EXPLANATORY MEMORANDUM

1.CONTEXT OF THE PROPOSAL

•Reasons for and objectives of the proposal

Pursuant to Article 395(1) of Directive 2006/112/EC of 28 November 2006 on the common system of value added tax (hereafter "the VAT Directive"), the Council, acting unanimously on a proposal from the Commission, may authorise any Member State to apply special measures for derogation from the provisions of that Directive in order to simplify the procedure for collecting VAT or to prevent certain forms of tax evasion or avoidance.

By letter registered with the Commission on 8 April 2015, Latvia requested authorisation to continue to apply a measure derogating from the overall principles governing the right of deduction of input VAT in relation to certain passenger cars. Together with the request for extension, Latvia submitted a report covering the application of Council Implementing Decision 2013/191/EU which includes a review of the percentage foreseen for the limitation of the right of deduction. The request and report were further completed on 30 July 2015.

In accordance with Article 395(2) of the VAT Directive, the Commission informed the other Member States by letters dated 21 and 24 August 2015 of the request made by Latvia. By letter dated 24 August 2015, the Commission notified Latvia that it had all the information it considered necessary for appraisal of the request.

General context

Article 168 of the VAT Directive provides that a taxable person is entitled to deduct VAT charged on purchases made for the purpose of taxed transactions. Article 26(1)(a) of the same Directive requires the use of goods forming part of the assets of a business for private purposes to be a supply of services for consideration if the VAT on the goods was eligible for deduction. This system allows for the recovery of initially deducted VAT in relation to the private use.

In the case of passenger cars, this system is difficult to apply, in particular because it is difficult to identify the split between private and business use. Where records are kept, they add an additional burden to both the business and the administration in maintaining and checking them, even in case Latvia would make use of the option provided for in Article 168a of the VAT Directive to limit the deduction on expenditure related to company cars to the proportion of the taxable person's effective business use.

In order to simplify VAT collection and combat tax evasion, in 2011 Latvia requested an individual derogation allowing it to restrict the right of deduction to 80% in relation to certain passenger cars. The derogation request was approved by the Council by Decision 2013/191/EU of 22 April 2013 and expires on 31 December 2015. Some categories of vehicles were specifically excluded from this restriction, such as cars purchased for resale, hire or lease; cars used for transportation of passengers (such as taxis) or goods; cars used for driving lessons; cars used for guard or emergency services; cars used as car sales demonstration vehicle. At the same time, businesses would be relieved from accounting from tax on the private use.

In accordance with Article 6(b) of the above mentioned Decision, Latvia has presented a report covering the application of the Decision which included a review of the percentage restriction.

It appears from the information provided by Latvia that the 80% rate of deduction no longer corresponds to the actual circumstances and that this rate should be decreased to 50%. Latvia is supporting the new percentage limitation with statistical figures derived from a special tax on light vehicles owned or held by commercial operators that are used for private and business activities. According to the information submitted by Latvia, the special tax was paid for 79% of all roadworthy light vehicles held or owned by legal persons. Latvian authorities also provide that the percentages of the legal persons that have at least one light vehicle registered and which paid the special tax on light vehicles was 87.6% in 2012, 92.5% in 2013 and 86.2% in 2014. In addition, 99.6% of the registered businesses in Latvia are small and medium enterprises. Latvia considers that, on the basis of this statistical information which covers most of the taxable persons, it can be concluded that their overall private use of passenger cars corresponds to 50%. The new limitation should therefore be set at 50%.

All the other conditions of the derogation will continue to apply. Thus, the new system will apply to all passenger cars with a maximum of eight seats in addition to the driver's seat and under a certain weight that are not used exclusively for business purposes. In the same way, passenger cars which are used for certain specific activities would also be excluded from the restriction on the right to deduct and would be treated under the normal rules: cars purchased for resale, hire or lease; cars used for transportation of passengers (such as taxis) or goods; cars used for driving lessons; cars used for guard or emergency services; cars used as car sales demonstration vehicle.

Given the change in percentage, a new derogation is more suitable than an extension of the existing one. The new derogation should be limited in time to 31 December 2018 in order to assess whether the conditions on which the derogation is based would still be valid. Any extension request should be accompanied by a report which includes a review of the percentage applied and should be sent to the Commission with that request by 31 March 2018.