EC: Green Paper on the future of VAT, towards a simpler, more robust and efficient VAT system

Comments from ACCA to the European Commission, June 2011.

Q1. Do you think the current VAT arrangements for intra-EU trade are suitable enough for the single market or are they an obstacle to maximising its benefits?

The levels of documentation required to support the required zero rating treatment for intra EU trade, as opposed to the level of documentation required to support a standard domestic VAT return, inevitably act as a drag on trading across member state borders. The fact that companies reportedly prefer importing from outside the EU to intra EU trade is itself an indication that there is a significant problem with the current system.

Q2. If the latter, what would you consider the most suitable VAT arrangements for intra-EU supplies? In particular, do you think that taxation in the Member State of origin is still a relevant and achievable objective?

Taxation in member state of origin remains the ideal for businesses provided that the potential administrative benefits are realised. The required adjustments would impose a burden at state level, but states are better able to cope with the required levels of investment into technology than individual businesses.

The only way to reduce the "learning burden" under the destination principle would be to unify rates and treatments across the whole of Europe, which is unlikely to be economically desirable or politically achievable.

Q3. Do you think that the current VAT rules for public authorities and holding companies are acceptable, particularly in terms of tax neutrality, and if not, why not?

The exemption of public authorities results in distortions to the free market ideal, so from an economic perspective this should be avoided/reduced as far as possible. Despite the persuasively argued policy reasons for the initial introduction of this exemption, the net cost to the European economy of the distortions and disputes which arise out of the exemption without input credit for whole sectors of economic activity must surely by now outweigh the purported benefits. To the extent that the imposition of VAT on the services provided by public authorities is undesirable, those supplies should be zero-rated, rather than exempted, so as to avoid the effective treatment of the public bodies as a final consumer.

If the aim of a VAT is to raise tax in a non-distortional manner, then any exemption is anathema to that aim. Both the OECD and the IMF countenance against the introduction of exemptions, describing them respectively as "a significant departure from the basic logic of VAT" and "abhorrent". Quite apart from the "legitimate" distortional effects, any aspect of the system which allows those who seek to evade VAT an opportunity to disguise their crime amongst authorised deviations from the principle of full taxation should be scrutinised and if at all possible removed. Equally, the exemption of holding companies from the VAT regime introduces an arbitrary disincentive against group structures which are otherwise beneficial for company law reasons.

Q7. Do you think that the current system of taxation of passenger transport creates problems either in terms of tax neutrality or for other reasons? Should VAT be applied to passenger transport irrespective of the means used?

The current differential taxation of the same journey undertaken by different means cannot be objectively economically justified. Subject to implementation of appropriate mechanisms to reduce the impact of double taxation on eg journeys into and out of the EU, all passenger transport should be standard rated and taxable in the territory of the supplier. 

Q9. What do you consider to be the main problems with the right of deduction?

The cash flow cost to businesses of supporting the VAT system is considerable. The simplification of that process, and the improvement of security around net repayment traders, are inextricably bound up with the machinery of payment and reporting. Simplification and clarification of the requirements on business would reduce both the direct cash cost of the current system and the indirect cost of administration.

Q10. What changes would you like to see to improve the neutrality and fairness of the rules on deduction of input VAT?

Under the existing system, developed in an era when paper was the main tool of business, VAT accounting on the basis of the paper trail of invoices is the most practicable method of recording transactions. However, with the move to electronic invoicing and payment systems, particularly in the B2B sector, alternatives should now be explored.

We cannot know what the world will look like in fifty years, but we do know it will not look like the world of today. It is almost inconceivable that technology will not create the mechanisms to implement an effectively "cash accounting" based electronic system, available to businesses of all sizes. The rate of technological change now seems to outpace the rate of legislative change. The Commission should seize this opportunity to radically reform and improve the system of VAT in the EU, and should be prepared to start along an innovative route, confident that the price of atrophy and stagnation will far outweigh the costs of change.

Q11. What are the main problems with the current VAT rules for international services, in terms of competition, tax neutrality or other factors?

The single biggest problem for business, which is responsible for administering VAT and bearing the burden of costs of that administration, is simply that the regime for services is different to the regime for goods. What business wants is a single system with a single set of rules and procedures that can be applied to all its transactions.

Q13. Which, if any, provisions of EU VAT law should be laid down in a Council regulation instead of a directive?

The relative merits of Regulations and Directives are well known. While taxation policy is the inalienable sovereign right of every Member State, the administration of the tax system, and the requirement for interoperability between the forms and procedures of different jurisdictions is more suited to the medium of Regulation.

Q15. If this is not achievable, might guidance on new EU VAT legislation be useful even if it is not binding on the Member States? Do you see any disadvantages to issuing such guidance?

The problem with issuance of guidance is that it is by definition non-binding in its scope. Nevertheless, if it can go some way towards enhancing the coordination and harmonisation of the 27 existing VAT regimes then it will serve a useful purpose. Businesses and regulators are increasingly seeing the benefits of so called "soft law" as a viable means of encouraging compliance with norms of behaviour.

Q16. More broadly, what should be done to improve the legislative process, its transparency and the role of stakeholders in the process, from the initial phase (drafting the proposal) to the final phase (national implementation)?

Coordination at an international level can only be helpful. However, the hands of the policy makers in each Member State are tied by local political considerations. There is little doubt that politicians would in principle be in favour of a simpler, broader based VAT with lower collection and compliance costs; the net effect would be both a direct increase in VAT income from consumers and a knock on impact of decreased costs to business. However, every voter in domestic elections is a consumer subject to VAT. Within the business community there are those who will lose from any change to the status quo, and it is in the nature of things that protests are louder than acquiescence, slowing the rate of otherwise desirable change.

Q19. Do you think that the current rates structure creates major obstacles for the smooth functioning of the single market (distortion of competition), unequal treatment of comparable products, notably online services by comparison with products or services providing similar content or leads to major compliance costs for businesses? If yes, in what situations?

The scope of distortions to the single market caused by VAT rate and treatment is considerable and well documented elsewhere. The task of weaning national governments off their diet of derogations and localised policy decisions in respect of what should be a unified European tax is not one to be undertaken lightly, but is essential to equipping the EU as a serious competitor on the global stage.

Q20. Would you prefer to have no reduced rates (or a very short list), which might enable Member States to apply a lower standard VAT rate? Or would you support a compulsory and uniformly applied reduced VAT rates list in the EU notably in order to address specific policy objectives as laid out in particular in "Europe 2020"?

The use of consumption taxes as a policy or redistributive tool, rather than simply a revenue raising measure, is in all but the most direct situations (for example the excise taxes on alcohol and tobacco) unlikely to be the most effective tool to achieve the ends. With this in mind, the use of VAT to address specific policy objectives, while not ruled out altogether, should be subject to detailed scrutiny. In almost every case there will be a more economically efficient, better targeted or less burdensome way to achieve the desired subsidy or stimulus. Never the less, there may be other external factors which make VAT the most desirable (or least undesirable) way of achieving the policy objective. Despite the difficulties and distortions of using VAT rates as a policy tool, they have historically been a favoured tool of many governments, leading to the wide range of varying rates embedded in the economic modelling of many Member States. Significantly reducing the number of reduced rates will face massive opposition from those member states which have implemented wide ranging derogations as part of their current system.

However, the proliferation of national variations is undeniably a fetter on the single market, and should if at all possible be reduced. There are some areas where use of reduced rates, while not necessarily economically the best solution, is nevertheless the best long term political option. The use of reduced rates as a redistributive policy tool to favour certain essential products (basic foodstuffs for example) is generally regarded as economically inefficient. The opportunity cost to governments of the revenues foregone in respect of ie food purchased by higher income families is greater than the benefit derived by low income households. The economically rational solution would therefore be to remove the zero rating on food, and replicate the benefit to low income families by means of a positive subsidy, funded out of the extra revenues now received from food purchased by high income households, and this solution has many supporters. The risk to this approach is that the subsidy, however it is operated, is no longer automatic at point of sale. Instead it becomes a specific item of expenditure within national budgets, and is as such potentially subject to attack on political grounds, or even simple erosion through fiscal creep if not actively supported by the government in office from time to time. Accordingly, notwithstanding the deviation from purity of principle embodied by the zero rating of food, ACCA would support the retention of reduced or zero rates for a limited list of essential items.

For the majority of items currently subsidised by reduced rates of VAT, more efficient and direct mechanisms should be investigated. For example, the "experimental" reduced rate for building services, designed as a supply side push to increase employment in the construction sector has consistently returned inconclusive results. However, the project has been prolonged and its scope widened, despite the distortions and compliance costs it introduces, and its apparent unsuitability as a means to the end of employment stimulation. Indeed, this entrenchment of an expensive and inefficient tax measure for what appear to be political rather than economic purposes has prompted commentators in the US to compare the measure unfavourably with their own regime of overtly political "tax expenditures". This contrasts poorly with the EU 2020 vision, and the pressure to further extend this and other similar measures should be resisted.

Q21. What are the main problems you have experienced with the current rules on VAT obligations?

The majority of problems arise for SMEs. They are less able to afford the type of expensive advice needed in the VAT arena, and in many cases less aware of the need to take that advice. Particular problems arise when they attempt to operate across Member State borders, not appreciating the differing rules which operate across the EU. The variance in registration requirements across Europe leads to many businesses operating without registration when they should have it, or incorrectly applying the wrong rate of VAT (or accounting for none at all) on supplies to residents of another Member State. Even where businesses appreciate the need to comply with regulation, the burden of doing so is a disincentive to take advantage of the other opportunities offered by the European Single Market.

Q24. Should the current exemption scheme for small businesses be reviewed and what should be the main elements of that reassessment?

The EC has committed itself to "think small first" in its 2008 communication on a Small Business Act for Europe. However, the existing VAT system has been designed from all directions at once, with the resulting impacts on small business dealt with through a patchwork of domestic derogations. As a result, small business does not benefit from a single simple system designed to be operated by unsophisticated taxpayers. Indeed, the provision of local schemes for small businesses can actually increase the burden of administration even for businesses which operate only in one territory. Before deciding whether to implement the local voluntary scheme for small businesses, the business should (as a matter of economic imperative) consider whether its needs will be best served by the standard system or the derogation scheme. However, this adds a further layer of administrative burden on small business which big business does not suffer.

Once businesses start trading across member state borders the potential complexity increases dramatically. There are a significant proportion of member states which require any foreign business trading in their jurisdiction to register for VAT. In many cases, small businesses may find themselves required to register for VAT in foreign jurisdictions when they have never been required to register at home. The drag on compliant cross border trade is clear; in practice, anecdotal evidence suggests that non compliance is rife. The obvious route to simplification of cross border trade is harmonisation.

The current situation, where taxability of a supply is dependent not only upon the location and status of the recipient but also the location and status of supplier, and can vary with changes to any one of the four elements, following logic that is not immediately apparent, is inefficient for all parties, but imposes a particular burden on small businesses who will by definition be making fewer intra EU supplies than comparable large businesses, and will hence suffer a proportionately greater marginal cost burden per transaction.

The goal of total harmonisation is not practically achievable in the short term, and will remain problematic in the long term, given the vast disparity between domestic economic and fiscal conditions of the member states. Even matters as seemingly simple as the level at which exemption from registration should be set present difficulties. Exemption thresholds are typically set at a given level of turnover, which varies considerably throughout the EU. Aligning the threshold at which registration is required across all member states, and imposing uniformity of registration requirements for non-resident businesses, would represent a significant step forward. A compliant small business would at least be able to know whether they are required to register for VAT if undertaking intra EU supplies, albeit that the local rules applicable in their new market might be different.

In order to retain the value of this measure, the threshold should be set at an absolute value in Euros. Although there may be economic arguments in favour of setting thresholds as a percentage of average business turnover in each Member State, having different Euro threshold values across the EU would significantly reduce the benefits to small business.

Q25. Should additional simplifications be considered and what should be their main elements?

For the reasons outlined above, any "additional" simplifications should be uniformly applicable across the whole EU. Allowing further disparate deviations from the "standard" system of VAT may provide short term relief for businesses in those Member States which implement them, but the impact on the single market will simply be to further fragment the legal landscape for small traders looking to expand within Europe.

When designing any future simplification measures, consideration should be given to the role that can be played by technology. For many small businesses the limit of technological benefits has already been reached, and their systems and processes will need radical overhaul before aims such as real time reporting of transactions can become a reality. None the less, any measures proposed for the future should be designed with the expectation that electronic delivery will become the dominant means of recording and reporting transactions. Designing measures and processes primarily for paper, rather than electronic, filing and delivery will simply perpetuate many of the current problems faced by business.

Q27. Do you see the one stop shop concept as a relevant simplification measure? If so what features should it have?

Combined with a sensibly high uniform registration threshold and streamlined and harmonised processes the one stop shop represents a significant opportunity to ease the burden on businesses of all sizes.

The one stop shop should enable businesses to register once only, in their principle state of establishment, and be able to rely on that registration for transactions in all Member States where registration might in future be required. The one stop shop should integrate an electronic portal allowing the business to report transactions across the EU, regardless of status, and access their VAT records via a single log in.

Q31. What are your views on the feasibility and relevance of an optional split payment?

The current accounting and legal frameworks are not readily compatible with the requirements of split payment accounting. Furthermore, the exercise of the option by one trader in the chain could impose cashflow and liability burdens involuntarily upon other linked traders. Until accounting methods have advanced to the point where all VAT registered traders are able to comply with the necessary requirements of real time reporting of each VATable transaction, split payment is likely to cause more problems than it solves.

Q33. Which issues, other than those already mentioned, should be addressed in considering the future of the EU VAT system? What solution would you recommend?

The existing VAT system has been in place for fifty years; its replacement should be designed with the next fifty years in mind. The architects of the original system simply would not recognise today's technological landscape, or the opportunities presented by modern business machines and the options available to the designers of a new system of tax on retail consumption. With that in mind, a new design must not be constrained by looking backwards, but must look forwards to the ideal of a simpler, broader based and fairer system of VAT.

While cash is not yet dead, nor will it be for many years if not decades to come, electronic recording of transactions is rapidly approaching universality. Most large retailers already operate massively complex point of sale recording devices simply to track the existing VAT attributes of the transactions they undertake. Enabling these systems to trigger a real time reporting mechanism for cash or electronic transactions, while no trivial operation, is by no means beyond current technology. In five, or even ten, years time advances in contactless payment technologies and interconnection of banking and payment systems with government infrastructures will doubtless enable manufacturers to build such functionality into even the most basic "cash register" or online payment interface. Combined with a sensibly high exemption threshold for small businesses, including if necessary subsidies to enable low margin operators to update their systems, the requirement to move over to such a system should not pose an undue burden on business over the medium to long term. Contactless payment alone may drive retailers to upgrade their payment systems; a requirement that the relevant machinery include VAT reporting functionality would introduce the technology across Europe as a simple part of economic progress.

Ambitious though such a project may sound, to strive for any less would be to condemn Europe to another generation of legacy systems. The costs of change will be less than the price of inactivity.

The increasing interconnection and interdependence of the global economy is linked to increasing mobility. As business moves to a more mobile model, so transparency increases and the controllers of international business become increasingly aware of the environments in which they operate. The current EU system of VAT is almost universally considered to be the least effective major VAT system currently in operation. This is perhaps an almost inevitable result of its age, its roots and the legal and political environment in which it has evolved. But business is not concerned with the past, it is concerned with the future. The emerging economies of the BRICs countries either already have or can relatively easily implement VAT systems which follow the ideals of wide base demonstrated by many of the more recent adopters of VAT, such as Australia, New Zealand and Singapore. More importantly, the US is once again, and perhaps more seriously than ever, looking at the implementation of a Federal VAT.

If such a system is put into place, there is little doubt that it will model itself on best practice from around the world, and will not the current EU model of variable rates and treatments within a supposedly harmonised system.

The effect of this will however be far wider than simply the introduction of a new, but relatively simple, aspect to operating in the US or other non-European economy. As tax burdens move from direct to indirect tax across the globe, so the option would open up as never before for the US to transfer its tax burdens from corporate income taxes to retail consumption taxes. Not only would the US present a more attractive VAT compliance environment than Europe, it would be in a position to improve its relative corporation tax burden with the reduced need for funding from corporate income taxes.

If Europe is to compete effectively with the other global economies, it must reform its VAT system not purely for the sake of VAT compliance costs, or to reduce the loss of revenue through fraud, but also to enable it to reduce the burden of corporate taxation on the most mobile source of revenue, growth and economic stability. If Europe continues to present to business a tangled and unfriendly VAT system, combined with relatively burdensome corporation taxes, it cannot hope to attract global investment in preference to other more attractive environments around the world.