REFORM
OF THE VALUE ADDED TAX SYSTEM
232. We discussed above[150]
the minor proposals which the Commission has made for amendments
to the current system of VAT. But the Commission has also published
a Communication[151]
which, although it makes no legislative proposals, floats ideas
for fundamental changes to the VAT régime.
233. The current system of VAT is destination-based.
For goods which are to be exported, no tax is paid in the Member
State of origin, but VAT is imposed in the importing country.
Tax can therefore be fraudulently evaded by diverting goods which
have been zero-rated for export back into the domestic shadow
economy. The abolition in 1993 of frontier formalities for goods
traded across internal EC borders, as part of the completion of
the Single Market, was bound to increase the scope for such fraud.
The Commission therefore made proposals in 1987[152]
which would have ended zero-rating on exports within the EC, introducing
instead a VAT system which would have taxed goods and services
in the same way whether they were destined for consumption domestically
or in another Member State. Thus sales to other Member States
would have become subject in the exporting Member State to VAT,
credit for which would have been given by the authorities in the
importing Member State. The Commission refers to this as the "origin-based
system".
234. In the event, these proposals were not agreed;
instead the zero-rating arrangements were retained, with some
modifications. However, the danger of increased fraud as a result
of the abolition of checks at borders was recognised. This system
was therefore explicitly designated the "transitional
régime", and a commitment was added to the Sixth
VAT Directive that it should be replaced by a "definitive
régime" which would be based on taxation in the
country of origin. The Commission was supposed to submit proposals
for such a system by the end of 1994, and it was generally expected
that they would be based on the same principles as the Commission's
former (1987) proposals.
235. Before any specific new proposals had come forward,
however, the October 1994 ECOFIN Council laid down the ambitious
criteria which any new régime would have to satisfy. It
would have to be demonstrably better than the present system,
and in particular to represent a fundamental simplification of
the system with no distortion of competition; reduce burdens on
businesses and administrations; ensure that the right revenue
reached the right Exchequer at the right time; and create no increased
opportunity for fraud. The UK Government had its own fifth condition,
the ability to maintain those zero rates in force at the time
the definitive system was adopted.
236. The Commission did not consider that a system
based on the 1987 proposals could meet these objectives. It therefore
produced in July 1996 a Communication on A work programme for
progression to a new common system of VAT for the Single Market[153],
exploring ideas for a definitive régime. Commissioner Monti
left us in no doubt of the Commission's ambitions when he said
that the proposal was "designed both to modernise and simplify
the existing VAT system and in due course to transform it into
a real common system with a single place of taxation[154]
for a company in its country of origin" (Q 229). The essential
characteristic of the new régime would be that each business
in the EU would have a single place of registration, taxation
and deduction of input tax. This would mean the elimination of
any distinction between domestic and cross-border transactions
within the Community: all the Community-wide business of a firm
would be taxed on the basis of the legislation of the country
in which the firm was registered. There would be a new mechanism
for redistributing VAT revenues, on the basis of statistical data
on consumption rather than declarations by businesses. Commissioner
Monti pointed out that unless some system of this kind was introduced,
as it had been successfully in Canada, there would have to be
a complex clearing system which would negate the potential benefit
to business of having to complete only one set of returns (Q 236).
237. HM Customs and Excise considered that the advantages
of the single place of taxation might be over-rated, as far as
small businesses were concerned. They told us that of some 1.6-1.7
million businesses registered for VAT in the United Kingdom, only
some 70,000-80,000 were involved in importing or exporting (Q
362). And even if a United Kingdom firm was engaged in cross-border
trading, it would under the present system have to register and
account for VAT in another Member State only if it was selling
goods direct to individuals in that country by mail order or from
a shop, not if it was simply exporting goods. For services, the
normal place of supply is where the supplier is established[155],
so cross-border provision should not create VAT complications.
And even where there might be liability for VAT in another Member
State, only firms exceeding the turnover threshold would have
to register. It follows that it is only larger businesses with
multinational operations which are likely at present to be required
to register in more than one Member State, and which would therefore
benefit from a new system. Smaller United Kingdom businesses might
actually suffer if the paperwork became more complex (QQ 352-353).
238. HM Customs and Excise do not deny the danger
of fraud arising from the zero-rating of exports. But Martin Brown
suggested that changing to the origin system would simply change
the nature of the fraud, with importers claiming VAT refunds when
no goods had changed hands (Q 358). Under either system, evasion
could only be overcome through mutual assistance, using spot audits
checked with other Member States through the VAT Information Exchange
System (Q 359). The risk of fraud would not be removed by the
single place of taxation system; it would now no longer relate
specifically to export transactions, but would be liable to arise
for any trades between companies registered for VAT in different
Member States. Moreover, HM Customs and Excise had doubts about
whether the proposed system of revenue allocation could work,
given the difference in Member States' statistical systems and
tax collection systems (Q 353).
239. We considered whether a common VAT system
would necessarily imply common rates of VAT. The Commission
Communication says that the new system would require the Member
States "to embark on a legislative harmonisation process
which is more extensive than has ever before been contemplated
in the field of indirect taxation … in order to restore the
economic efficiency of VAT as a system of taxation"[156].
It claims that "the introduction of a single [standard] rate
would provide a perfect solution avoiding any tax-related distortion
of competition and, above all, ensuring that the tax is applied
simply and uniformly throughout the Union[157]
- nevertheless, an approximation within a band could prove sufficient.
The decision setting the rate should be a political one and should
take account of the general need for sufficient revenue, the need
to share the burden among the main types of statutory contributions
and charges (direct taxation, indirect taxation, social contributions)
and the thrust of medium-term tax policy". Harmonisation
of the number and scope of reduced rates "is necessary from
a purely technical standpoint … The Commission remains convinced
that only a small number of rates is compatible with the objective
of simplifying the tax"[158].
And exemptions and other derogations should be limited in order
to ensure as wide a base as possible for the tax.
240. In his evidence to us, Commissioner Monti was
clear that, with a single place of taxation, "a higher degree
of convergence of rates" would be needed (Q 235), but he
did not specify whether he thought that rates or bases would have
to be identical. HM Customs and Excise explained (Q 349) that,
under the present arrangements, Member States could opt for two
reduced rates[159],
but in addition they were allowed to continue to use lower (or
zero) rates that were in operation before the Directive came into
force. It was under these provisions that the United Kingdom continued
to zero-rate goods like public transport, young children's clothing,
food, books and newspapers. Some other Member States had a zero
rate, and some had rates between zero and 5 per cent for various
products.
241. The Irish Government takes the view that a certain
initial degree of VAT approximation was essential for the Single
Market to function; but it considers that this level was largely
achieved by 1993, and that whereas in general the present system
works well, plans for a common VAT system "would most likely
create problems". It sees strong barriers to political agreement
on a new system (p 176). The Chairman of the CBI Tax Committee
believes that "a single [VAT] taxation base for ease of registration
and compliance requirements is the sort of thing that the Single
Market should facilitate", though "that does not necessarily
mean that the whole European system must be totally harmonised
and made more rigid" (Q 326). But he recognised that with
a single place of taxation there would have to be "a reasonable
approximation of rules", and measures to stop firms from
exploiting differences in rates (Q 330).
242. Sectors with special interests have drawn our
attention to their concerns. The Food and Drink Federation claims
that abandoning the zero rate of VAT on basic foodstuffs "would
threaten United Kingdom economic stability by adding to inflation,
… would hit poorer households particularly hard, [and] would
cause considerable damage to the industry's competitiveness";
it considers that "it is quite possible to simplify the VAT
system without threatening the zero rate" (pp 173-174). The
Newspaper Society asks us to "recommend the avoidance of
the harmful consequences of harmonisation, through preservation
of the zero rate on the printed word", arguing that such
matters should remain the prerogative of Member States (pp 179-180).
The House Builders Federation tells us that: "Across Europe
the industry believes that VAT harmonisation on housing would
damage employment in construction and reduce access to housing"[160].
243. Asked whether he thought further harmonisation
of VAT was essential for the success of the Single Market, Martin
Brown of HM Customs and Excise replied: "We have got a Single
Market that works at the moment". The big step forward had
been getting rid of frontier documentation in 1993: even the Commission
accepted that the transitional system "has, on the whole,
functioned satisfactorily". Further minor adjustments would
be needed to deal with inconsistencies, "but not harmonisation
of rates, not harmonisation of coverage according to the grand
vision of the Commission's Communication" (Q 354).
244. We have considered
whether we should welcome or deplore the apparent loss of momentum
on the issue of VAT. There seemed to be two main arguments for
change.
245. First, the single
place of taxation system is presented as having significant advantages
for businesses - in particular for small firms wishing to export,
which would have to grapple with the bureaucracy of only one Member
State. We were initially attracted to it for this reason, but
we then found that in fact small firms would benefit only in rare
circumstances, and the proposed system for redistributing revenue
might well lead to more rather than less bureaucracy.
246. The other main reason
for considering a new VAT system would be if it offered a real
likelihood of reducing the scope for fraud on goods traded between
Member States. This is a matter of considerable concern to us,
particularly in the context of enlargement. Unfortunately, it
does not seem that changing the VAT treatment of traded goods
would eliminate the scope for fraud. We note that changing from
the present destination-based system to the origin-based system
proposed by the Commission in 1987 would merely have changed the
method of operation of fraudsters, and we fear that the same might
be true of the single place of taxation system.
247. Moreover, we
note other major drawbacks to the single place of taxation system.
Without considerable convergence of national VAT bases and rates,
businesses would have an interest in establishing themselves where
VAT rates were lowest (because they could then sell their products
more cheaply all over the European Union). This would erode overall
VAT revenues. In addition, we think that the concentration of
business registration in low tax Member States would create enforcement
problems, because enforcement is likely to be more difficult
if revenue authorities have to tax business activities which are
occurring well outside their territory.
248.
We conclude that there seems to be no compelling argument for
a completely new system of VAT. A change to a system based on
a single place of taxation would impose comprehensive new restrictions
on the VAT policies of Member States, as far as we can see to
no particular benefit. We judge that if the Commission were to
bring forward such a proposal it would fail the test of proportionality.
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