Documents considered by the Committee on 19 December 2018 Contents

6VAT: exemptions for small businesses

Committee’s assessment

Politically important

Committee’s decision

Not cleared from scrutiny; further information requested; drawn to the attention of the Business, Energy & Industrial, Northern Ireland Affairs and Treasury Committees

Document details

Proposal for a Council Directive amending Directive 2006/112/EC on the common system of value added tax as regards the special scheme for small enterprises

Legal base

Article 113 TFEU; special legislative procedure; unanimity

Department

Treasury

Document Number

(39449), 5334/18 + ADDs 1–3, COM(18) 21

Summary and Committee’s conclusions

6.1Small businesses often face high costs for complying with their legal obligations related to the collection of Value Added Tax (VAT). To reduce this burden, the EU’s VAT Directive—which underpins the domestic sales tax systems of all Member States—contains the option for individual EU countries to apply special derogations to small businesses. In particular, it allows for the so-called “SME exemption” which allows smaller companies not to charge VAT on their sales.53 In the UK, this applies to firms with an annual taxable turnover of £85,000 or less (the maximum permitted by EU law).54

6.2In January 2018, the European Commission presented a legislative proposal (the SME VAT Directive) to amend the VAT Directive as it applies to small companies. It is part of a wider package of EU VAT reform proposals, which also include new flexibility for individual Member States to vary their VAT rates, and the way in which VAT is accounted for on cross-border sales within the European Union. The key components of the SME VAT proposal are to:

6.3We have set out the detail of the proposals in “Background” below, as well as in our Report of 28 April 2018. The Government has engaged actively in the negotiations on the VAT reform proposals, including the new SME Directive, despite the UK’s imminent withdrawal from the European Union. In a letter dated 5 December 2018, the Financial Secretary to the Treasury (Rt Hon Mel Stride MP) informed us of the state of play in the negotiations on the SME Directive, explaining that negotiations between the Member States had resulted in some initial changes to the draft legislation but not as yet to any fundamental alterations to the proposed VAT registration threshold or allowing companies from other Member States from making use of the SME exemption.56

Our conclusions

6.4We thank the Minister for his latest update on the SME exemption proposals on Value Added Tax, which will be of great interest to small businesses across the European Union. We have noted that on key issues—the harmonisation of the VAT registration threshold at €85,000, and the practical implementation of extending the SME exemption to businesses from other Member States—further negotiations are likely to take place.

6.5We agree with the Government’s active stance in the negotiations, because it remains unclear whether the amendments will need to be applied in the UK despite its scheduled withdrawal from the EU on 29 March 2019. The draft Withdrawal Agreement, ratification of which remains uncertain, would create a post-Brexit transitional period potentially lasting until December 2022. If the Agreement is ratified and the Directive took effect during the transition, the Treasury would have to transpose it into UK law. This could have significant implications for small businesses. It is particularly concerning in this regard that the UK will lose its veto over the proposal on 29 March next year, but it could nevertheless apply here in full.57

6.6In terms of the practical effect, having to transpose the Directive could mean that the Government would be under a legal requirement to lower the VAT registration threshold for SMEs by nearly £10,000, as the UK limit is currently above the upper threshold of £76,70058 proposed by the European Commission (and to which, so far, the remaining Member States have not objected). Any new EU legislation would, for the duration of the transition, override the UK’s discretion to legislate in breach of the Directive. UK application of the Directive would also mean that British SMEs could make use of the VAT exemption when selling into any of the remaining Member States for the duration of the transition (and vice versa).

6.7As we previously noted in our letter to the Financial Secretary of 14 November 2018, we remain concerned about the long-term implications of the Irish backstop which the Government negotiated as part of the Withdrawal Agreement (should it be ratified). The backstop would require Northern Ireland to remain aligned with EU law on VAT in respect of the provision of goods indefinitely.59 That means the SME VAT proposal could take effect there even beyond the transitional period, although the exact extent to which the provisions of the VAT Directive relating to the small business exemption would apply in Northern Ireland under the backstop is unclear.60 We have today sought clarification on that matter from the Financial Secretary.61

6.8Moreover, the substance of any future UK-EU VAT Agreement—with the aim of superseding the relevant parts of the Irish backstop—could require continued UK-wide adherence to specific provisions of EU VAT law. The Government’s ambition is to reach an agreement on “common processes and procedures” to avoid the need for any new VAT-related border controls on goods moving between the UK and the EU. The Financial Secretary, by letter dated 5 December 2018, has again refused to provide further detail about the Government’s expectation of what such ‘processes and procedures’ might be, and to what extent they would be based on EU VAT law (including the exemptions the VAT Directive permits in relation to small businesses). In our view, it therefore remains a possibility that any future UK-EU VAT arrangement could lead to the UK having to apply significant elements of EU VAT legislation, even though it will lose its veto over any future amendments on 29 March next year.

6.9The above concerns do not arise in a ‘no deal’ scenario, where the Withdrawal Agreement—and therefore the transitional period and the Irish backstop—are not ratified. In such a scenario, the UK would be free to amend or repeal elements of its VAT law as of 30 March 2019 (for example to zero-rate women’s sanitary products).

6.10However, without a Withdrawal Agreement UK exports would face the immediate re-imposition of VAT controls on goods destined for the EU (as the latter has refused to copy the UK’s approach of deferring VAT controls at the border in a ‘no deal’ scenario).62 Similarly, UK-registered businesses will immediately cease to be covered by the various simplifications to account for VAT on trade with the EU, such as the application of the ‘country of origin’ principle for cross-border sales below a certain value threshold.63 These changes would also automatically occur at the end of any transitional period, barring a new agreement on VAT having already been reached with the EU by that point. To minimise the disruption resulting from the UK’s exit from the common VAT area, the Treasury will therefore at some stage have to engage in negotiations with the EU on matters of Value Added Tax (whether as soon as possible in a ‘no deal’ scenario, or during any transitional period under the Withdrawal Agreement).64

6.11In light of these political uncertainties, and the potential for the SME VAT proposal to lead to a substantial reduction in the UK’s VAT registration threshold, we have decided to retain the proposed Directive under scrutiny. We thank the Minister for his commitment to provide further information as the negotiations progress, including during the transitional period should the Withdrawal Agreement be ratified.

6.12Given the potential impact of the SME VAT proposal on small businesses throughout the UK, we also draw these developments to the attention of the Business, Energy & Industrial and Treasury Committees. We consider the Northern Ireland Affairs Committee may also have a special interest, given the continued applicability of EU VAT law under the proposed ‘backstop’.

Full details of the documents:

Proposal for a Council Directive amending Directive 2006/112/EC on the common system of value added tax as regards the special scheme for small enterprises: (39449), 5334/18 + ADDs 1–3, COM(18) 21.

Background

6.13The European Union forms a Single EU VAT Area, where each Member State is required to levy value added tax on supplies of goods and services. Uniquely, within this area VAT on imports of goods between EU Member States is not checked by customs officers at the border (as is the case for goods entering from outside the EU). To enable this system to work while minimising the possibilities for tax evasion or fraud, EU VAT law imposes significant ‘behind the border’ administrative burdens on businesses, which are responsible for collecting the tax and paying it to the relevant tax authority. For small businesses in particular, VAT compliance costs can be significant.

6.14To mitigate these costs, the general EU VAT Directive65 contains several provisions designed to ease the burden on small businesses dealing with value added tax, which are collectively known as the “SME scheme”. In particular, individual EU countries can use the “SME exemption”, which allows them to exempt smaller businesses based domestically from charging VAT to their customers if their annual turnover is below a specific threshold.66 Small businesses which cannot use the SME exemption, or choose not to make use of it, can also apply various other simplification regimes aimed to reduce overall VAT-related administrative burdens.

6.15However, the current EU legal framework is not seen as ideal, because the VAT exemption threshold does not apply to businesses seeking to supply goods or services to a customer in another Member State. This means SMEs seeking to engage in cross-border trade within the EU would have to account for VAT under that country’s domestic rules for any sales, acting as a barrier to expansion and competition. That would be the case even if their turnover would qualify them for the SME exemption, if they were based in the customer’s country (giving domestic firms a competitive advantage).

6.16Moreover, at domestic level the VAT exemption for small businesses incentivises companies to remain below the turnover threshold to avoid becoming subject to additional administrative requirements relating to VAT. This effect is considered particularly pronounced in the UK, because its VAT registration threshold is the EU’s highest, at £85,000.67

6.17To address these issues, the European Commission presented a legislative proposal in January 2018 to amend the SME-specific provisions of the Value Added Tax Directive (as part of a wider process of reform of the Single EU VAT Area, including a proposal to allow Member States to vary their VAT rates more flexibly).68 The main elements of the SME VAT proposal, which we set out in more detail in our Report of 3 April 2018, were to:

6.18The Commission wanted these changes to take effect alongside the wider reforms of the EU’s VAT system in summer 2022. However, that timetable depends on the progress made by the EU’s national governments on the proposals: under the Treaties, each Member State has a veto over new European tax legislation.

6.19The Financial Secretary to the Treasury submitted an Explanatory Memorandum on the proposal for a revised VAT scheme for small businesses in February 2018. In it, he welcomed the Commission’s aim of “[reducing] the burden placed on SMEs by the administration of VAT and that lessens any VAT threshold-related distortions”, including the extension of the SME exemption to small businesses from other EU countries. However, the Minister also identified a number of areas of concern or which the Government thought required further clarification, in particular with respect to the interaction between the Treasury’s own work on reform of the UK VAT threshold—on which it launched a consultation in March 2018—and the Commission proposals for a new maximum VAT exemption threshold, and the transitional relief mechanism where the threshold is exceeded.

Developments in the legislative process since April 2018

6.20Negotiations on the SME VAT proposal have been taking place in Brussels for most of 2018. As draft legislation related to taxation, each Member State has a veto and negotiations are typically slow. A report prepared by the Austrian Presidency of the Council for EU Finance Ministers in November 2018 noted that “further work […] will be required, before a final agreement on this dossier can be reached among the Member States”, to ensure that the proposal “does not lead to weakened tax control and increase of risks of VAT fraud/evasion”.71

6.21On 5 December 2018, the Financial Secretary to the Treasury provided a further update with more detail on the state of play in the discussions since his original Explanatory Memorandum. We have summarised the key points from his letter in relation to the four main elements of the Commission proposal below.

The VAT registration threshold

6.22The original Commission proposal would allow individual EU Member States to continue to set their own national VAT registration threshold, but only up to a new harmonised limit of €85,000 (£75,415). The Minister says there has been “limited discussion on this thus far” among the Member States, and as such it is unclear if the harmonised limit will make it into the final Directive.

6.23If this aspect of the proposal is not modified by the Member States, and the new Directive had to be applied in the UK (for example during the post-Brexit transitional period, see below), it would require a lowering of the existing VAT threshold from £85,000. No other EU country currently operates a threshold potentially affected by the proposal, so it is unclear what level of support there would be for removing or increasing the limit.72

Transitional relief for SMEs which exceed the VAT threshold temporarily

6.24To remove the incentive for small businesses to artificially keep their taxable turnover below the VAT registration threshold, the Member States are agreed that they would continue to benefit from the SME exemption if their turnover exceeds the national threshold by 25 per cent or less in any given year (which would be £106,250 in the UK if the threshold is maintained at £85,000).73 If the threshold is exceeded by more than a quarter, or if it is exceeded by any amount for two consecutive years, the business has to register for VAT and the exemption ceases to apply.

6.25This is a change from the original Commission proposal, under which the exemption threshold could be exceeded by 50 per cent without the company losing its VAT-exempt status. The Minister has called this “an improvement”, but the Government remains concerned that further changes are necessary to “ensure it does not impose an undue burden on business”.

Extending the VAT exemption to businesses from other Member States

6.26The new Directive would allow businesses from one EU country selling into another to benefit from the VAT exemption, if their turnover is below the locally-applicable limit. However, to avoid larger firms from benefitting from the exemption by applying for it using only their local turnover, the proposal would set a “Union turnover threshold” of €100,000 (£88,723) for business who make supplies in more than one Member State. If a company had a cumulative EU-wide turnover above that threshold, it would be ineligible for the VAT exemption in other Member States.74

6.27The Minister explains that the “mechanism and information exchange requirements to enable the application of this threshold remain unclear”, and negotiations on this element of the proposal are continuing. Of particular concern has been how this new system would be monitored and enforced, given it requires each Member State to have access to information about a company’s turnover in every other Member State. The Financial Secretary has noted the Government’s objective is to ensure that any “obligations are proportionate and do not create undue burdens to small businesses”.

SME simplifications relating to VAT returns, invoicing and interim VAT payments

6.28In its original proposal, the European Commission had suggested creating a new set of simplified obligations for the benefit of small enterprises that do not benefit from the SME exemption (for example, those with an annual turnover above the exemption threshold that applies in their home country). It had wanted any company with a turnover lower than €2 million (£1.8 million) per year to be able to rely on simplified provisions relating to storage of invoices, the submission of VAT returns75 and exempting them from any obligation under domestic law to make interim VAT payments throughout the financial year.

6.29The Minister’s letter explains that the Member States have removed these provisions from the proposed Directive entirely, which avoids the legislation interfering with existing domestic schemes such as the UK’s Annual Accounting Scheme and invoicing rules for small businesses.76 The Government therefore supports this change.

Next steps

6.30The Minister finished his latest update to us by saying that the Treasury “will continue to work with other Member States to help improve the proposal and suggest alternative approaches” and provide further updates on the progress of these discussions. There is no firm timetable for formal adoption of the new legislation on the SME VAT threshold yet, and the Government “anticipate that the dossier will now be passed onto the incoming Romanian Presidency” of the Council.

Potential applicability of the new VAT rules for SMEs in the UK

6.31When we last considered the proposal on the VAT obligations for SMEs in April 2018, we noted that it was politically important: its substance was clearly relevant to the UK’s own debate around the VAT burden for small businesses, including the VAT registration threshold.

6.32Moreover, despite the UK’s decision to leave the European Union, there is a significant possibility that the new tax legislation, once adopted, remains relevant for UK businesses and the Treasury for some time after EU withdrawal actually takes place in March 2019. This is so for several reasons:

6.33Whether or not the Withdrawal Agreement, including the backstop, will actually be ratified remains an open question. The Government postponed the vote on Agreement on 10 December 2018, and it is not yet clear when the House of Commons will now formally consider the legal text. The exact implications of the SME VAT proposal, and the broader package of the EU’s VAT reform proposals, can therefore not yet bet determined with any certainty.

6.34In a ‘no deal’ scenario, where the Withdrawal Agreement is not ratified, the UK would cease to be bound by EU VAT legislation overnight on 29 March 2019. While this would create new legal flexibility to vary VAT rates and the administrative burden on businesses of collecting the tax, it would also mean there would be no transitional period. In practice, the legal arrangements that allow UK goods to enter the EU-27 free from VAT-related customs controls would then disappear overnight. The re-imposition of such controls at French, Belgian and Dutch ports—and even, potentially, at the Irish border—are likely to add to the disruption of trade that would occur in the event of a disorderly Brexit. The need for EU businesses importing goods from the UK to navigate such VAT controls, which would not apply to goods purchased from within the EU, may also make such goods less competitive within the Single Market.

6.35In light of the uncertainties about the potential implications of the SME proposal for UK businesses, we have decided to retain it under scrutiny in anticipation of further information and analysis from the Financial Secretary to the Treasury in due course.

Previous Committee Reports

See (39449), 5334/18 + ADDs 1–3, COM(18) 21: Twenty-Third Report HC 301–xxii (2017–19), chapter 3 (3 April 2018).


53 The loss of revenue is minimised by the fact that it is only the tax on the value added by the SME that is lost, as the company would still have paid VAT on supplies of goods and services it purchased.

54 The SME exemption threshold varies by EU country, and EU law sets different limits for different Member States. As noted, in the UK it is £85,000, the highest of any Member State. Under the VAT Directive, the UK Treasury (and certain other Member States) can only increase this threshold to maintain its value in real terms as it was in 1977. For other Member States it is set at a fixed level, with no up-rating.

55 In many Member States this would represent an increase in their permitted VAT registration threshold. Under the VAT Directive, different thresholds apply for different Member States as a legacy of subsequent waves of EU enlargement and changes to VAT law. See articles 286 and 287 of Directive 2006/112/EC.

56 See “Background” for more information on the contents of the Minister’s update.

57 Under Article 113 of the Treaty on the Functioning of the European Union, the legal basis for the VAT Directive, each Member State has a veto over new EU tax legislation.

58 At current exchange rates, the proposed limit of €85,000 translates into £76,734.

59 See Article 9 and Annex 6 of the Irish Protocol.

60 The Irish Protocol stipulates EU law applies in Northern Ireland only insofar as the provisions ‘concern goods’. The SME exemption relates to a company’s turnover, irrespective of whether they sell goods, services or both. It is therefore not immediately clear whether the SME scheme as laid down in the VAT Directive would apply in Northern Ireland in its totality by force of the backstop.

61 Letter from Sir William Cash to Mel Stride (19 December 2018).

62 See for the UK Government’s approach its ‘no deal’ technical notice of 23 August 2018 on “VAT for businesses if there’s no Brexit deal”. The European Commission’s Brexit notice on indirect taxation, and its Communication of 13 November 2018 on the EU’s ‘no deal’ contingency planning, make no allowance for the waiver of VAT-related customs controls on goods entering the EU from the UK as of 30 March 2019.

63 For most business-to-consumer sales between EU Member States, a company can pay VAT at their domestic rate to their national tax authority while the value of the sales is below a certain threshold. This does not apply to non-EU businesses, who must register for VAT for any sales they make within an EU Member State. See for more information our Report of 28 January 2018 on the EU’s recent e-commerce package.

64 At present, only Norway has an agreement on VAT cooperation with the EU. This does not, however, remove the need for customs and VAT-related controls on goods entering the EU from Norway.

65 Directive 2006/112/EC, as amended.

66 Consequently, small companies which do not charge VAT can also not deduct their input VAT. They are effectively treated as a final consumer. The Netherlands and Spain are the only Member States not to use the SME exemption.

67 See also the report by the Office for Tax Simplification, “Value added tax: routes to simplification“ (November 2017).

68 See our Report of 3 April 2018 for more detail on the full set of EU VAT reform proposals, and their potential implications for the UK.

69 The SME exemption threshold varies by EU country. As noted, in the UK it is £85,000, the highest of any Member State. Under the VAT Directive, the UK (and certain other Member States) can only increase this threshold to maintain its value in real terms as it was in 1977. For other Member States it is set at a fixed level.

70 This means, for example, that a French SME selling goods to a UK customer would qualify for the SME exemption if its turnover was below the UK threshold (not the French one).

72 The Irish VAT registration threshold is the second-highest after the UK, at €75,000 for sellers of goods. This is below the proposed €85,000 limit.

73 This presumes the UK’s current limit of £85,000 is maintained. If the maximum harmonised limit of £75,000 were to apply, the maximum taxable turnover before the VAT registration requirement applied would be £93,750. For the purposes of calculating the annual turnover, the Directive would require Member States to use a calendar year (rather than a rolling 12 month period, as is the case in some countries like the UK).

74 A company would still be eligible for the VAT exemption in the Member State where it is established, provided it was below the domestic VAT registration threshold. The ‘Union turnover threshold’ requirement applies only in relation to the VAT exemption in other Member States. For example, a UK business with a turnover of £50,000 in the UK but £200,000 in France would remain eligible for the VAT exemption in the UK, but not in France.

75 At present, article 252 of the VAT Directive makes it optional for Member States to allow annual VAT returns for any business. The Commission proposal would make it compulsory to offer this option to small businesses.

76 The Annual Accounting Scheme in the UK is open to businesses with a turnover below £1.35 million, but requires businesses to make interim payments (which would have been affected by the Commission proposal). See also https://www.gov.uk/vat-annual-accounting-scheme/return-and-payment-deadlines.

77 See Article 132 of the Withdrawal Agreement.

78 Reference to WA and Protocol.




Published: 24 December 2018