(BRUSSELS) - The European Commission proposed on Monday sales tax cuts on locally provided services like restaurants and haircuts as part of proposals to shake-up EU value added tax rules.

However, the package faces tough negotiations between member states with Germany and some other countries long opposed to giving some sectors special VAT breaks.

The commission, the European Union's executive arm, said its proposals aimed to make it easier for member states to apply reduced VAT rates in a greater number of labour-intensive or locally supplied services than currently allowed.

Member states would have greater freedom to apply rates of between five percent and 15 percent for such services as haircuts, home renovations, house-cleaning, bike repairs, restaurants and catering.

Currently, EU governments can only apply temporarily a reduced VAT rate as low as 5.0 percent on products or services from a list under strict rules. However, many member states have obtained over the years various temporary derogations for various services.

Normally EU countries cannot apply a VAT rate of less than 15 percent in order to avoid big price discrepancies across what is supposed to be the EU's single cross-border market.

"I propose generalising the optional application of reduced rates in sectors where there is sufficient evidence that no real distortions to the internal market will occur," EU Internal Market Commissioner Laszlo Kovacs said.

"There is no reason why restaurant services, for example, should be allowed to benefit from a reduced rate in one half of the European Union but not in the other half," he added.

The commission said it had evidence that reduced rates in such labour intensive or locally provided services did not distort cross-border competition.

Kovacs said he expected the European Parliament would approve the plan in February or March of next year and EU finance ministers in mid 2009.

Under the commission's proposals, children's nappies, or diapers, and audio-books, would also be eligible for reduced VAT.

The commission said it was also studying the possibility of applying reduced VAT rates on energy saving goods and services, which Britain and France have championed. Its conclusions are due later this year.

The UEAPME European association for small and mid-sized companies welcomed the commission's proposals which it said would help combat the "shadow economy" and urged member states to approve the package.

"The European Commission has come up today with a valid proposal likely to put an end to years of uncertainty and patchy solutions on reduced VAT rates," said Gerhard Huemer, head of economic and tax policy at UEAPME.

"The decision to provide member states with the permanent option of applying reduced VAT rates in labour-intensive sectors deserves particular praise, and represents an important tool in the fight against undeclared work, which will become a less attractive choice," he added.

The reduced VAT rates are a sensitive issue in Europe with France, which currently holds the European Union's rotating presidency, long in favour of more flexibility in the face of German reservations.

"I'm delighted that the commission has heard our arguments I hope we will be able to convince our German and Danish friends," said French Economy Minister Christine Lagarde.

The new focus on VAT rates in Europe comes amid a debate about reducing sales tax on fuel, which French President Nicolas Sarkozy recently proposed as a way of providing relief to consumers struggling with high oil prices.

The idea, which would require unanimous backing from other EU countries to go ahead, has found little support from other nations in the bloc.

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