Tax

The European Commission’s radical proposals for a Europe-wide VAT system has sent ripples of concern through EU governments and businesses.

The proposals remove each government’s responsibility for control and collection of the tax. They make member states collectively responsible, with each then receiving a share of a cumulative VAT “pot”. If implemented, businesses would face yet another review of their accounting systems and potentially incur costs in making the necessary adjustments.

Until 1993, when the transitional VAT system was introduced, trade between EU member states was no different to trade with countries outside the EU. VAT and import duty, where applicable, were payable by the importer in the country where the goods were consumed. Under the old system, administration was costly and burdensome and was a barrier to intra-Union trade.

The transitional system is based on the “destination” principal, with tax generally paid and collected in the member state where the goods or services are finally consumed. It was designed to allow the free movement of goods by removing all borders between states.

But the transitional system still gives individual EU countries a great deal of administrative flexibility in respect of VAT. As many businesses have found over the past three years, in order to operate in the EU it has been necessary to be able to understand and implement the VAT legislation of fifteen different member states as well. As a result, there has been an additional cost imposed on businesses, not only in appointing and maintaining fiscal representatives in various member states, but in changing accounting systems and training staff to enable the business to continue trading within the EU. The extra cost to business of these intra-Union transactions has been estimated to be in the region of five times that of a domestic supply.

So how far do the new proposals go towards changing this inequitable position? Experience gained from the transitional system has led the Commission to fundamentally redefine the essential characteristics, and hence the objectives, of the single market. Apart from eliminating checks at EU borders, which the transitional system has gone some way towards achieving, there must be neutral taxation of trade within and between member states.

Equal treatment of all transactions within the EU must be achieved and, not least, member states tax revenues must be maintained.

Initially suggested in 1989, the proposed “origin system” has made little progress until now. In summary, the origin system taxes all the transactions of a business in only one member state. Consequently, the right to deduct VAT will also be exercised exclusively in that one member state. This should make it as simple and cost effective to trade with business or individuals in another member state, as it is to trade in the domestic market, that is, the EU will effectively become a single market.

As a consequence of eliminating distinctions between domestic and intra-Union transactions, there must be extensive harmonisation of VAT rates across Europe. Without harmonisation and with few other cross-border restrictions, we will inevitably shop around for the lowest VAT rate. The Commission is very aware that the VAT rate is one of only many political issues which it must resolve before any new system is implemented. In looking at the rates harmonisation issue alone, consideration will have to be given to the use of the VAT exemptions and the zero rate. While the Commission remains convinced that only a small number of rates is compatible with the objective of a simplified tax system, the UK may have to contemplate the loss of its zero rate altogether.

Another issue to be considered by the Commission is the reallocation of revenues displaced by the implementation of the origin system. It has already been suggested by the Commission that reallocation of this revenue should not be based on the figures taken from VAT returns as this would necessitate the maintenance, by suppliers, of records on cross-border transactions, just as required now. The Commission believes it is possible to establish yearly consumption figures from the statistics provided in each member state’s national accounts and VAT will then be reallocated to member states from the pot based on these consumption figures.

Finally, one of the problems which has plagued businesses involved in EU trade since the introduction of the transitional system is the varying interpretation of VAT legislation between member states. This has led to confusion, frustration and inevitable costs for countless businesses.

The Commission has acknowledged this is an issue which it must address.

It has stated its intention to resolve this by proposing the Commission’s VAT committee becomes a regulatory committee with powers to implement acts adopted by the Council.

The proposals are certainly radical, but the Commission has a long way to go before any of them can be implemented. At the end of 1995 the Commission put forward proposals for setting maximum rates of VAT in the EU, but in light of the proposed changes it has been decided to withdraw them.

The question of rates is a political one which must take into consideration the tax policies, direct tax rates and the required level of revenue of each member state. It seems unlikely to be easily or quickly resolved.

It is also essential that member states’ administrations cooperate with each other and have confidence in each others ability to administer the tax. This is not an issue politicians can resolve easily. It will take time, patience and undoubtedly some strict new legislation on administration will have to be implemented by every state in exactly the same way, with large and common penalties for non-compliance.

With a timetable already in place, the next three years will see a series of proposals covering all relevant issues to ensure implementation of the new system. The final proposals for harmonisation of VAT are due to be presented in 1999. The Commission is aware that significant changes will take time to implement and the implementation date is thought to be, at the earliest, sometime in 2001. However, finance directors and governments need to consider the impact of the proposals on their businesses now. Although the implementation date may be into the next millennium, it is not too early to influence the Commission’s proposals.

Elaine Bell is a member of the international VAT group at Coopers & Lybrand.