Reduced VAT is back

At the beginning of 2006 the EUMinisters of Finance agreed to approve a Directive (2006/18/EC) which prolonged the option for Member States to apply reduced VAT rates to some labour intensive services, including the renovation of dwellings, until the end of 2010.

The Ministers also asked the European Commission to make a presentation to the European Parliament and the Council by the end of June this year regarding the overall impact of reduced rates, notably in terms of job creation, economic growth and the proper functioning of the internal market, based on an independent study.

This study and the presentation of its results were intended to better inform the debate on reduced VAT with the ultimate aim of finding a definitive, rational and harmonised approach to the issue. The Commission feels a harmonised approach is needed to avoid different levels of tax being applied to goods that can be traded across the EU.

Results

The main findings of the study provided positive arguments in favour of a permanent application of reduced VAT rates to renovation work for those Member States that would wish to do so.

The study reinforces the conclusions the Commission came to in 2003, that reduced VAT rates did not have a positive impact on employment because at the time they were temporary and experimental in the countries that tried them. However, a permanent reduction of VAT would have a significant positive impact on employment in a range of labour intensive services from building renovation work to hairdressing. Furthermore, by lowering the VAT on some products and local services such as renovation work, activities can be shifted from the šinformalš economy towards the šformalš one.

According to the study, a permanent reduction in VAT will lead to an equivalent reduction in its price. Contrary to the doubts expressed by the Commission there is a strong tendency towards a full pass-through of the reduction of VAT to the final price paid by the consumer. The speed and the strength of this pass-through is for services that are labour intensive and for which competition is strong.

Finally, the study states that for those products and services that are not traded across EU borders, such as renovation work, the application of reduced VAT rates will not have any negative implications for the smooth functioning of the internal market.

However, it was also found that most arguments in favour of lower VAT are equally valid for other policy instruments (subsidies, fiscal deductions etc.) and it is therefore important to examine, on a case by case basis, which is the best instrument. In particular as regards the creation of jobs, it is important to check whether a reduction in VAT is the best approach.

Future Rates

In a Communication published at the beginning of July, the Commission presented the results of this study and indicated some possible scenarios for the future. According to the Commission, reduced VAT rates could be based on a 3 level structure, namely:

• A very low rate (between 0% and 5%) for goods and services of first necessity such as food for example; discussions should also consider other needs such as medical treatment or social housing;

• An intermediate rate (between 10% and 12%) for other purposes that are not basic needs, but that are considered justifying preferential treatment for other reasons, such as cultural and educational goods and services, public transport, energy and environment, etc.

• A standard rate for all other goods and services.

In this framework, only an šintermediate rateš would apply to renovation work, which would imply a significant increase in those Member States that are currently applying a reduced VAT rate on this type of works-Belgium (6% currently) and France (5,5%) for example would see a near doubling of the rates they currently apply.

The commission recognises however that according to the principle of subsidiarity, more flexibility could be given to the Member States as regards the level of VAT rates for local services, such as renovation work.

It is too early to be sure of the final outcome because the aim of this Communication is to open the debate at the European level with the aim of reaching an agreement before the end of 2010 when the current provisions come to an end. It should also be noted that fiscal issues such as reduced VAT require a unanimous vote by the Council of Ministers.

FIEC will actively participate in these debates and undertake the appropriate initiatives, in order to ensure that those Member States so wishing can benefit from the positive impact generated by the application of reduced VAT rates to renovation work.