in favour of lower VAT are
equally valid for other policy instruments, for example targeted
subsidy schemes or targeted changes in income tax;
"all empirical evidence indicates that compliance
costs associated with lower VAT rates can be sizeable;
"the key to an efficient application of lower
VAT or any other subsidy is to keep low mechanical revenue losses;
and
"the choice of financing scheme to secure budget
neutrality should be carefully considered in the context of the
goals to be achieved by reduced VAT rates."
20.12 The executive summary concludes:
"To summarise, there seems to be a strong
argument for making the current VAT structure more simple and
uniform, but also an argument for selective cuts in VAT rates
primarily in locally supplied services and parts of the hospitality
sector. We stress that the current study cannot be seen as a per
se endorsement for further reductions in VAT. The devil is
in the detail and we stress the need to consider each case on
its own merits and to seriously appraise whether alternative non-VAT
instruments may be preferable to reduced VAT rates."
The Government's view
20.13 The Financial Secretary to the Treasury (Jane
Kennedy) says that:
- the draft Directive, document (a), has no direct
policy implications for the UK;
- the Government supports extending most of the
temporary derogations granted to those Member States that acceded
after 1 January 1995, in order to ensure more equality of treatment
between Member States;
- non-prolongation of derogations considered to
conflict with a smooth functioning of the single market and with
other Community policies does not set a precedent which could
be applied to UK derogations, which continue to apply unless and
until there is unanimous Council agreement to introduce a definitive
system of VAT;
- any future proposals from the Commission regarding
the structure of VAT reduced rates, or which might affect the
UK's zero rates, would require the Council to act by unanimity;
- the Government has always made clear that it
will not agree to any proposals that would harm its social objectives
or undermine the fairness of the UK VAT system; and
- the Government has a manifesto commitment not
to extend VAT to food, children's clothes, books, newspapers,
and public transport fares.
Conclusion
20.14 The draft Directive, document (a), is unexceptionable.
But the Communication at document (b) concerns important issues
and we note with approval the Minister's robust reiteration of
the Government's continued stance on this matter.
20.15 We clear the documents, but wish to see
in due course the Government's response to the Commission's call
for comment on its suggestions in the Communication.
85 "Copenhagen Economics is an international consulting
company dedicated to providing private and public decision makers
with economic insight." - see http://www.copenhageneconomics.com/Default.aspx?ID=19
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