1Single EU VAT Area
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Committee’s assessment |
Politically important |
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Not cleared from scrutiny; further information requested; drawn to the attention of the Business, Energy & Industrial Strategy, the Northern Ireland Affairs and Treasury Committees |
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Document details |
(a) Proposal for a Council Directive harmonising and simplifying certain rules in the value added tax system and introducing the definitive system for the taxation of trade between Member States; (b) Proposal for a Council Regulation as regards the certified taxable person |
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Legal base |
Article 113 TFEU; special legislative procedure; unanimity |
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Department |
Treasury |
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Document Numbers |
(a) (39085), 12882/17 + ADDs 1–2, COM(17) 569; (b) (39083), 12880/17, COM(17) 567 |
Summary and Committee’s conclusions
1.1Since October 2017 the European Commission has tabled four legislative proposals—six years in the making11—to begin a substantial reform of the EU’s value added tax (VAT) system and create a ‘true’ single EU VAT area.
1.2The proposal we discuss in this chapter is focussed on the VAT treatment of cross-border business-to-business12 sales of goods and services within the EU, with the aim of introducing the “definitive” system of value added tax for such transactions. The other three elements of the VAT reform package relate to VAT rates, exemptions for small businesses, and administrative cooperation between national tax authorities in the EU. We have discussed these in the other three chapters of this Report.
1.3The Commission proposal for the “definitive” VAT system on cross-border sales builds on a system—first introduced on a ‘transitional’ basis in 1992—which allowed for the complete abolition of customs and tax controls on goods moving between EU countries. Under the new legal framework drafted by the Commission, VAT on intra-EU business-to-business (B2B) sales would continue to be paid to the Member State of the company making the purchase (the so-called ‘destination’ principle).
1.4However, the proposed legislation would end the current practice of making the purchaser account for the VAT (the so-called “reverse charge mechanism”), a key feature of the transitional system. Instead, the supplier would have to account for the VAT, as is the case for purely domestic transactions. While increasing the burden on businesses wishing to sell goods or services to another EU country, it would end a current loophole that incentivises so-called widespread “missing trader” fraud (estimated to cost EU governments £44 billion annually).13
1.5To mitigate the impact of this change on suppliers, the Commission has simultaneously proposed to expand the use of an EU-wide mechanism that allows suppliers to pay VAT on sales to any Member State in their own country (the so-called “One Stop Shop” or OSS), and enabling businesses to deduct input VAT via this system.14 Moreover, the current reverse charge mechanism would be maintained for transactions where the buying business had “Certified Taxable Person” (CTP) status, meaning they were officially considered a reliable taxpayer, unlikely to engage in VAT fraud. In parallel, the Commission wants to introduce a number of ‘Quick Fixes’ to reduce VAT-related burdens on businesses and remove opportunities for fraud while the broader reforms are under consideration.
1.6The Government cautiously welcomed the proposals, but told us in October that further detailed consideration would be necessary. In particular, the Financial Secretary to the Treasury (Mel Stride) highlighted the problems that could arise from two parallel systems of accounting for VAT depending on whether the buyer is a “reliable taxpayer” or not; the potential impact of changes to cash flow that both tax authorities and businesses may experience as a result of the proposed changes; and the need for further scrutiny to ascertain what new opportunities for VAT fraud the proposals might create. The Minister did not assess the implications for UK businesses, both buyers and suppliers, of leaving the EU’s common system of VAT.
1.7The Committee considered the proposal in December 2017, and retained it under scrutiny. We expressed concern about the lack of clarity from the Government about its plans to mitigate the VAT-related barriers that Brexit would, by default, impose on UK-EU trade flows unless a new agreement is in place by the time the UK is due to leave the single EU VAT area (at the end of the post-Brexit transitional arrangement, the end date of which is not yet known).
1.8When the UK ceases to be bound by EU VAT law, VAT will become an import tax on goods going in either direction, including customs controls which are currently absent due to the UK’s membership of the Single Market. UK businesses would cease to benefit from the systems and mechanisms in place to minimise VAT-related barriers to trade within the EU, such as the One Stop Shop. Conversely, the Government would no longer be restricted by EU law when setting VAT rates and administrative requirements for businesses.15 It appears the Government is seeking to remain aligned with EU VAT law to minimise new barriers to trade, as it has not told the Committee with respect to any of the VAT reform proposals that it categorically will not apply to the UK (despite the fact they are unlikely to take effect until 2022 at the earliest).
1.9With respect to the substance of the Commission proposal for the “definitive” system, the Financial Secretary to the Treasury (Mel Stride) was cautiously optimistic about the thrust of the reforms. However, he highlighted concerns about the creation of two parallel systems for VAT on identical cross-border transactions (with responsibility lying with the buyer if they had CTP status, and with the vendor if they did not). Moreover, the European Commission will only set out its proposals for the technical detail that would underpin the new system in the form of an Implementing Regulation later this year.
1.10The Minister wrote to the Committee in February 2018 with more information on the discussions on the proposal within the Council so far.16 He noted there was particular opposition to the expansion of the One Stop Shop and its potential use to deduct input VAT and the added value of the “Certified Taxable Person” status, the core elements of the Commission proposal to end the use of the reverse charge mechanism for cross-border B2B sales within the EU. With respect to the VAT-related trade barriers that Brexit would impose in the absence of a new agreement with the EU, he said only that “arrangements” would “depend on” the upcoming trade negotiations.
1.11As we have noted before, the European Commission’s VAT reform proposal for cross-border supplies is substantive and far-reaching. If implemented in the UK, it will affect businesses, consumers and the Exchequer alike. We note that there is substantial national opposition to key parts of the proposal, with both the expansion of the One Stop Shop and the introduction of the “Certified Taxable Person” status attracting criticism within the Council. This means the timetable for adoption of the new legislation, and consequently its entry into force, remains highly uncertain.
1.12In any event, we cannot properly scrutinise the proposals without taking into account Brexit. The UK’s exit from the EU has significant consequences for the VAT treatment of UK goods and services exported to the European Union. Absent an unprecedented agreement to the contrary, UK goods sent to the EU will face VAT controls at the border for the first time since 1992, posing particular problems at the border on the island of Ireland.17 British businesses would also no longer be able to make use of the Mini One Stop Shop simplified accounting mechanism for sales to EU-based consumers without registering for VAT in another EU country, and have to revert to paper-based applications for VAT refunds on business expenses incurred in the EU.
1.13The Committee remains seriously concerned about the inability, or unwillingness, of the Government to share a detailed proposition for the mitigation of VAT-related barriers to trade flows between the UK and the EU as and when the UK leaves the single EU VAT area (either in March next year or at the end of any subsequent transitional period). In his latest letter, the Financial Secretary is able to offer us only the obvious insight that “arrangements in this regard will depend on the conclusion of the negotiations”.
1.14Plainly, that does not tell us what the Government hopes those arrangements would, ideally, be. As we have noted in the other chapters of this Report, the Minister’s Explanatory Memoranda on the various elements of the VAT reform package strongly suggest the Government is considering remaining closely aligned with, if not directly bound by, EU VAT law to minimise barriers to trade with the EU after Brexit.
1.15In any event, the UK will be under an obligation to continue applying EU VAT law for the duration of any transitional period from March 2019 onwards. It cannot yet be ruled out that the VAT reform package—including the proposal on the “definitive” system for cross-border supplies—will have to be implemented in the UK. As we have stated previously, this raises a potentially serious problem: when the UK ceases to be a Member State, it will lose its Treaty-based veto over new EU tax legislation. The Government could then find itself in the position of having to implement VAT legislation which it would have blocked had it still been a member of the Council.
1.16It does not appear that the safeguarding mechanism the Government is seeking would allow the UK to unilaterally reject new EU VAT legislation that takes effect during the transition without potentially triggering the re-imposition of customs controls on UK goods entering the EU.18
1.17Moreover, in the area of VAT, EU law creates a symmetrical and reciprocal system to ensure proper taxation of cross-border supplies; a refusal by the UK during the transition to implement changes adopted by the remaining Member States could undermine the feasibility of the UK’s continued participation in the system altogether. To take the “definitive VAT” proposal, it is not clear how the UK could—by way of example—unilaterally reject the eventual abolition of the reverse charge mechanism and use of the One Stop Shop for cross-border sales while it remains part of the single EU VAT area if it was abolished by the EU-27. That would render it unclear who was accountable for VAT on sales of goods from the EU to the UK: HM Revenue & Customs would require the vendor to account for the tax, while the EU-based supplier would simultaneously expect to have to account for the VAT through the One Stop Shop.
1.18While this is an extreme example, any decision by the UK to diverge from the harmonised standards that underpin the common VAT system could have unforeseen consequences, potentially rendering the whole cross-border system that allows for border controls to be waived technically unworkable.
1.19As such, it could be that the Government’s long-term objective is continued alignment with EU VAT legislation beyond the transition, to maintain the “freest and most frictionless trade possible”. This is our interpretation of the various Explanatory Memoranda we have received from the Treasury, which appear to assume the VAT Directive could still restrain the Government’s domestic room for manoeuvre in 2022 and beyond. However, any arrangement that sees the UK having to keep in lock-step with EU VAT law indefinitely raises serious issues about the extent to which the UK would have freedom post-Brexit to modify the fundamentals of a major part of its tax system. Therefore, the Committee will continue to monitor negotiations on the proposal as its substance develops within the Council.
1.20The Committee looks forward to receiving further information from the Minister about the Government’s proposals for a new UK-EU arrangement on VAT, and in particular how a trade agreement with the EU could ensure value added tax is collected on goods imported into the UK via the border with Ireland (given the Government’s objective of avoiding any physical infrastructure there). We also ask to be kept informed of progress in the negotiations on the “definitive” VAT proposal, in particular as regards the Member States’ alternative proposals to end the use of the reverse charge mechanism for business-to-business supplies while still closing the current loophole allowing for rampant missing trader fraud on cross-border sales. In the meantime, we retain the proposal under scrutiny.
Full details of the documents
(a) Proposal for a Council Directive harmonising and simplifying certain rules in the value added tax system and introducing the definitive system for the taxation of trade between Member States: (39085), 12882/17 + ADDs 1–2, COM(17) 569; (b) Proposal for a Council Regulation as regards the certified taxable person: (39083), 12880/17, COM(17) 567.
Background
1.21Since 1993, with the complete abolition of intra-EU customs controls as part of the Single Market, the EU has operated a curious system of Value Added Tax (VAT) on cross-border business-to-business (B2B) sales within the EU. Under this system, a supplier can make a sale of goods or services to a customer in another EU country at a zero-rate of VAT, after which the customer effectively must charge VAT to himself and pay it to their national tax authority.19
1.22This system was meant to operate only on a transitional basis, as it allows for substantial amounts of VAT to be fraudulently evaded on goods through missing trader fraud (estimated to cost EU Governments up to €53 billion (£47 billion)20 each year).21 After repeated efforts to end the ‘transitional’ phase by shifting the responsibility of accounting for VAT to the supplier at their domestic rate (the so-called ‘origin’ principle)—which would most closely reflect a ‘true’ internal market by eliminating differences in VAT treatment faced by suppliers for domestic and intra-EU sales—the European Commission and Member States in 2011 decided to fully implement the transitional ‘destination’ based system instead, where the VAT must be accounted for in the country of consumption.
1.23In October 2017 the European Commission tabled a legislative proposal to this effect. The main elements of the proposal are:
- to end the reverse charge mechanism, meaning that suppliers, and not buyers, would become responsible for accounting for VAT on cross-border business-to-business sales, at first for goods only and for cross-border supplies of services at a later stage. This would end the use of zero-rating of cross-border supplies that provides opportunities for missing trader fraud, as the supplier would have to charge VAT when selling to a business based elsewhere in the EU;22
- to mitigate the impact of this change on suppliers by expanding the use of an EU-wide mechanism that allows suppliers to pay VAT on sales to any Member State in their own country (the so-called “One Stop Shop” or OSS),23 and by retaining the reverse charge mechanism where the buying business had “Certified Taxable Person” (CTP) status (i.e. they are a reliable taxpayer); and
- lastly, in recognition of the likely lead-in time for these reforms to take effect, to introduce a number of so-called ‘Quick Fixes’ to mitigate VAT fraud and reduce burdens on businesses in the interim, including increased use of the VAT identification number; new evidentiary standards for proof of intra-EU supplies to reduce cross-border VAT evasion; and new VAT treatment of call-off stock and chain transactions of goods.24 The Commission has proposed that most of the improvements offered by its “Quick Fixes” would only be available where the supplier has the new “Certified Taxable Person” status, to incentivise take-up of the CTP scheme.
1.24the Government cautiously welcomed the proposals, but told us in October 2017 that further detailed consideration would be necessary. In particular, the Financial Secretary to the Treasury (Mel Stride) highlighted the problems that could arise from two parallel systems of accounting for VAT depending on whether the buyer is a “reliable taxpayer” or not; the potential impact of changes to cash flow that both tax authorities and businesses may experience as a result of the proposed changes; and the need for further scrutiny to ascertain what new opportunities for VAT fraud the proposals might create. The Minister did not assess the implications for UK businesses, both buyers and suppliers, of leaving the EU’s common system of VAT.
1.25The Committee considered the proposal in December 2017, and retained it under scrutiny because:
- the Commission proposals are a major development in the EU’s common system of value added tax, as they are the first significant step in ending a system for cross-border VAT within the EU that was introduced nearly twenty-five years ago as a temporary measure;
- our ability to effectively scrutinise the Commission’s proposed Directive is hampered by the fact that its proposal for the detailed, technical implementation of the “definitive VAT system” will not follow until later this year;
- during the post-Brexit transition period, any changes to VAT law—including potentially this proposal—would apply to the UK if they take effect during that period; and
- there remains considerable uncertainty surrounding the long-term implications of Brexit for the UK’s VAT system, and the extent to which the Government may wish to stay aligned with EU VAT law to minimise VAT-related barriers to trade between the UK and the EU that are currently absent. In particular, such alignment would be necessary to avoid the need for VAT controls at the border on flows of goods between the UK and the EU, and to allow UK-based businesses to make full use of the various mechanisms EU law has created to remove or mitigate the VAT-related obstacles to intra-EU cross-border trade.25
1.26We therefore asked the Minister for further information on the Brexit implications for the UK’s VAT regime; the Government’s position with respect to the “definitive” VAT system proposal; the accuracy of the Commission’s impact assessment, in particular the envisaged €41 billion reduction in VAT fraud; the value of the new “Certified Taxable Person” status; and whether the ‘Quick Fixes’ might be dealt with separately to expedite their entry into force.
The Minister’s letter of 19 February 2018
1.27The Financial Secretary to the Treasury (Mel Stride) replied to the questions raised by the Committee in our Report of 6 December 2017 by letter of 19 February.26
1.28With respect to the VAT-related trade barriers that will impede UK-EU flows of goods and services as and when the UK leaves the single EU VAT area (and with it the system that enables goods to be moved between EU countries without customs controls), the Minister says only:
“The UK’s arrangements in this regard will depend on the conclusion of the negotiations. However, as the Government has made clear, the UK will seek a deep and special partnership with the EU, one which is based on strong and mutual respect and friendship and one which is based on as free and frictionless trade in goods and services as possible.”
1.29As such, it is still not possible for the Committee to categorically rule out that the new VAT system on cross-border supplies—or the supplementary proposals on VAT rates, exemptions for small businesses, and administrative cooperation between tax authorities—will not apply in the UK. Indeed, the Government’s Explanatory Memoranda on the various elements of the VAT reform package, which we discuss elsewhere in this Report, implicitly assume they may apply in the UK, even though they are not due to take effect until 2022 at the earliest.
1.30As such, the remainder of the Minister’s letter (on the substance of the Commission proposal) remains relevant. We have summarised it below.
The “definitive” VAT system
1.31The Committee had asked the Minister about the merits of agreeing the principles of the proposed changes, while leaving the detailed implementation to a later stage. He now writes that the Government “would prefer to see greater detail from the outset regardless of the opportunity for input during discussion on the implementing regulation”.
1.32As regards the accuracy of the Commission’s impact assessment—namely that the proposals would reduce VAT fraud in the EU by over €40 billion annually—the Government is agreement that the taxation of cross-border B2B supplies as proposed “is likely to eliminate Missing Trader Intra-Community (MTIC) fraud in its current form”, but could “provide new opportunities for variants of missing trader or other forms of fraud”. The precise impact of the proposal on business costs (which the Commission said would be reduced by nearly €1 billion per year) is “difficult to establish” precisely, according to the Minister, although he notes the assessment was driven by three assumptions:
- non-established suppliers may no longer need to register for VAT in other Member States (or submit local VAT returns and an intra-EU sales list) by using the One Stop Shop;
- Similarly, the requirement to submit an intra-EU sales list to account for cross-border supplies to businesses would be removed when there is no zero-rated intra-EU acquisition; and
- Businesses generally would benefit from the standardisation of reduced VAT rates for goods and the provision of information on applicable VAT rates online (as proposed in a separate Directive).
1.33These elements remain under discussion, and the One Stop Shop proposal in particular is likely to face significant opposition within the Council (see below).
The extension of the One Stop Shop for cross-border supplies
1.34With respected to the proposed extension of the One-Stop-Shop (OSS), which would allow a supplier to account for VAT on a cross-border sale to their national tax authority at the rate of the Member State of consumption, the Minister tells us that “discussions […] have been limited”, although there is a “willingness to explore the issue further”. However, some Member States “continue to have fundamental problems with the OSS system” which they are likely to raise again in the discussions on this proposal.
1.35In any event, even most of the Member States open to further discussion of the extension of the OSS has “expressed misgivings over the proposed changes to allow deductibility of input VAT through the OSS”, as this notion was already rejected in previous discussions on the Mini One Stop Shop for suppliers of electronic services “over fraud concerns”.
The “Certified Taxable Person”
1.36As regards the introduction of the “Certified Taxable Person” status for reliable taxpayers with lower risk of perpetrating VAT fraud (and therefore able to benefit from the ‘Quick Fixes’ that would reduce administrative burdens), the Minister explains:
“Most Member States have questioned how consistency of approach and application could be achieved and how the proposed changes would work in practice, including over the resources required to grant and effectively monitor continued compliance with CTP criteria; whether the proposed criteria were the most suitable; the difficulties that new businesses may face in proving financial credibility; and how such criteria would be applied consistently across all Member States.”
1.37In terms of the assessment of applications and impacts on tax administrations of having to enforce the CTP concept, the Minister adds that “the proposals do not address the technical detail of how the changes would work in practice”, including for example in relation to the Commission’s proposed requirement that a criminal history check would have to be made before CTP status could be granted.
The “Quick Fixes”
1.38The European Commission had proposed to link the “Quick Fixes”—which aim to reduce administrative burdens and close some known loopholes for VAT fraud as an interim measure—to the “Certified Taxable Person” status, meaning that their use would be mostly restricted to businesses which have obtained such status.
1.39The Minister notes that this link “appears unpopular among Member States, the majority of whom favour swift agreement on the ‘quick fix’ changes as they recognise progress on the concept of CTP is likely to be difficult”. However, at this stage it is not yet known if the “Quick Fix” elements could be split off from the main proposal to expedite their adoption and entry into force.
Previous Committee Reports
Fourth Report HC 301–iv (2017–19), chapter 9 (6 December 2017).
11 The outline of the proposal was first announced in the Commission’s 2011 Communication on the Future of VAT.
12 Different EU rules apply to cross-border business-to-consumer sales. See our Report of 24 January 2018 on VAT and cross-border e-commerce for more information.
13 See “Background” below for more information on missing trader fraud under the current system.
14 At present, an embryonic version of the One Stop Shop is available only to businesses who sell electronic and broadcasting services to consumers based in another EU country.
15 See for more information on EU rules on VAT rates the separate chapter in this Report.
17 In the draft Protocol on Ireland annexed to the Withdrawal Agreement, the EU has proposed that Northern Ireland should stay in the EU’s VAT and excise area to avoid the need for border controls on the island of Ireland itself.
18 The draft Withdrawal Agreement allows the EU to unilaterally suspend parts of the Agreement or any other Agreement with the UK if it considers that the UK has failed to interpret or apply the Agreement correctly.
19 In 2013, the European Commission estimated that VAT on cross border B2B supplies within the EU amounted to around €600 billion (£510 billion) each year and involved between 3.2 and 3.7 million firms. For imports into the EU from non-EU countries (including from the UK when it leaves the EU after Brexit), VAT must still be paid at the border before it can enter the EU’s territory.
20 €1 = £0.88415 or £1 = €1.13103 as at 28 February.
21 Intra-EU missing trader VAT fraud takes place when the company buys goods from another Member State, because purchasing the goods is VAT-free. When selling the goods on domestically, the company receives the entire amount of VAT, which it pockets rather than transferring it to the Treasury. Because the company disappears, this type of fraud is called missing trader fraud. Carousel fraud takes this a step further: the same goods are bought and resold by the fraudster several times via middlemen, and each time the amount of collected VAT increases and the company either disappears or becomes insolvent before the tax authority can collect the accumulated VAT.
22 The Commission’s 2017 proposal would only legislate for the principle of moving to a new system of cross-border VAT for B2B sales, with further detailed draft legislation to follow later in 2018. The Commission estimates that its plans, if adopted by the Member States, would result in a reduction in VAT fraud of €41 billion (£37 billion) and compliance costs for businesses by €1 billion (£890 million) annually.
23 At present, an embryonic version of the One Stop Shop is available only to businesses who sell electronic and broadcasting services to consumers based in another EU country.
24 The Committee set out the substance of the “Quick Fix” proposals in some detail in its Report of 6 December 2017.
25 See the introduction to this Report for more information on the possible implications for UK businesses of leaving the Single EU VAT area. The Committee also discussed these in more detail in its Reports of 6 December 2017 and 24 January 2018.
3 April 2018