The VAT rules and rates can be changed at an EU level, which undermines one of the arguments for leaving the EU, as Richard Asquith explains.
Do you remember one of the rallying calls for Brexit at the 2016 EU referendum concerned the freedom to set VAT rates? The Leave campaign stirred indignation at how the UK could not cut VAT rates on products such as household fuel, feminine hygiene products or e-books. The UK had surrendered the right to offer VAT subsidies on many worthy social and educational causes to unelected bureaucrats in Brussels.
Well, the EU has now beaten the UK to the accolade. In October, EU Finance Ministers agreed to allow states to cut VAT rates on e-books and journals, which adds to new EU-agreed freedoms from 2021 to set reduced or nil VAT rates on most products. Allowing for a likely Brexit transition period of two years, that means all EU countries would gain sovereignty over their VAT rate setting at the same time or before the UK leaves the EU.
Harmonised VAT too wholesome to stomach
Currently under the EU VAT Directive, which member states are required to adopt, countries may only have one standard VAT rate, plus a maximum of two reduced VAT rates, the lowest of which must be 5% or above. States may also have a zero-rate. These reduced rates may only be applied to a prescribed, limited range of goods and services. These are listed in Annex III of the EU VAT Directive and include over 75 rates across the trade bloc. There are some variations to this regime, with a few early-joiner states having rates below 5%.
The rationale for such prescriptive rules and lack of local fiscal freedoms is to ensure countries do not distort the operation of the Single Market by giving uncompetitive tax subsidies to their national providers.
However, these rules have resulted in over 240 exceptions and many seemingly unfair anomalies. This includes the seemingly perverse rule on charging the standard, higher VAT rate on e-books compared to their subsidised printed version. Also, most EU countries must charge full VAT on children’s clothing, while states which joined over fifteen years ago, such as the UK, secured zero-rating.
New reduced VAT freedoms
Under the new EU rules, scheduled for 2021, EU states will have the flexibility to apply reduced VAT rates on any products and services. There will be some broad rules to keep it manageable for businesses providing taxable supplies, including only four VAT rates in each state:
- One standard VAT rate
- Two rates between the standard rate and 5%
- One rate between the reduced rates and 0%
- One rate of 0%.
There will be some prohibited supplies which must be charged at the standard rate, including alcohol, gambling, tobacco, petrol and diesel, weapons, and some household appliances.
Freedom means pleading and complexity
While campaigners for local tax subsidiarity and rate setting may welcome the EU agreement, they should be wary about what comes next. The pressures from the innumerable worthy pressure groups on state governments will become loud, and governments will come under heavy pressure from popularist campaigns.
The freedoms will also create huge complexity for businesses trading across the Single Market. They will have to track a ballooning number of VAT rates – already 75 under the current system – and national product and service variations. This will demand heavy investment in tax advice and accounting system upgrades. Or, instead, prove enough of an incentive to stop trading in other states, undermining the whole single market objective of harmonised VAT.
It may be that the EU states and Brexit campaigners alike will soon be longing for the days they could blame Brussels for its unfair VAT system.
About Richard Asquith
Richard Asquith is the VP of Global Indirect Tax at Avalara, a global transaction tax technology company. He leads Avalara’s outsourced international VAT compliance service. Richard originally qualified at KPMG in the UK, and then spent over ten years with EY in Hungary, Russia and France.