Nick Hart, Senior Director, Indirect Taxes, Radius
Ever mindful of the increasing tax gap created by loss of tax revenues due to noncompliant businesses operating in the online market and to fraudsters, the European Union is undertaking an overhaul of value-added tax (VAT) regulations. The combined measures represent one of the most substantial reforms of the system since the single market was created in 1993.
The VAT system created in 1993 was labeled “transitional” and was never intended to be permanent. In the digital age, with high volumes of goods and services moving rapidly among member states, it has become anachronistic. The European Commission has been pressing for reform for years, and presented its latest proposals in October 2017.
The proposed reforms seek to cut red tape, and in particular make it easier for online businesses to declare and pay VAT for goods and services sold across borders to EU-based buyers.
The VAT Gap and Cross-Border Loopholes
The European Commission estimates that EU countries collectively lose 152 billion euros each year in uncollected VAT. This is the so-called “VAT gap,” or the difference between what is presumed due and what is collected. As the European Commission’s VAT-loss estimate suggests, the tax is a critical source of tax revenue for EU member states. In 2015, VAT revenues amounted over 1 trillion euros, or 7 percent of the EU’s GDP.
Under the current system, many types of transactions between parties in different member states are not subject to VAT (or are subject to a zero percent VAT rate). Each of the 28 members has its own VAT rates and compliance processes.
Unscrupulous organizations have for many years exploited the system and developed ways to put the VAT they’ve collected into their own pockets. Since, for example, the system does not generally levy VAT on cross-border transactions between businesses, criminals operating through a company have been able to purchase goods from a different member state VAT-free, sell the goods in another country while charging VAT to the purchasers and then pocket that tax rather than remitting it to the government.
Pierre Moscovici, Commissioner for Economic and Financial Affairs, declared in October, “Criminals and possibly terrorists have been exploiting … loopholes for too long…This anachronistic system based on national borders must end!”
The Basics of the EU’s New Proposal
In addition to combatting fraud, the European Commission’s proposed reforms seek to simplify the EU’s VAT regime and make it more consistent across member states. To ease the transition, EU authorities will initially “focus only on transactions in goods.” The proposal does not seek to create a unified EU VAT rate at this time, but leaves the 28 member states’ rates in place.
To help ease the compliance burden, the proposal sets up a “One Stop Shop” — an online portal where businesses make declarations and payments in their own language using the same rules and administrative templates their home country has. Member states would then pay VAT to each other directly. A similar system is already in place for the payment of VAT-related electronic services.
The proposal also simplifies invoicing, ending the requirement to prepare a list of cross-border transactions for tax authorities (the “recapitulative statement”).
It also creates a new category of trusted businesses known as “Certified Taxable Persons.” Companies that meet the criteria will be rewarded with even simpler VAT-compliance rules.
It’s important to emphasize that the European Commission’s October proposals — which are part of the Action Plan on VAT first adopted in April 2016 — apply largely to business-to-business (B2B) transactions, so “EU consumers will not be directly affected.” Other elements of the Action Plan, however, will directly impact consumers. If all measures that the EU intends to implement are successful in closing the VAT gap, then individuals will benefit from increases in public expenditures. This will be made possible by member states collecting more VAT revenues through simplified, fraud-resistant systems.
Reforms could also lead to increased trading within the EU. Currently, businesses trading with other member states have compliance costs 11 percent higher than those that sell only within their own country. With a simplified system, competition could increase in cross-border business-to-business sales.
It’s worth noting that the EU’s aim of increasing participation and transparency echoes a recently implemented UK VAT measure that requires “online marketplaces to display a valid VAT number for all their sellers using their platform.” The measure looks to eliminate the widespread practice of non-UK companies selling goods online in the UK without registering and paying VAT. Under the UK measure, large online marketplaces such as Amazon are jointly liable with their third-party sellers for any unpaid VAT.
The message from both UK and EU legislators is clear: Cross-border VAT loopholes for businesses won’t be around much longer and noncompliant online traders are under particular scrutiny.
The European Commission’s proposal will be sent to the European Parliament and the Council of Ministers for approval. Member states must approve it unanimously to proceed.
Then a transitional agreement will be implemented. That is scheduled to happen this year. After further changes as necessary, a definitive new VAT regime should be implemented in 2022.