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European Union

Harmonization of national legislation relating to VAT

The Castagnede Report produced by the Commission this month recommends that the EU should begin a gradual reconciliation of the member states' VAT rates, ie turnover tax, and it should harmonize reduced rates by widening their field of application. The report comments that the level of VAT rates in member states still varies considerably with the normal rate lying somewhere between 15% and 25% and reduced rates lying between 5% and 17%. The report states that there are a number of substantial differences between the member states in their application of VAT. Denmark does not apply any reduced rates; Austria, Portugal, Finland and Sweden apply two reduced rates; the other member states apply a single reduced rate but also apply special rates, including a zero rate on some products. At the moment these differences do not cause distortions in competition or affect trade flows. However, the Commission is concerned that with the continuation of market integration, the arrival of the single currency and the increased use of electronic commerce, competition will increase, creating the need to harmonize VAT.

The conclusions of the Castagnede Report are as follows:

  • the disparity between the VAT rates of member states makes it difficult to hope for total harmonization in the near future. Instead, the aim should be to achieve a difference in rates compatible with the normal functioning of the internal market. Progress towards reconciliation should begin as soon as possible but it should be based on a realistic and gradual method;
  • within the framework of the VAT transitional scheme, efforts must be made to rationalize the structure of rates, with special attention paid to the common definitions of the categories of goods and services to which a reduced rate may be applied;
  • the process of reconciliation of rates could begin with the abolition of exemption schemes, accompanied by the definition of scales within which member states would set the reduced rates. The report advocates the maintenance of two reduced rates, 3-6% for one and 10-14% for the other, for a transitional period. However, the report does not mention the maintenance of the zero rate and the suggestion is that this should be abolished; and
  • the report expresses concern over national governments favouring the preservation of their revenue over and above the application of reduced rates. It states that reduced rates should be applied to social and cultural requirements, and should be considered for products such as new cultural goods linked to the information society (CD-ROM), services linked to the requirements of social mobility and employment and services for access to justice and law. The report also advocates the experimental application of reduced rates to certain labour intensive activities to help avoid undeclared work.

Disagreements have arisen regarding the field of application of the reduced rate in the member states. According to the Commission, extending reduced rates would lead to budgetary difficulties for member states. The Commission believes that applying the reduced rate to labour intensive services would not help job creation; reduction in social security contributions would have a more pronounced effect. However, a survey by the EU of Crafts and Small Enterprises concludes that a reduction in VAT would have a positive effect. The report must now be proposed to the European parliament before any final decision can be made.

Third report on VAT collection and control procedures

The Commission has just published its third report on the subject of VAT, based on a study by the Anti-Fraud Sub-Committee (SCAF) of 479 cases of fraud representing a total of Ecu573 million in tax. VAT is the largest source of Community revenues, although its relative share is rapidly declining. VAT also represents one of the largest sources of funding for the member states. A drop in VAT receipts must be compensated by greater recourse to GDP resources, which are financed by all the member states. Therefore one member state's lack of efficiency in collecting VAT has consequences for all the other member states.

The study finds that the most frequent types of fraud, seen in 57% of the cases surveyed, involved suppression of tax on sales and abuse of rules on tax deduction in their most simple and direct form. On the sales side, this fraud consisted of failure to produce an invoice, to register sales or to pay VAT invoiced. On the purchase side, deductions not justified by an invoice or deductions on the basis of a falsified invoice were more common.

European Central Bank meeting

On September 11 the Board of Governors and the General Council of the European Central Bank (ECB) met to decide a number of practical issues regarding the Euro, the second exchange rate mechanism (ERM II) and the timetable of meetings. The ECB confirmed that there would be a total of seven Euro bank notes consisting of Ecu5, 10, 20, 50, 100, 200 and 500. A series of print runs will be launched this Autumn and the mass printing of notes will start at the beginning of January. The seven Euro bank notes will have no distinctive national feature, unlike the coins which have a national feature on one side. Both the Euro notes and coins will come into circulation in January 2002 and there will be a six month period where they will circulate alongside national coins and notes.

The central banks of the countries not taking part in the single currency launch — the UK, Sweden, Greece and Denmark — will have to contribute 5% of their subscription fee to ECB's capital. The ECB will dispose of an initial capital of just under Ecu4 billion, but in practical terms, the four central banks will not have to pay this sum because it amounts to less than the existing assets that they have at the European Monetary Institute, the forerunner of the ECB. With regard to ERM II, the ECB supported the draft agreement between the ECB and the national central banks of the countries not participating in the Euro launch, which establishes the procedures for the setting up of a new exchange rate mechanism. ERM II will take the place of the EMS' exchange rate mechanism in January. For the four currencies participating in ERM II, the fluctuation bands against the Euro will remain at about 15%. Participation of ERM II will not be obligatory for the four currencies not joining the single currency in January.

Michael Reynolds
Allen & Overy

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