Value-added tax (VAT), a key source of revenue for European governments, has proven to be a great mechanism to collect tax. However, it should be undone from its costly complexities. As soon as we have passed the phase of short-term measures, the EU should push for an accelerated streamlining of the VAT system, with the focus on generating income as quickly as possible.
Countering the impact of the Covid-19 pandemic is costing governments immense amounts of money. They are spending like never before to fill the holes in corporate and household budgets. At the same time, the shutdown of the economy has turned off the tap on much of governments’ tax income. In many countries the budget deficit, the gap between a government’s income and its expenditure, is reaching levels not seen before in peacetime.
In Europe, but also in other countries that over the years have adopted a VAT system, VAT is used as a fiscal tool to support businesses. Extensions of deadlines, rate cuts, concessionary schemes: governments are going out of their way to support the stuttering economies not just to help businesses to survive but also to kick-start the spending that has slowed down due to the crisis. In the current timeframe even those who normally favor a free-market policy now support an interventionist approach. The Richard Nixon quote “We are all Keynesians now” immediately springs to mind.
Expectations for the Near Future
For the short-term it is clear that a holding pattern will not be enough. Governments will continue to look into options on how they can empower businesses to fight the Covid-19 crisis. Businesses are therefore recommended to actively check in with influencers and sounding boards, such as industry organizations and advisers, to win VAT reliefs.
Apart from the implementation and extension of temporary measures we may also see that new planned legislation may be delayed. A very recent example is the introduction of the new EU VAT rules for e-commerce, that were supposed to kick in on January 1, 2021. The European Commission now has proposed to postpone the entry into application of the VAT e-commerce package by six months, giving member states and businesses more time to prepare for the new rules.
Timewise the introduction may indeed not be ideal, but somehow the postponement feels a little ironic. The package has been presented as a huge support to both member states (that are meant to gain 7 billion euros ($7.5 billion) a year extra) and businesses (that will benefit from a substantial reduction in cross-border VAT compliance costs).
VAT rate cuts may well be a next step in the battle against the economic downturn. These will probably not be enacted before summer as we have to wait until people are again allowed outside on the high streets without too many restrictions: Otherwise the cuts would miss effect.
Building a Better VAT System
The reliefs may continue for some time, but at some point the historic budget shortfalls of governments need to be addressed (and not just through rate increases). The Covid-19 crisis drives momentum toward the EU, that has been looking for a while now into options to improve the VAT system. Where normally the political landscape (EU unanimity is a real blocker) complicates the decision making, now the time might be right to push for an accelerated streamlining of the VAT system.
Over the years VAT has proven to be a great mechanism to collect tax. A clear critical success factor is that VAT can bring in a great deal of a government’s income with little administrative cost and without as much need for intrusive enforcement. Also, VAT is more resistant to economic shocks than other taxes. In fact, VAT has often been imposed as “crisis tax.” At the time of the American Civil War an excise system (basically a sort of VAT) was introduced to finance the outgoings. In the following century, European countries would adopt a VAT system to cover the immense spending on the First World War and to revive the devastated economies.
Since the late 1960s VAT has grown as a stable source of income for most countries around the globe. The neutrality properties, demonstrated in Europe, have encouraged the spread of VAT around the world. Apart from the U.S., nearly every country around the globe now has some sort of VAT system. The current crisis could, however, prompt the U.S. to start looking (again, as recent calls were silenced) into the introduction of VAT.
Three Fixes to Make VAT Immediately More Efficient
Despite its proven success, the EU VAT system in its current set-up has various features causing costly inefficiency issues. There are a few fixes that would immediately strengthen the system as a tax collecting mechanism, which is so needed now, and stop tax authorities and taxpayers getting distracted over details:
1. Single VAT Rate
Although VAT is charged throughout the EU, each EU member state is responsible for setting its own rates. The rate depends on the product or service involved in the transaction. Each EU country has a standard rate which applies to the supply of most goods and services. One or two reduced rates may be applied to supply of specific goods and services. There are also “special rates” which were set according to VAT rates implemented in EU countries before they joined the EU.
The variety of all these rates is making the system overly complex, causing (lengthy) discussions between business and tax authorities around the scope and substantial maintenance as the rates change. Ideally, there will be one single VAT rate throughout the EU, putting an end to all of this.
2. Exemption with the Right to Deduct
In order to further streamline the VAT system the EU should give up the current concept of VAT exemptions. Under the current regime supplies of goods and services, such as in the education, healthcare and financial sector, may be exempt. In most cases, if a supply is exempt from VAT, deduction of the VAT paid (input VAT) on goods and services purchased in order to make that supply is not allowed.
Considering the number of cases (at national and EU-level) in which taxpayers and tax authorities are disputing the right to recovery input, we should ask ourselves whether the deduction restrictions in relation to exempt activities should not just be lifted. Exemptions with the right to deduct already exist for cross-border trade, so why not extend that concept?
3. Simple Adjustments for Non-Business Use
The rules for VAT adjustments for non-business use should be revised. Each EU member state has its own rules to prevent VAT-free consumption, such as the adjustments for the private use of company cars. However, these detailed rules are often blown out of proportion—they are far too complex for the potential “leakage.” An EU-wide set of rules that work to the greatest extent possible with flat rates should be developed.
Jan Sanders is a VAT Partner at PKF Netherlands.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.