EU VAT Action Plan: The future of an illusion

With the EU referendum just days away, the EU is between a VAT rock and a hard place, writes Nicholas Hallam, chief executive of VAT consultancy Accordance

OVER THE last couple of years, the prime minister has had a few run-ins with former Polish premier (and current president of the European Council) Donald Tusk – the particularly divisive issue being David Cameron’s plan to restrict the levels of benefit payments to EU nationals living in the UK.

Tusk was resistant to agreeing restrictions because it could be seen as undermining the principle of the free movement of people across the EU; for Cameron on the other hand, benefit payments to those recently arrived from the EU had become politically toxic – a symbol of both the EU’s lust for control, and its perceived unfairness.

It may have surprised Cameron, then, when earlier this week Tusk went on the attack against the hubris of the European project:

“Obsessed with the idea of instant and total integration, we failed to notice that ordinary people, the citizens of Europe, do not share our Euro-enthusiasm.”

Putting on the brakes

Without ever mentioning Brexit directly, Tusk’s speech suggested that ‘euro-scepticism’ and ‘euro-pessimism’ were an understandable reaction to the illusion of “a utopia of Europe without nation states, a utopia of Europe without conflicting interests and ambitions, a utopia of Europe imposing its own values on the external world.”

Strong stuff, and coming from the president, it seems a real indication that the brakes will be put on the drive to an “ever closer union”, which is good news for Cameron – unless it is already too late for him.

Over the last few days, support for ‘Leave’ appears to have surged: immigration is once again dominating the news, Brexit is now very much on the cards.

I was very kindly invited by the Institute of Directors to be a panellist at their Brexit debate last month; our section was on the possible effects of departure from the EU on professional services, the law and taxation in the UK.

As far as VAT goes, we really do not know what the consequences will be, because we don’t know what an eventual deal with the EU might look like; and that uncertainty seems typical of the whole professional services and legal sector.

Nevertheless, it was striking how optimistic the Brexiteers are in the face of these large unknowns.  Priti Patel, who gave one of the keynote speeches, spoke with passion about the possibilities for Britain beyond a declining, moribund Europe. According to her, Brexit is an opportunity for the UK to reclaim its 19^th century heritage as a great trading nation: globalisation and technology mean that we can well afford to step away from Europe and its problems.

One of my co-panellists – Swati Dhingra, professor of Economics at the LSE – is not so sure.

The formidably well-informed Dhingra is a leading researchers into the economics of Brexit, and her view is that geography matters:

“Reducing trade barriers between the UK and the rest of the world is a laudable aim and would be likely to increase trade and raise UK income. But it is not an adequate replacement for EU membership. The best-known fact in international economics is that international trade and investment fall substantially with distance (Head and Mayer, 2014). Doubling the distance between two countries roughly halves the trade between them. The UK is much closer geographically to the EU than to other large economies such as the United States or China and, therefore, it is not surprising that roughly half of the UK’s trade is with the EU.” 

What’s more, her research suggests that massive economic powers like the US and China are unlikely to come to favourable trade terms with plucky, free ranging independents. Size matters; strength answers to strength. Dhingra believes that it makes sense to have a say in the conduct of your local mega-trading bloc.

Changing business landscape?

Assuming that Dhingra is correct, and that, post-Brexit, UK companies attempt to trade with and operate in the EU at pretty much the same level they do now (though on perhaps altered terms) the question of how business and consumption tax is treated in Europe will continue to be of great significance to the UK economy.

It was a bit of a shock, then, to hear Jonathan Heath, head of HMRC’s VAT Central Liaison Office (the section that works with other Member States), say last month that he expected the UK to cease to participate in European VAT discussions immediately should the UK vote to leave the EU. Influence on future reform would be gone.

Heath was responding to questions after a session he took at the International VAT Association’s recent conference in Vienna. Much of the session (and the conference) was given over to analysis of the European Commission’s recent EU VAT Action Plan.

As EU VAT Commissioner, Donato Raponi, ruefully noted, it was the Commission’s second such plan in five years, the latest version having been put together in the aftermath of the Commission’s failure to introduce a single, standard VAT return for the whole of Europe. Member states have hugely different fiscal cultures (HMRC, for instance, operates with a gossamer light touch compared to its European counterparts): they could get nowhere near agreeing the basic information a standard VAT return ought to include.

The new plan (subtitled Time to Decide) is effectively a challenge from the Commission to Member States: “are you serious about wanting a consistent VAT system for the single market?”

Its two major structural proposals are for developments out of the one-stop-shop for electronic services that was introduced in January 2015. Firstly, a one stop shop framework for e-commerce distance sales (sales made by an EU business directly to a consumer in another member state); and then, beyond that (at an unspecified future point) the creation of a genuine ‘single VAT area’ through the extension of the one stop shop to cover B2B transactions relating to goods.

Obstacles

I have written before for Financial Director about the obstacles to the application of the one stop shop principle to e-commerce.

The fundamental problem is the degree of tax authority integration and coordination required for the system to operate: member states would have to align VAT registration thresholds (hugely contentious because of cultural differences about tax collection); audit foreign companies on each other’s behalf; and collect VAT owed to other member states (Greece collecting VAT on Germany’s behalf, for example).

The scheme for a ‘single VAT area’ effectively envisages the beginnings of a supranational tax authority: not quite President Tusk’s ‘instant and total integration’, but nevertheless a major reconfiguration of EU tax sovereignty.

(As a counter-balance, there are also proposals to allow Member States more freedom in respect of setting VAT rates – though Commission representatives observe that Member States are likely to reject too much freedom, as domestic governments like to blame the EU for high taxes!).

The Commission is basing the case for further VAT harmonisation on the need to fight fraud: there is an annual ‘VAT gap’ (the difference between the collected and the collectible) of €170bn (£133m). It is a vast amount of money, but, as Jonathan Heath of HMRC pointed out, about €120bns of that sum can be attributed to mistakes rather than deliberate criminality.

The total annual VAT take in the EU is in the region of €1 Trillion; and while the gross amounts involved may be staggering, a 5% fraud rate compares favourably to alternative systems. US sales tax, for example, where the evasion percentage runs well into the double figures.

Indeed, it seems that member states have already started pushing back against the new plan.

At least two have asked the Commission for permission to apply a reverse charge mechanism to all domestic transactions, on the basis that it is a highly effective anti-fraud mechanism!

The Commission is now caught between its vision of integration and its commitment to fighting fraud. If accepted, the proposal would further fragment the EU’s VAT framework, and perhaps spell the end of the Commission’s campaign to harmonise VAT.

As far as VAT is concerned, the UK may be about to leave the EU at precisely the moment the EU finally begins to behave in the way that it desires.