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VAT Gap: EU countries lost an estimate total of €152 billion in Value-Added Tax (VAT) in 2015, according to a new study by the European Commission, showing urgent need for VAT reform.

The European Commission launched on 4th October 2017 plans for the largest reform of VAT rules in the EU in a quarter of a century. The reboot will improve and modernize the system for governments and businesses. Overall, over €150 billion of VAT each year is lost; which means that Member States lose revenues that could be used for schools, roads and health care. Of these, it is estimated that about €50 billion – or €100 per EU citizen every year – is due to cross-border VAT fraud. This money can be used to finance criminal organizations, including terrorism. It is estimated that this amount will be reduced by 80% thanks to the proposed reform.

The VAT reform proposal would also make the system more robust and easier to use for businesses. The Commission wants a VAT system that helps European companies derive all the benefits of the single market and compete in global markets. Companies that carry out cross-border transactions currently suffer a higher compliance cost of 11% than those which trade on a national level only. Simplification and modernization of VAT should reduce these costs by around € 1 billion.

A definitive VAT system that works for the single market has been a longstanding commitment of the European Commission. The 2016 VAT Action Plan explained in detail the need to reach a single, simplified and anti-fraud European VAT area.

With today’s package, the Commission proposes to fundamentally change the current VAT system by taxing sales of goods from one EU country to another in the same way as goods are sold within individual Member States. This will create a new and definitive VAT system for the EU.

The ‘VAT Gap’, which is the overall difference between the expected VAT revenue and the amount actually collected, again demonstrates the need for serious reform so that Member States can make full use of VAT revenues for their budgets. While the collection of VAT revenues shows some signs of improvement, the missing amounts remain unacceptably high. The report comes just ahead of proposals by the Commission to overhaul the VAT system

It will be sought an agreement on four fundamental principles, or “cornerstones” of a new definitive single EU VAT area:

  • Tackling fraud: VAT will now be charged on cross-border trade between businesses. Currently, this type of trade is exempt from VAT, providing an easy loophole for unscrupulous companies to collect VAT and then vanish without remitting the money to the government.
  • One Stop Shop: It will be simpler for companies that sell cross-border to deal with their VAT obligations thanks to a “One Stop Shop”. Traders will be able to make declarations and payments using a single online portal in their own language and according to the same rules and administrative templates as in their home country. Member States will then pay the VAT to each other directly, as is already the case for all sales of e-services.
  • Greater consistency: A move to the principle of “destination” whereby the final amount of VAT is always paid to the Member State of the final consumer and charged at the rate of that Member State. This has been a long-standing commitment of the European Commission, supported by Member States. It is already in place for sales of e-services.
  • Less red tape: Simplification of invoicing rules, allowing sellers to prepare invoices according to the rules of their own country even when trading across borders. Companies will no longer have to prepare a list of cross-border transactions for their tax authority (the so-called “recapitulative statement”).

Today’s proposal also introduces the notion of a Certified Taxable Person – a category of trusted business that will benefit from much simpler and time-saving rules. Four “quick fixes” have also been proposed, to come into force by 2019. These short-term measures were explicitly requested by Member States to improve the day-to-day functioning of the current VAT system until the definitive regime has been fully agreed and implemented.

Next Steps

This legislative proposal will be sent to the Member States in the Council for agreement and to the European Parliament for consultation. The Commission will follow this initiative in 2018 with a detailed legal proposal to amend the so-called “VAT Directive” at technical level, so that the definitive VAT regime proposed today can be smoothly implemented.

Background

The common Value-Added Tax (VAT) system plays an important role in Europe’s Single Market. The first VAT Directive dates from 1967. It was originally put in place to do away with turnover taxes which distorted competition and hindered the free movement of goods and to remove fiscal check and formalities at internal borders. VAT is a major and growing source of revenue in the EU, raising over €1 trillion in 2015, corresponding to 7% of EU GDP. One of the EU’s own resources is also based on VAT. As a consumption tax, it is one of the most growth-friendly forms of taxation.

Despite many reforms, the VAT system has been unable to keep pace with the challenge of today’s global, digital and mobile economy. The current VAT system dates from 1993 and was intended to be a transitional system. It is fragmented and overly complex for the growing number of businesses operating cross-border and leaves the door open to fraud: domestic and cross-border transactions are treated differently and goods or services can be brought free of VAT within the Single Market.

The Commission has consistently pressed for the reform of the VAT system. For companies trading across the EU, borders are still a fact of daily life when it comes to VAT. Current VAT rules are one of the last areas of EU law not in line with the principles underpinning the Single Market.

While average EU figures are improving, individual VAT collection performances vary significantly amongst Member States. The largest VAT Gaps were reported in Romania (37.2%), Slovakia (29.4%) and Greece (28.3 %). The smallest gaps were observed in Spain (3.5%) and Croatia (3.9 %). In absolute terms, the highest VAT Gap of €35 billion was in Italy. The VAT Gap decreased in most Member States, with the strongest improvements in Malta, Romania and Spain. Seven Member States saw small increases: Belgium, Denmark, Ireland, Greece, Luxembourg, Finland and the UK.

This October, the European Commission will set out proposals for the most far-reaching update to the EU’s VAT rules in 25 years. VAT fraud should become easier to tackle and VAT collection made more efficient. Recent media reports have also linked large-scale VAT fraud with organized crime including terrorism. Solutions to this problem can only be found by Member States working together.

While Member States have already made efforts to reduce the VAT Gap, modernizing the VAT system and adapting it to the challenges posed by massive fraud is the best way to secure the future of the single market. The reform of the current VAT system should also help the development of the digital single market and complement the agenda set by the Commission to achieve a fairer and more efficient tax system in the EU.

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