Reduced VAT Future?

In October 1999, AN EU Directive on ‘reduced VAT rates’ (Directive 1999/85/EC), amending the main VAT directive (77/388/EEC), was adopted. The aim of the new law was to give Member States the option of applying a reduced VAT rates to certain labour-intensive services, listed in Directive's “Annex K”.

This was allowed for a maximum of 3 years until 2002, but in that year the Council of Ministers decided to extend the application of this directive by a further year.

In July 2003, in line with its strategy to rationalise and simplify the VAT system within the EU internal market, the European Commission adopted a proposal for a general review of the reduced rates of VAT. However since the Council of Ministers had not reached an agreement on the content of this proposal by then, it was decided to further extend the validity of the 1999 Reduced VAT Directive until the end of 2005.

With nine months before this deadline, the discussions within the Council of Ministers remain completely deadlocked. If nothing changes, the Member States will no longer be allowed to apply reduced VAT rates under the 1999 Directive from January 1, 2006. This will have negative consequences for employment and economic activity.

In order to understand these consequences better, the Fédération Française du Bâtiment (FFB), one of FIEC's two French members, led by its president Christian Baffy, carried out a study to assess what the impact of the full VAT rate on France's construction sector.

Undeclared Work

The introduction of a VAT rate of 5,5% for rehabilitation and maintenance work in France in 1999, helped reduce ‘undeclared work’ in the building and civil engineering sectors. The number of infringements have since been less numerous and the extent of undeclared work has been considerably reduced.

The reduction in undeclared work also had social and economic benefits. Under the reduced VAT regime there was a significant decline in infringements of fiscal and social legislation by the construction sector. Indeed, for the first time the construction industry has shaken off its poor record for breaking the law, and is now on a level footing with other sectors. The rate of infringement in the building sector dropped by half, which was a marked improvement on other sectors subject to reduced VAT laws. These saw a decrease of just a third.

According to FFB, the fight against undeclared work, which has been going on for several years, is finally beginning to bear fruit thanks to a lower tax level. The re-establishment of a VAT rate at 19,6% would see this effort completely wiped-out in just a few months.

As well as having benefits for the sector itself, the reduction of undeclared work is of benefit to consumers. The chief problem with undeclared, unauthorised work is that consumers’ statutory rights are eroded. There is an absence of the proper documentation for the works executed, and the end product is not guaranteed in any way. This means it is difficult to use legal proceedings to settle disputes and rectify defective work.

On the other hand, declared work improves consumer protection through the existence of a guarantees for the works invoiced. The re-introduction of a higher VAT rate would encourage consumers to sanction contractors not to declare all or part of the works that they plan to carry out, with a corresponding loss of their security.

The VAT rate of 5,5% resulted in beneficial effects for employment. But a survey carried out for the purpose of this study among 20000 households, clearly illustrates that a re-introduction of a standard rate of VAT would be disastrous in terms of activity and employment.

Among the households which had work started between April 2000 and May 2003, 14% said they would not have commissioned some or all these improvements if it were not for the 5,5% VAT rate.

Among those who envisaged initiating home improvement projects ‘soon', 47% declared themselves ready to give up all or part of these projects in the event of a return to a VAT rate of 19,6%. In fact 10% would give them up completely, while 37% would scale them back.

The abolition of the 5,5% VAT rate would imply the loss of around 85000 jobs in the French building sector at the beginning of 2006 alone.

Fiec Position

The Commission recently adopted a communication entitled “Working together for growth and jobs: a new start for the Lisbon Strategy”. The Lisbon Strategy aims to make the EU “the most competitive and dynamic knowledge-based economy in the world capable of sustainable economic growth with more and better jobs…” If Member States are committed to the Lisbon Strategy they should give clear political signals of their intent.

FIEC believes, in the light of the results presented above, one of these strong signals could be to allow those Member States that are currently applying the 1999 Reduced VAT to continue do so beyond the end of this year.