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Communication on VAT reduced rates - guide

07 July 2008
by eub2 -- last modified 07 July 2008

The European Commission made a proposal on 7 July 2008 to change the VAT Directive 2006/112/EC so as to provide EU Member States with the flexibility to apply reduced VAT rates for some specific services on a permanent basis. The Commission proposal covers areas where there is sufficient evidence that reduced rates do not create problems for the proper functioning of the Internal Market. The sectors concerned are mainly so called labour-intensive services and locally supplied services, including restaurant services. The proposal is also part of the small business act as SMEs dominate the sectors concerned. The proposal does not alter the principle that the application of reduced rates is optional for Member States.


Why is the European Commission's proposal limited in scope?

Reduced VAT rates are exceptions to the standard rate (minimum 15%). Before making a proposal for a broad review of VAT rates, the Commission needs evidence on the effectiveness of reduced VAT rates in order to promote certain policies without impacting on the proper functioning of the Internal Market.

At this stage, more assessment is needed of the impact of reduced VAT rates for environmental purposes, and the Commission awaits the results of studies currently being carried out.

Likewise, the use of VAT rules as a tool in other EU policies needs further reflection and analysis before any in-depth review to rationalise and simplify the current rules.

Why are energy savings and energy efficient materials and appliances not in the present proposal? When will the Commission come up with a proposal on VAT reduced rates for environmentally friendly goods and services?

Indeed, the current proposal does not include provisions on the use of VAT reduced rates for environmental purposes.

However, it does give Member States the possibility of applying reduced VAT rates to renovation and repair works, with a view tot increased energy-saving and efficiency.

The feasibility of a more far reaching proposal from an environmental point of view is currently being examined by the Commission services, in accordance with the request from the European Council in March 2008 to examine areas where economic instruments, including VAT rates, can have a role to play to increase the use of energy-efficient goods and energy-saving materials.

The results of these analyses will allow the Commission to assess the most cost effective way to promote the production and use of energy-saving materials and energy-efficient appliances and equipment. Those results are expected in the autumn.

The Commission will then present the results of these analyses, accompanied by relevant proposals and recommendations.

Does this proposal have any environmental impact at all?

Yes absolutely. Services relating to the entire housing sector (including, construction, renovation, repair, maintenance) and to repair and renovation, maintenance of places of worship, cultural heritage and historical monuments will be eligible for reduced rates. The proposed changes to the Directive will thus make it possible for Member States to apply reduced VAT rates to renovation and repair work aiming at increased energy-saving and efficiency. This means, for example, that the installation in a private dwelling of thermal insulation, high performance double glazing, etc. can be subject to a reduced rate.

Moreover, some technical adaptations have an environmental content. In particular, the Commission proposes to review the current wording in order to allow a reduced rate for all services provided in connection with street cleaning, purification and recycling of waste water, sewage, refuse collection and waste treatment, or waste recycling and services leading to reuse.

When will the Commission come up with a more comprehensive review of the VAT reduced rates, as announced in its communication of 2007?

A more in-depth review of the whole structure of VAT reduced rates- including a review of the numerous derogations granted to various Member States and of the levels of VAT rates to be authorised for certain Member States - is left for a later stage. This is mainly due to the lack of political guidance from the Council. Before an in-depth review of the whole VAT reduced rates structure can be carried out, a clearer view is needed of the use and effectiveness of reduced VAT rates in promoting certain other policies. The outcome of the broad debate currently ongoing in the Council and with the stakeholders on the basis of our communication of 2007 should be available before any such review is done.

Will the Member States be obliged to apply reduced rates in the new category of goods proposed?

No. Reduced rates are optional, and the current proposal will not touch this principle. It will therefore remain the responsibility and competence of each Member State to assess whether a reduced rate in some of the sectors listed in Annex III of the Directive might be introduced on its territory.

It has to be stressed that the Commission's proposal gets rid of the current restriction, whereby Member States can only apply reduced rates for labour intensive services in a maximum of two sectors. Member States would now have the option to apply reduced rates in as many sectors described in the proposal as they wish.

Does the Commission intend to modify current derogations granted to some Member States with regards to zero-rate?

No: the current proposal, given its restricted scope, does not touch the zero-rates currently applied in some Member States. The rationalisation of the overall Community legal framework will be part of future proposals subject to political guidance from the Council.

Why does the Commission propose reduced rates while the economic study carried out concludes that one single rate is the best policy choice?

Indeed, the Copenhagen Economic study concludes that moving towards a more uniform VAT rates structure has considerable advantages from a purely economic point of view. However, they also conclude that carefully targeted reduced VAT rates may provide specific benefits, in particular in terms of economic growth. They can induce consumers to shift activities from DIY (do it yourself) and the "underground" economy to the formal economy. Moreover, when applied to locally supplied services, they do not affect the functioning of the Internal Market. There are also arguments in favour of introducing reduced VAT rates in sectors employing many low-skilled workers in order to permanently create jobs for such workers.

Reduced rates are generally in force in most of the Member States. In this respect, abolishing existing reduced rates would have negative impact on the economy, in particular on inflation. Moreover, in some sectors, ,it might also bring back activity in DIY (do-it yourself) or in the black economy

On this basis, the Commission concludes that there are good reasons to include local services in the list of goods and services eligible for a reduced VAT rate. It thus proposes to include in Annex III all the categories of Annex IV, which by virtue of Article 107 are local and not likely to distort competition, and to extend the scope of reduced VAT rates to some other services which are local because of their basic characteristics. The place of supply rules ensure the taxation of the services at the place of consumption, they cannot be supplied from a remote location, they are largely directed at the local market and the supplier and customer are located in a geographically limited area.

Will this proposal benefit SMEs?

This proposal forms part of the Small Business Act adopted on 25 June 2008. Although it is not aimed exclusively at SMEs, it will have a positive effect for them. Indeed, the proposal will allow the continuation or introduction of reduced VAT rates in sectors such as the housing sector, restaurants, domestic care services, small repairs, where SMEs are predominant.

The proposal will give legal certainty on the continued application of VAT reduced rates in these sectors.

Why are alcoholic beverages excluded from restaurant services? Will this not increase compliance costs for restaurant?

The addition of restaurant and catering services will offer equal treatment to all Member States. However, in order to ensure consistency with the category concerning foodstuffs, the supply of alcoholic beverages is excluded. The exclusion of these beverages is necessary in order to avoid a standard VAT rate being applied to alcoholic beverages bought in shops and a reduced VAT rate being applied when they make up part of a restaurant service. Making this differentiation is already applicable in some Member States applying currently a reduced rate to restaurants (Slovenia, Greece for example) and seems easily manageable for the businesses concerned.

Is the flexibility given to Member States to apply a reduced rate not a first step in the de-harmonization of the VAT legislation?

No. This proposal covers mostly sectors where a lot of Member States are, de facto, applying reduced rates. Their legal basis is not Annex III (the common list of goods and services to which Member States may apply reduced rates) but derogations or the labour intensive services scheme, which are not available to all Member States in an equal way. By giving all Member States the possibility to apply a reduced rate in sectors as housing, restaurant services, labour intensive services etc, this proposal does not de-harmonise the system but ensures more equal treatment and a more level playing field in the EU. Finally, one should keep in mind that as long as the Internal Market is not affected, the Treaty establishing the Community does not provide for the need of harmonisation.

Will the proposal improve the competitiveness of EU companies?

Overall economic growth is likely to occur, as it is foreseeable that a shift will occur from do-it-yourself and black economy activities to the formal economy (activities with limited need for formal training and specialised machinery), i.e. locally supplied services for households, especially domestic care, cleaning, small repairs and maintenance, and restaurants.

Will proposal create a burden for businesses which have to comply?

It is not expected that proposal would have a significant impact in terms of compliance costs.

On the contrary, if a particular Member State decides to apply the option of a reduced rate to the entire housing sector, this would mean that difficult distinctions would not have to be made in order to apply the correct rate. The same goes for the application of a reduced rate to restaurant services: distinctions between supply of non-prepared, prepared food and food supplied by restaurants or catering enterprises become obsolete if the same rate is applied.

Why is 2011 fixed as date of entry into force of the Directive?

Because the temporary provisions concerning labour-intensive services and the derogations for reduced rates granted to new Members States expire at the end of 2010.

Has the public been consulted on the future of reduced rates?

The Commission launched a public consultation to involve all stakeholders in the review of the VAT rates legislation. The main objective of the consultation was twofold. On the one hand, it aimed to ascertain the views of all interested parties on the scope of this review. On the other hand, it sought to gather relevant feedback on the economic, social, environmental impacts of applying reduced VAT rates for the on-going analysis of the cost effectiveness of reduced VAT rates to achieve different policy objectives.

The almost 600 contributions received by the Commission largely support the approach of the Commission consisting in a 2 steps action:

  • First step: deal with urgent matters for which enough elements are already available to justify a limited extension of the current scope of reduced rates;
  • Second step: a more in depth revision of the general rules governing VAT rates.

A large majority of stakeholders support the permanent inclusion of the current labour-intensive services and other locally supplied services.

A detailed summary report of the results of the public consultation

Source: European Commission