Tearing up the VAT Directive: Reduced rates reform

The VAT Directive: Light reading for a Sunday afternoon?

One of the EU's greatest – if less talked-about – achievements has been the harmonisation of tax systems, particularly indirect tax systems, and the simplicity that brings for businesses and consumers not just in the EU, but around the world.

What would be 28 separate tax systems with wildly different rates, regulations and flaws is, for VAT at least, held together by systems such as the VAT Directive, and backed up by the European Court of Justice (ECJ).

To risk that simplicity, then, would be a daring move. More reduced rates make things more complicated and most economists don't even believe they are helpful in moulding social policy. Add to this the fact that VAT Directive modifications require unanimous approval from all member states and the size of the challenge, and of the risk, becomes clear. But it is a move which Donato Raponi, the head of the European Commission's (EC's) VAT unit, believes can be pulled off.

Speaking exclusively to International Tax Review, he outlined plans to allow member states to set their own reduced rates, possibly even zero rates, and said that the EU will abandon the 15% minimum VAT rate from 2016.

"We are reflecting how we can give more flexibility, full flexibility," says Raponi. "Why impede one member state from applying a reduced rate? It's national policy."

"The standard rate and the minimum standard rate are valid until the end of this year," he adds. "We have to make a proposal [if we want] to prolong this minimum standard rate [and] we will not do it. We are not prolonging this minimum standard rate."

Raponi's CV reads well: he has had five years as head of the VAT unit, before which he headed up the EC's administrative cooperation division, and the excise duties, energy, transport and environmental division.

Almost two decades of experience in the Commission gives him the know-how it takes to get major changes – like the 2015 VAT place of supply changes and their mini one-stop shop (MOSS) crutch – through. Though the changes were conceived before Raponi took the VAT unit job, it was he who got them over the line.

"The destination principle means we no longer need to have more approximation of rates, because approximation of rates is one of the conditions for implementing the origin-based principle"

And it is the destination principle which makes the removal of reduced rate regulations possible.

"The destination principle… means we don't need any more to have more approximation of rates, because approximation of rates is one of the conditions for implementing the origin-based principle," says Raponi.

The destination principle is turning on its head the way most VAT in the EU still works. Under the old system, if a company sells a good or service cross-border to a consumer, VAT is paid in the jurisdiction where it is based.

Under the destination principle, the company is charged VAT in the jurisdiction where the consumer is based – undoing in one fell swoop the strategy used by multinationals including but certainly not limited to, Amazon of basing their operations out of low-VAT jurisdictions such as Luxembourg.

Selling the 2015 changes to Luxembourg was difficult – its approval was necessary for the destination principle to become a reality – and the country will benefit from transitional 'parachute payments' of around €1.1 billion ($1.2 billion) during the next four years.

There are, obviously, concerns about Raponi's vision, and a debate is sure to kick off in earnest when the plans are formally presented in September – though the proposals are already being looked on favourably by the Commission's leadership.

One person who is early to the debate is EY's global head of indirect tax, Gijsbert Bulk.

"There's a limited number of reduced rates – that's a political compromise," he says. "At the time [when EU VAT rules were being written] the member states said 'look, all these reduced rates cause so much confusion' so there were good reasons for deciding that, and limiting them."

"I think there's going to be a lot of political debate, which will be needed within the European Union to come to agreement on this issue," says Bulk. "I also feel that if that leads to a situation where it's a free-for-all and every member state has the freedom to make its own choices, then that is not necessarily in the interest of business."

"Mr Raponi mentions – and rightly so – that with today's technology, with databases and all of these line items you can describe and further definitions you may be able to capture some of the interpretation problems. But, still, for businesses it could become very complex, I think."

The technological glue which makes the rollout of the destination principle possible – it is expected that the cross-border sale of some goods will be added to the list of consumer-country-taxable items in the next year or two – is the MOSS system.

The MOSS system is only an aide to the destination principle. Businesses need not use it; however, by crunching the VAT returns for all 28 member states into just one, quarterly return, it certainly makes the lives of in-house tax teams much easier.

"From what I'm hearing and seeing, the take-up [of MOSS] from a technology standpoint and also from a tax-technical standpoint, has been good," says Bulk. "Those that are in it, those that apply it, we don't come across many issues or complaints."

"If it’s a free-for-all and every member state has the freedom to make its own choices, then that is not necessarily in the interest of business"

"Whether we are already in a situation where we have full or 90% compliance? That's an open question to me, because there may well be some traders in electronically-supplied services, which have not registered in some member states."

What the Commission must be sure to pick up on with this next round of changes is how quickly online marketplaces can change. From the destination principle changes being discussed to being implemented, the digital landscape and model for trading cross-border online had changed beyond recognition.

While in 2008, when the changes were being formulated, most e-services, telecommunications and broadcasting (the three areas included in the 2015 changes) were carried out by multinationals, by 2015 they were also supplied by a vast array of sole traders and microbusinesses.

It is these small businesses which have been negatively impacted by the 2015 changes. The cost of compliance is completely disproportionate – and far higher than the amounts tax authorities can hope to extract from them – but the lack of a threshold, under which businesses would pay VAT only in their home countries, has left tens of thousands facing a choice between closing their businesses or being non-compliant.

Such is the scale of the problem for small businesses that EU Commissioner for the digital single market, Andrus Ansip, has pledged a review of the changes, and that a threshold will be implemented as soon as possible lest, as campaigners have warned, the digital single market be left dead in the water.

Raponi, for his part, had wanted a threshold implemented from the start – it was the member states themselves which turned this option down.

"The idea of having a minimum threshold was discussed in Council at the time these rules were negotiated but this was firmly rejected by member states," said Pierre Moscovici, European Commissioner for Economic and Financial Affairs, Taxation and Customs, in January.

While Richard Asquith, vice president of global tax at tax compliance software company Avalara, believes that "member states will most likely resist the EU Parliament's call for a threshold as this would undermine their tax revenues".

Bulk believes that a high rate of compliance with MOSS, or at least with the 2015 changes and any extension to them, is necessary before radical changes to the VAT Directive are pursued.

"In what Mr Raponi indicates, it seems that his view is that you can work with these reduced rates if you apply the destination principle and if you have the mini one-stop shop, but I think we need to make some extra progress first and step up and increase compliance."

"These developments go very fast, but I think we have to accept that in tax and in VAT we sometimes lag behind a little bit. But it does make sense to think things through a little, and take some time to do so. That is something that every legislator knows," Bulk adds.

According to Bulk, there are three lenses through which the proposed changes must be viewed before assessing the benefits or detriments to businesses – the political, legislative and economic lenses.

Of the political lens, he says: "in the first place it's probably desirable from a social perspective that foodstuffs fall within the reduced rate or even a zero rate. But there's also an operational or legal lens through which you could look and ask what exactly is a 'foodstuff'?"

"There's also a third lens, the economic lens, because if you ask this question to economists they will say that, in economic terms, reduced rates are not a very good instrument to stimulate demand or to subsidise goods and services."

In Bulk's native Netherlands, for example, there is a reduced rate levied on theatrical productions, plays, musicals and more. The idea is to make such cultural events accessible to everybody, so that those on lower pay can afford to go to the theatre.

In reality, however, it is essentially a tax break for the kind of people who already attend such events – predominantly the wealthy. Even reduced rates on food are economically flawed because people with higher incomes spend more on food.

"There's no perfect answer here, and that's why what's been said here is part of a political debate, and as far as I'm concerned it's only the start of the political debate," says Bulk.

It certainly feels like the political debate has started in the room already, as Bulk and I move back and forth across various examples of how reduced rates do or do not work well.

"These developments go very fast, but I think we have to accept that in tax and in VAT we sometimes lag behind a little bit"

My eyes move from the impressive view of Amsterdam from EY's Cross Towers building toward Bulk, then down to the copy of the VAT Directive which sits next to him.

It is a small, A5-printed book which one might finish in an afternoon were it a novella, and is the very document which the changes we are discussing would tear up, or at the very least force a substantial rewrite of.

"All I know is that politicians sometimes expect too much of reduced rates," says Bulk. "Maybe if the EU gets certain things in return for that [allowing greater reduced rate flexibility], such as other VAT reforms that they want and the further introduction of the destination principle, of the mini one-stop shop, maybe that's on Mr Raponi's mind."

Whatever is on Raponi's mind, businesses find themselves at a fascinating junction in the development of European tax – though another piece of uncertainty to throw onto the pile created by BEPS is not likely have been on anybody's wish lists.

Taxpayers can take solace, however, from the fact the reforms have clearly been planned by Raponi since his championing of the destination principle, and fit into a wider blueprint designed to make Europe the global best practice leader in the way VAT is applied.

Raponi's handling of the EU's cross-border rulings project pilot, which allows companies to attain advance rulings on cross-border VAT, has been a resounding success, and in April it was extended until 2016.

Once the flaws in the MOSS system are ironed out and the destination principle is being applied to a wider basket of goods and services, the reduced rate changes will be far easier to implement, and ensure a more equitable spread of VAT across the EU in today's digital economy.

All we can do now, is wait for the debate to start – and maybe cancel that order for a copy of the VAT Directive as next weekend's light reading.

EU VAT changes timeline 2008 – VAT changes agreed upon by all 28 member states. European Commission recommends a threshold, but member states reject the notion. 2012 (December) – Implementing regulation to develop and clarify the rules is published by the Commission. 2013 (June) – Regulation is endorsed by ECOFIN in record time. 2014 – Most tax authorities across Europe begin to publicise details of the changes and encourage taxpayers to use the mini one-stop shop (MOSS). 2015 (January 1) – Regulations are implemented. Businesses selling e-services, broadcasting and telecommunications cross-border now have to pay VAT in the country where their consumer is based, rather than to the country where they are established. Cross-border selling is no longer covered by domestic thresholds. 2015 (late January) – Implementation of the system is going well, with minimal IT problems. European Commissioner for Economic and Financial Affairs, Taxation and Customs Pierre Moscovici rules out adding a threshold to the regulations. 2015 (early June) – Figures on the amount of tax collected through the MOSS system are released. Donato Raponi, head of the VAT Unit at the European Union, expects around 80% of the tax take to come from large multinationals. 2015 (July) – Donato Raponi discusses plans to use the destination principle, hand-in-hand with MOSS, to increase flexibility for governments in setting VAT rates 2015 (September 7 – 9) – Conference in Dublin, Ireland with representatives of member states, Norway, the OECD and the Expert Group on the Taxation of the Digital Economy all present. 2016 – Wheels will be in motion for extra services and some goods to be taxed according to the destination principle, and added to the MOSS system. Expect plenty of debate around the use of reduced rates.