Opinion of the Economic and Social Committee on: - the 'Proposal for a Council Directive amending Directive 77/388/EEC as regards the rules governing the right to deduct Value Added Tax', and - the 'Proposal for a Council Regulation (EC) on verification measures relating to the refund system and administrative cooperation measures necessary for the application of directive 98/xxx/EC'
Date: 1999-01-28
Institutions: European Economic and Social Committee
Subjects: ESC opinion, EU control, VAT, administrative cooperation, tax relief

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those already in existence and those in the process of
being set up.

2.9.
The Committee has on many occasions expressed
its support for the principle of pre-accession aid for
agriculture in the applicant countries. Whilst well aware
that Community efforts are no more than a back-up for
action taken at national level, and can never replace the
efforts of the applicant countries themselves, there is
now growing concern that the ECU 500 million to be
earmarked annually for all ten CEEC applicants is
downright inadequate.

Brussels, 27 January 1999.

that

2.10.
the
The Committee would point out
numbers of those employed in agriculture in the CEEC
will fall dramatically in the next few years. The cost of
providing urgently needed jobs and social protection,
however, far exceeds the available resources of the
common agricultural policy. The Committee therefore
reiterates its proposal that, in addition to Phare, ISPA
and SAPARD, a stand-alone fund financed largely from
the EU budget be set up to cover the pre-accession
period. Given current political discussions about a
possible freezing of the EU budget, the Committee
would point out that such action would inevitably
have a serious impact on the proposed pre-accession
programmes.

The President

of the Economic and Social Committee

Beatrice RANGONI MACHIAVELLI

Opinion of the Economic and Social Committee on:

— the ‘Proposal for a Council Directive amending Directive 77/388/EEC as regards the rules

governing the right to deduct Value Added Tax’, and

— the ‘Proposal for a Council Regulation (EC) on verification measures relating to the
refund system and administrative cooperation measures necessary for the application of
directive 98/xxx/EC’ (1)

(1999/C 101/17)

On 27 July 1998 the Council decided to consult the Economic and Social Committee, under
Article 99 of the Treaty establishing the European Community, on the above-mentioned
proposals.

The Section for Economic and Monetary Union and Economic and Social Cohesion, which
was responsible for preparing the Committee’s work on the subject, adopted its opinion on
15 December 1998. The rapporteur was Mr Walker.

At its 360th plenary session (meeting of 28 January 1999) the Economic and Social Committee
adopted the following opinion by 99 votes to eight, with five abstentions.

1.

Introduction

1.1.
As a result of the changes made to the common
VAT system by the transitional arrangements, it was
possible to eliminate, on 1 January 1993, the checks and
administrative procedures prior to or on crossing an
internal border of the European Union, while safeguard-
ing to the maximum the Member States’ discretion for

(1) OJ C 219, 15.7.1998, pp. 16-20.

determining their national VAT systems, in particular
by retaining a large number of options and powers in
the Directive.

1.1.1. However, the abolition of physical barriers
placed greater emphasis on the intangible obstacles to
trans-national activities faced by businesses.

1.2.
The wide variety of rules for determining the
place where a transaction is taxed and, consequently,
the place where the tax is deducted or refunded, and the

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lack of uniformity in the way in which the present
system of VAT is applied, means that the Single Market
is effectively segmented into fifteen tax areas, creating
confusion, additional workloads, administrative compli-
cation and legal uncertainty for traders. Thus, traders
have to know the law, and the way in which it is applied,
in each Member State where they carry out taxable
transactions and in those Member States where they
incur VAT-bearing expenditure.

1.2.1.
Conversely, traders can exploit these differ-
ences by using clever tax accounting or manipulation,
and this distorts that fairness of competition which is
supposed to be the hallmark of the Single Market.

In July 1996, the Commission presented a work
1.3.
programme accompanied by a timetable of proposals
for the introduction of a genuine common system of
VAT suited to the demands of the Single Market. Under
this programme, Community action will be based on
three pillars:

— more uniform application of the tax;

— modernization of the tax, and

— a change in the taxation system (place of taxation).

1.4. However, independently of the move to a system
of taxation at the place of origin, the Commission
considers that it is now an urgent necessity to modernize
the general provisions of the present system and to
achieve more uniform application. This phase has
become the absolute priority of the work programme.

1.5.
In a working paper dated 14 May 1997, the
Commission also indicated that VAT obligations should
be one of the sectors to be covered in the second phase
of the SLIM (Simpler Legislation for the Internal Market)
initiative. The Commission felt that there was a need for
the immediate examination of simplification measures
which would reduce the burdens on business in the short
term and, at the same time, pave the way for the
introduction of the new common system of VAT.

The working party set up to examine the
1.5.1.
subject identified the VAT refund procedure laid down
in the Eighth VAT Directive as one of the subjects which
is in urgent need of simplification.

1.5.2.
Following the work of this group, the Com-
mission report on the SLIM initiative, approved by
the Internal Market Council on 27 November 1997,
recommended a study of how to achieve a radical reform
of the existing refund procedures in the Eighth Directive.

persons established in the Community to recover the
tax paid in a Member State in which they are not
established.

1.6.1.
The second section concerns expenditure not
eligible for a full deduction of VAT. This section forms
part of the exercise of modernizing the present system
and ensuring its more uniform application. The objective
of the proposed measures is to approximate the national
rules, which are currently very divergent in this area.
The need for this approximation has been intensified by
the judgement of the European Court of Justice in the
Aro Leasing (1) case.

1.7.
There is also a proposal for a regulation on the
measures for verification, the system for recovering tax
refunded to traders from the Member State in which the
expenditure was incurred and on the administrative
cooperation which will be required.

1.8.
The two sections of the proposed Directive, at
first sight independent of one another, are deemed to be
inseparable if the neutrality of the tax is to be assured.

1.8.1.
Firstly, if the rules governing the refund/deduc-
tion of tax paid in a Member State where the trader is
not established were amended without approximating
the right to deduct, this would provide a solution to
existing distortions of competition but would create
new distortions, in particular for suppliers of services
who were in direct competition on the market of a
given Member State and who were subject to different
deduction rules. Secondly, VAT is not fully deductible
under the proposed expenditure rules and Member
States retain a margin of discretion. The change in the
refund procedure prevents traders from exploiting any
resulting differences, so as not to create situations of
unfair competition.

2. The Commission proposals

2.1. Deduction of the VAT paid in a Member State
where the taxable person is not established

2.1.1.
The Sixth VAT Directive establishes the prin-
ciple that every taxable person is entitled to the deduction
or refund of VAT, regardless of the Member State in
which the VAT-bearing expenditure was incurred.

The Eighth VAT Directive harmonized,
2.1.2.
throughout the EU, the arrangements for the refund of

1.6.
The first section of the proposed Directive is the
outcome of this study. The objective of the proposed
measures is to simplify the procedures enabling taxable

(1) Judgement of the Court (Sixth Chamber) of 17 July 1997.
Case C-190/95. European Court Reports 1997 p. I-4383.

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VAT to taxable persons established in a Member State
other than that making the refund. The main objective
of that Directive is to place taxable persons who are not
established in the Member State where they pay VAT
on a similar footing to taxable persons established in
that Member State, who exercise their right to deduct
by directly setting-off the tax on their periodic returns.

welcomes the present proposals as being entirely consist-
ent with this view. At the same time, the Committee is
concerned by the length of time which it is taking to
implement the new common system of VAT and would
not wish the updating of the transitional system to have
the effect of impeding or delaying the introduction of
the new definitive system.

2.1.3.
In practice, the operation of the Eighth Direc-
tive refund procedure poses considerable problems both
for traders and the national administrations of the
Member States. On the one hand, traders find that they
are exposed to long-winded procedures and, sometimes,
adversarial attitudes which make it pointless to pursue
a claim; on the other hand, national administrations are
involved in time-consuming and tortuous verification
processes that yield no gain to their national exchequers.

2.1.4.
In the light of this situation, the Commission
has decided that remedial action is both necessary and
urgent. The details of the Commission’s proposals are
set out in Appendix 1.

2.2. Expenditure which is not eligible for full deduction

2.2.1. Without further harmonization of the rules
governing the right to deduct, the changes created by
the Commission’s proposals on the place of deduction
would have the effect of increasing the distortion of
competition because of differences between the rules of
the state where tax is paid and that where it is deducted.

2.2.2.
Appendix 2.

The Commission’s proposals are set out in

2.3. Verification, refund and administrative cooper-

ation procedures

2.3.1.
The Commission’s proposals for a regulation
governing the procedures for verification, the claiming
of refunds by Member States granting deductions from
the Member State in which the expenditure was incurred
and administrative cooperation procedures are set out
in Appendix 3.

3. General comments

In its opinion dated 11 July 1997 on the Com-
3.1.
mission proposals for a new common system of VAT (1)
the Committee stated that ‘The Economic and Social
Committee considers that the imminence of a substantial
change to a definitive system should not be allowed to
obscure the need for interim reforms to the existing
transitional system, which should then be carried for-
It therefore
ward into the new definitive system.’

(1) OJ C 296, 29.9.1997, p. 51. (Rapporteur: Mr Walker).

3.2.
The Economic and Social Committee has repeat-
edly expressed its strong support for the SLIM Initiative
and therefore endorses the Commission’s proposal to
implement the recommendations for the reform of
the Eighth Directive procedures which have been put
forward under this initiative.

3.3.
It is generally acknowledged that the Eighth
Directive refund procedure has fallen into widespread
disrepute both amongst traders and the representatives
of national administrations. At best, the procedure is
so complicated and time-consuming that traders are
exposed to uncertainty and frequently consider it more
cost-effective not to submit a claim while, in the worst
cases, the stance adopted by some Member States is so
obstructive that pursuing a claim is largely a waste of
time.

The result is that,

in an unacceptably high
3.4.
proportion of cases, traders are effectively discouraged
from obtaining a refund. They are therefore being
deprived of a right which is conferred upon them by the
Sixth Directive. This is incompatible both with the basic
principles of VAT and the concept of a Single Market.

3.5.
By the same token, national administrations find
the procedures so complex and costly to administer that
the vast majority of them have sought derogations.
Clearly, a system in which derogations are the rule
rather than the exception must be fundamentally flawed.

3.6.
The Commission has also established a con-
vincing case that the present situation leads to distortions
of competition. It must be recognized that absolute
equality of competition is an ideal towards which one
should strive while accepting that,

a)

it can never be wholly achieved; and,

b) each successive step along the way involves
additional cost and the nearer one approaches to
total equality the more exponential the increase in
cost becomes.

3.6.1.
It is worth bearing in mind that the costs
involved are not only financial but also political, in
terms of the inevitable loss of sovereignty.

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3.6.2.
Therefore, although the Member States would
be obliged, under the present proposals, to forego some
of the options which they currently have to impose
limitations on the right to deduct and apply national
interpretations to the definition of what constitutes an
allowable business expense for VAT purposes, this can
be justified by the need to eliminate or reduce distortions
of competition.

3.6.3.
In this context, it is important to remember
that, even where the level of distortion is not high in
terms of the overall balance of trade, it may result in
significant sectoral distortions which erode the fairness
of competition in those sectors affected.

The Economic and Social Committee accepts the
3.7.
proposition that the two sections of the proposal are
inextricably linked if the neutrality of the tax is to be
ensured.

3.8.
The Economic and Social Committee also accepts
that the discretion given to Member States at present,
and the differences of interpretation and application
which exist between different Member States, exposes
the system to the risk of tax fraud and legitimate
manipulation.

4. Specific comments

4.1. Deduction of the VAT paid in a Member State
where the taxable person is not established

4.1.1.
proposal is simplification of the existing procedures.

The primary aim of this section of the present

4.1.2.
The Economic and Social Committee agrees
with the Commission that the only change which can
significantly simplify the current system is to permit
traders to deduct VAT paid in Member States where
they are not established by setting it off against the tax
due in the Member State or Member States where they
are registered for VAT.

4.1.3. Where the taxable person is only identified in
a single Member State, this should create no problems
because all tax paid within the Community will be
deducted in that Member State, regardless of where it
was incurred, provided that it relates to legitimate
business expenditure.

4.1.4. However, were this section to stand alone, this
would still lead to distortions of competition because
the various Member States would apply different rules
in deciding what was, and what was not, legitimate
business expenditure in this context. That is why the
two sections are inter-dependent and must be seen as a

single proposal; neither will achieve the desired effect
without the other.

4.1.5. Where the taxable person is registered for VAT
in more that one Member State, the situation becomes
more complicated because situations can arise where it
is difficult, or even impossible, to determine the country
in which the taxable transactions (to which the goods
or services on which tax has been paid relate) have taken
place and, therefore, the country in which deduction
should be permitted.

4.1.5.1.
Take, for instance, the example of a lorry
which is owned by a German company, is registered in
the Netherlands and is used for transporting goods
between the UK and Italy, in both directions. The
company has physical establishments and is registered
for VAT in both countries. The situation is complicated
by the fact that in some cases the freight charges are
paid by the supplier and in others by the recipient. It
may be necessary to purchase fuel or tyres or replacement
parts or to have repair work carried out on the vehicle
during its journey through France, a country in which
the company has no physical presence or VAT regis-
tration and carries out no taxable transactions. It could
be very difficult in these circumstances to apportion the
right to deduct between the UK and Italy on anything
other than a purely arbitrary basis.

4.1.6. Nevertheless, this complication should not be
seen as reducing the value of the Commission proposals,
which represent a major improvement for both traders
and national administrations over the subsisting situ-
ation with the Eight Directive.

The requirement for taxable persons to present
4.1.7.
supporting documentation, broken down by Member
State, with their periodic returns, and to furnish copies
of the invoices or import documents, constitutes an
additional formality but the burden imposed by this on
businesses will be a great deal less than that which they
incur at present in making Eight Directive claims which
are, in many cases, fruitless.

4.1.8.
Under the Commission’s proposals, the regu-
lations governing the eligibility of expenditure for
deduction would be those of the Member State of
deduction and not those of the Member State where the
expenditure was incurred, as at present. The Economic
and Social Committee accepts the logic of this change.
The Member State granting the deduction can, of course,
obtain reimbursement from the Member State where
the tax was paid.

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4.2. Expenditure which is not eligible for full deduction

since what is considered a luxury in one context might
not be so in another.

4.2.1.
The objectives of this section are simplification
of existing procedures and the elimination of distortions
of competition. The latter can only be achieved by an
element of harmonization.

4.2.2.
It must be acknowledged that a great deal of
expenditure on accommodation, food and drink can
reasonably be regarded as legitimate business expendi-
ture because it is incurred primarily for business purposes
and would not have been incurred at all but for the
demands of the business; if, for example, a businessman
travels to visit a client and stays in a hotel, where he
consumes a meal, this should be regarded as business
expenditure because, were it not for the necessity of
visiting his client, he would not have made the journey
or stayed in the hotel or eaten that meal.

4.2.2.1.
It is true that he would have had to stay
somewhere and have eaten a meal, because shelter and
food are primary needs, but he could have satisfied these
needs by staying at home, where the shelter would have
incurred no incremental cost and the meal would have
been a great deal less costly.

By the same token, if a businessman takes a
4.2.2.2.
client to lunch, he does so in the hope of securing or
retaining his business and this can also be regarded as a
legitimate business expense.

4.2.2.3. However, it has to be conceded that charges
of this nature are open to abuse, in that they are often
ascribed to business activities when the primary purpose
is not commercial and, while such opportunities exist,
it would be naı¨ve to expect that they will not be
exploited.

4.2.2.4. Moreover,
it is undoubtedly difficult for
administrations to distinguish between legitimate and
fraudulent claims or to verify the element of business
expenditure where there has been a genuine combination
of business and private consumption.

4.2.2.5.
For these reasons, the Committee approves
the Commission proposal to apply a flat-rate deduction
limit of 50 % to charges of this nature as a practical and
pragmatic solution.

4.2.3.1. Differences between Member States in the
interpretation and application of these rules will continue
to give rise to some distortions of competition but the
Economic and Social Committee considers that the level
of distortion is unlikely to be significant in total or in
its impact on any particular sector.

4.2.4.
The Committee shares the Commission’s view
that entertainment expenses should be treated similarly
to luxury expenditure, as in principle they fall under the
heading of final consumption. There would therefore
be no right to deduct value added tax in respect of
entertainment expenses.

The position with regard to passenger cars is
4.2.5.
more complex in that the sums involved could have
significant budgetary effects on those Member States
(the majority) which do not currently grant any right to
deduct. On the other hand, the degree of distortion of
competition is more pronounced by virtue of this fact.

4.2.5.1.
The situation has been brought more sharply
into focus by the recent ruling of the European Court of
Justice in the Aro Leasing case, where it was held that
the leasing of motor vehicles is a service and does not
constitute a supply of goods. Under existing legislation,
this means that a taxable person located in one of those
Member States which do not grant a right to deduction
could lease a passenger car from a company established
in one of the three Member States (Germany, Holland
and Luxembourg) which do give a right of deduction
and could then make an Eighth Directive claim for
refund upon the Member State in which the leasing
company was established. It would not be necessary for
the vehicle to originate or be registered in that Member
State or ever to have entered its territory.

4.2.5.2.
Clearly, this ruling gives rise to the potential
for major distortions of competition although, in prac-
tice, the impact may be greater in some Member States
than in others. Those Member States which do not
currently give a right to deduct stand in considerable
danger of substantial loss of revenue and any estimation
of the budgetary effects of the Commission proposals
on those Member States should be seen in the light of
this situation.

The Committee agrees with the Commission
4.2.3.
that luxuries, however defined, should continue to be
ineligible for deduction but believes that considerable
scope will remain for differences in interpretation
between the Member States on what constitutes ‘luxury’
expenditure, as this is largely a subjective judgement.
Furthermore, it is not susceptible to a single definition,

4.2.6.
The Commission proposals would resolve the
Aro Leasing problem and they represent a significant
improvement on the subsisting situation for both traders
and national administrations but they remain complex
and the options granted to the Member States create the
potential for residual distortions of competition due to
differences in the way in which Member States elect to
exercise the options.

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the Committee welcomes

4.2.7. However,
the
improvement of the situation brought about by the
Commission proposal. Further
simplification, e.g.
across-the-board application of the 50 % rate, would
produce unequal tax treatment on a large scale, as
individual groups of citizens would derive a dispro-
portionate benefit from it, whilst government might be
deprived of considerable funds.

4.2.8.
The Committee would point out that, where
an expense is deemed to contain elements of both
business and private expenditure and the right to deduct
is withheld in respect of the latter, it is inconsistent to
require output tax to be levied on that portion of the
expenditure, since this would effectively constitute
double taxation. This would apply even where a
company was reimbursed by an employee for the private
element of the expenditure incurred.

4.3. Verification, refund and administrative cooper-

ation procedures

4.3.1.
The Economic and Social Committee, agrees
with the Commission that the present proposals will
substantially assist the verification process because the
national administrations in each state will be dealing
with traders who are registered for VAT in that State
and of whom they have some background knowledge.
Directive 77/799/EEC on mutual assistance enables the
Member States concerned to exchange any information
they consider necessary in order to exercise their
respective powers of inspection.

the Committee notes that past
4.3.2. However,
experience has shown that the Member States are not
yet making full use of the opportunities provided by
the Community instrument and that, as a result, the
Commission has felt obliged to provide for additional
measures of verification in the interim.

As

the Commission acknowledges,

4.3.3.
these
additional measures reduce the simplifying effects of
changing the deduction system and are only acceptable
in the short term. The Committee welcomes the Com-
mission’s assertion that the length of time for which
they are applied must be strictly limited to the time
required to improve cooperation between the Member
States. It notes with approval that the Commission will
regularly examine the use of these measures and their
practical results for Member States.

4.3.3.1.
The Committee urges the Commission to
repeal these measures at the earliest possible opportunity
and, in order to achieve this, to encourage Member
States by all means in its power to improve their levels
of cooperation.

5. Conclusions

5.1.
The Economic and Social Committee welcomes
the Commission proposals as representing a fundamen-
tal improvement on the position which currently per-
tains. Businesses and national administrations alike
would be relieved of a considerable proportion of the
burdens which they presently have to bear and, for
many traders, obtaining the refund of tax paid in
Member States in which they are not established would
at last become a reality.

5.2.
For these reasons, the Committee approves the
proposal to allow traders to deduct VAT incurred in
Member States where they are not established from their
periodic returns in those Member States where they
are established and to abolish the Eighth Directive
procedure. It agrees that this is the only effective way to
simplify the present system.

5.2.1.
The Committee also broadly approves the
proposals concerning expenditure which is not eligible
for full deduction.

5.3.
The Committee hopes that the period for which
the additional verification measures are in force will be
curtailed to the greatest possible extent.

5.4.
The Committee regards the present proposals
as constituting a further important step towards the
creation of a true Single Market, in line with its previous
recommendation that ongoing reforms to the existing
VAT system should continue to be carried out pending
the introduction of a new definitive system. Nevertheless,
it considers that these measures do no more than tinker
with problems that can only be finally resolved by a
new common system of VAT. In this context, it calls
upon the Member States to adopt a constructive and
positive approach to the subject of VAT reform in the
interests of European integration and the realization of
the Single Market.

In its Annual Report concerning the financial
5.5.
year 1997 (1), Court of Auditors said of the present
transitional VAT arrangements that, ‘In spite of the
introduction of an a posteriori system of information
exchange (VIES), the potential for fraud has thus been
increased’. The report went on to say that, ‘In the
absence of a viable alternative, the current “transitional”
system will remain in place for several more years.
Substantial improvements appear unlikely in the absence
of a clear determination to give priority to fighting fraud
in intra-Community trade’. The ESC endorses the
position taken by the Court of Auditors and stresses the

(1) OJ C 349, 17.11.1998, pp. 16-17.

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need for the Member States to find the political will and
determination to agree on a new definitive system of
VAT without further delay. It would point to the fact

that the present transitional arrangements came into
force on 1 January 1993 and were intended to last only
until 31 December 1996.

Brussels, 28 January 1999.

The President

of the Economic and Social Committee

Beatrice RANGONI MACHIAVELLI

APPENDIX I

to the opinion of the Economic and Social Committee

In practice, the operation of the Eighth Directive refund procedure poses considerable problems for both
traders and the national administrations of the Member States.

First, the procedure has given rise to complaints, from traders, and in particular that:

— administrative formalities are burdensome (requests must be made in an official language of the
country of refund, documents must be presented by fixed time limits, etc.). In practice, traders are
frequently obliged to employ local advisors to handle them;

— more and more Member States are failing to respect the time limits for refunds laid down by the
Directive. Thus traders are compelled to pay the tax in advance and shoulder the cost over long
periods this can represent a considerable financial burden. Uncertainty as to when the refund will be
made and, consequently, as to the size of financial burden to be borne creates uncertainty for traders
as to the costs to pass on to their customers;

— national administrations apply the provisions of the Eighth Directive extremely literally and rigidly,
so that requests are frequently rejected on technicalities and traders are given the impression that
national administrations wish to discourage the use of the refund procedure.

The burden and the cost of administrative formalities, together with the extended period for refund
payments, mean that taxable persons who are entitled to a refund of VAT are discouraged from
exercising that right. As a result, the practical difficulties which taxable persons encounter in making a
claim undermine the very principle of the deductibility of the tax and its intended neutrality irrespective
of the Member State of supply.

On the other hand, the refund procedure creates considerable problems for the competent national
administrations, since it has proved more difficult that expected to operate. Each refund request involves
a physical intervention by the administration of the Member State of refund. The Member States must
consequently allocate a significant number of officers to the completion of tasks deemed to be
unproductive, the purpose of which is to refund a tax collected on the national territory to taxable
persons from other countries. Even more important is the lack of effective verification as to whether
applications for refund, and the amounts to be refunded, are justified. The information available allows
the Member State to verify only:

— the applicants’ status as taxable persons (on the basis of certification by the Member States in which

they are established);

— the conformity of the invoices or import documents;

— the correct application of the limits to the right to deduct which are in force in the Member State of

refund.

However, the Member State of refund has no information as to how the expenditure is actually divided
between activities which are taxed, exempt or outside the scope of VAT or as to how the right to deduct
is exercised (according to the proportion deductible or actual attribution). Thus, the Member State is
unable to take account of the taxable person’s overall tax situation and is obliged to take decisions on
the basis of incomplete information.

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The Member States are well aware of this situation; in 1993, the complexity and cost of the procedure
led eleven of the then twelve Member States to ask for a derogation on the basis of Article 27 which
would enable them to introduce special measures for taxing certain work on moving, tangible property
located in the territory of the country but directly related to the intra-EU transport of goods, so that
traders would not have to use the Eighth Directive as a matter of course.

These derogations, authorized by Council Decisions, were justified by the fact that the increasing use of
the refund procedures could impede the development of intra-Community trade in certain services.

The Council also amended the fifteen Commission proposals for a Decision on special measures for the
taxation of telecommunications services, with a view to simplifying collection of the tax, so that
operators did not have to use the Eighth Directive procedure.

In view of these problems, it was not unexpected for the SLIM Initiative to make a recommendation on
the Eighth Directive refund procedure, which was supported by representatives both of national
administrations and the business community.

It should be stressed that these difficulties will be definitively resolved by the introduction of the new
common system of VAT, as set out in the work programme adopted by the Commission in July 1996.

Under this new system, based on the principle of taxation in the country of origin and on a single place
of taxation and deduction, every taxable person would be able to deduct the VAT in one place, even if
the transaction were taxed in another Member State. Consequently, the Eighth Directive procedure
would become redundant.

The Commission has, however, decided to react promptly to the SLIM recommendations, while bearing
in mind that any legislative initiative in this area can only be of a temporary nature, pending the entry
into force of the new common system of VAT.

The objective of the present proposal is therefore to improve the operation of the existing system of
VAT in the short term by simplifying a procedure which, in the view of the business community, impedes
the operation of the Single Market, while not undermining the continuation of the work envisaged by
the work programme for the new common system.

Consequently, certain parts of the present proposal will be revised as and when proposals for the
introduction of the future system are presented.

The Commission is proposing additional verification measures, the justification and need for which will
be regularly reviewed, with the sole object of immediately permitting adequate monitoring of the
deduction on the absence of satisfactory cooperation between Member States in the area of verification.

Another consequence is that, were the Council not to adopt the present proposal within a reasonable
period, the Commission would feel obliged to withdraw it, so that the Council did not have to go on
discussing a proposal which could not achieve its objective and which, if adopted belatedly, could
jeopardize the transition to the new common system.

The Commission takes the view that the only change which can, in fact, significantly simplify the
common system of VAT in general, and the refund procedure in particular, is to authorize taxable
persons to deduct the VAT paid in a Member State where they are not established, by setting it off in
their periodic returns against the amount of VAT for which they are liable in a Member State where
they carry out taxable transactions, for which the VAT-bearing goods or services are used.

The purpose of this present proposal is to introduce this right to deduct into Article 17 of the Sixth
Directive, with the result that the special refund procedure for taxable persons established in the EU
(i.e., the procedure laid down in the Eighth Directive) will disappear.

In substance, the proposed measures, which take the legal form of an amendment to paragraph 3 and
the inclusion of paragraph 3a in Article 17, achieve the following result, as regards taxable persons
established in the European Community:

— the taxable person is identified in a single Member State: the VAT is deducted in that Member State,

irrespective of the Member State where he incurred the VAT-bearing expenditure;

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— the taxable person is identified in several Member States:

a) he is identified in the Member State where he has incurred the VAT-bearing expenditure:

the VAT is deducted in that Member State (no change as compared with the present situation).

b) he is not identified in the Member State where he has incurred the VAT-bearing expenditure:

the VAT is deducted in the Member State where he supplies goods or services for which the
expenditure is used.

It follows logically from this amendment of Article 17 that the amount of VAT eligible for deduction
will now be determined according to the rules of the Member State of establishment, and no longer
according to the rules of the Member State which collected the tax, as is the case at present.

In terms of formalities, this proposal requires taxable persons to present a specific document, to be
attached to their periodic return, on which they enter the VAT amounts paid in other Member States
for which they are exercising their right to deduct. These amounts are to be broken down by Member
State. A copy of the invoices or import documents is to be attached to this specific document in order to
provide proof.

APPENDIX II

to the opinion of the Economic and Social Committee

As regards the rules for the deduction of VAT, Article 17(6) of the Sixth Directive states that:

‘Before a period of four years at the latest has elapsed from the date of entry into force of this Directive,
the Council, acting unanimously on a proposal from the Commission, shall decide what expenditure
shall not be eligible for a deduction of value added tax. Value added tax shall in no circumstances be
deductible on expenditure that is not strictly business expenditure, such as that on luxuries, amusements
or entertainment.

Until the above rules come into force, Member States may retain all the exclusions provided for under
their national laws when this Directive comes into force.’

Proposals submitted by the Commission failed to find a consensus in the Council and were finally
withdrawn on 21 November 1996 as a logical consequence of the Commission’s adoption in July 1996
of the work programme for the introduction of a new common system of VAT.

In the meantime, Member States have approached the issue in different ways. Three of them (Germany,
Holland and Luxembourg) grant the right to full deduction in accordance with Article 17(2) for the
expenditure in question, or for the most important categories of such expenditure, the only exclusion
being that which has no business characteristic. The remainder exclude or limit the right to deduct so as
to eliminate or substantially simplify cases where a distinction has to be made between expenditure
relating to the private needs of the taxable person and others, and expenditure connected with the
economic activities of the taxable person.

This situation does not meet the essential requirements of uniformity of the basis of assessment and tax
neutrality.

The taxable persons of a Member State which authorizes full deduction of the tax for all expenditure
except that which has no business characteristics enjoy an advantage over taxable persons of a Member
State where some categories of expenditure are excluded from the right to deduct. This can lead to
distortions of competition in international trade in goods and services, in so far as its effects are reflected
in the price.

Although the existence of this diverse treatment is not a new problem, the establishment of the Internal
Market on 1 January 1993 highlighted these differences far more sharply by bringing national laws, and
the way they are applied in the Member States, into more direct juxtaposition.

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The Commission therefore feels it necessary to act on the mandate conferred upon it by Article 17(6) of
the Sixth Directive and to resume the approximation of the different national rules which exist at
present, while leaving Member States some margin of discretion to take account of their specific
situations.

It should not be forgotten that the right to deduct is a basic feature of the VAT system; consequently,
any exclusion from this right is an exception to the rule and is unacceptable unless it is specifically
justified.

Clearly, therefore, it must be confined to categories of expenditure which, even when incurred as part
of the normal running of a business, usually contains some element of the final and private consumption.
In general, moreover, it should apply to situations where there can be no real verification of how such
expenditure is apportioned between the business and private elements, so that risks of abuse or tax fraud
are created.

Typically, such expenditure is that relating to passenger cars, expenditure on accommodation, food and
drink, and expenditure on luxuries, amusements or entertainment.

Expenditure on passenger cars must be considered to refer to capital goods, the non-business use of
which cannot be ruled out and which, above all, may change from year to year.

Although expenditure on accommodation, food and drink can be incurred because of the business
activity, exercised, it can also be said to have private characteristics, since it is expenditure which satisfies
primary needs.

It should be borne in mind that the basic principle that the tax charged on goods and services used for
the purposes of taxed transactions is deductible means that the deduction cannot apply to expenditure
which is not of a strictly business nature, such as expenditure on luxuries, amusements or entertainment,
in accordance with the present version of Article 17(6).

The Commission proposal incorporates various systems to take account of the specific nature of such
expenditure as part of the activity of taxable persons.

In general, the normal deduction rules would apply to the VAT on expenditure relating to passenger
cars. However, if difficulties in verifying the non-business use of these goods were so great that they
prevented a Member State from applying the normal deduction rules in practice, an optional system for
limiting the deduction would be established, enabling Member States which so wished to measure the
non-business use of passenger cars in a simplified fashion.

A Member State which made use of this option could set a maximum percentage for deduction which
might not be lower than 50 % of the input tax, this amount corresponding to the maximum business use
which, it is assumed, would have been or would be made of the passenger cars.

By utilizing this option, the administration would not need to monitor the way in which a substantial
majority of taxable persons apportioned the private and business usage of their passenger cars in their
accounts.

However, where the percentage of business use was not as high as the percentage of the ceiling for
deductible VAT set by the Member State of the deduction, the deduction would be made according to
the normal rules.

Application of a maximum deductible percentage enables a simplified distinction to be drawn between
the input tax which is:

a) related to the non-business use of cars (i.e. private use but also use linked to transactions outside the

scope of VAT); and,

b) related to the business use of cars i.e., for transactions within the scope of VAT, both transactions in

respect of which VAT is deductible and exempt transactions where VAT is not deductible.

Consequently, where the taxable person carried out both transactions in respect of which VAT was
deductible and transactions in respect of which VAT was not deductible, the proportion of input VAT
relating to the business use of passenger cars would still have to be analyzed in order to determine the
VAT attributable to the former and latter transactions.

However, when the business use of the goods in question was negligible, the time spent by the
administrations on the verification process would not be commensurate with the results. That is why
the present proposal provides for total exclusion from the right to deduct where the business use is less
than 10 %.

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Special consideration is given to taxable persons whose business activity consists in the operation of
passenger cars or who rely on such goods to engage in their activity (e.g. taxable persons whose economic
activity consists of the sale, hire, renting or leasing of passenger cars or who operate taxis, driving
schools etc.). In this case, the normal deduction rules are applied, but only if any non-business use is
negligible (i.e. less than 10 %).

As regards expenditure on accommodation, food and drink, the Commission feels that their characteristic
of final consumption may justify their exclusion from the right to deduct. However, such expenditure
may be caused by the needs of the business activity (e.g. because it is incurred in the course of business
travel). Therefore, a flat-rate limit on the deduction is considered fair, with the flat-rate percentage for
deduction being set at 50 % of the VAT charged on expenditure on accommodation, food and drink.

However, deduction would continue to be completely ruled out for expenditure that is not directly and
strictly linked to the needs of the taxed transactions (i.e. expenditure on luxuries, amusements and
entertainment).

APPENDIX III

to the opinion of the Economic and Social Committee

A bilateral refund and compensation system for debts

This document contains the information required to operate a refund system between the Member
States, so that the Member State in which the deduction is made (Member State of deduction) can obtain
a refund thereof from the Member State where it was paid (Member State of purchase). The attached
proposal for a Regulation deals with this debt refund and compensation system, and with the verification
measures to be established by the Member States.

The proposal for a Regulation provides for the introduction of a debt compensation and refund system
which operates bilaterally between the Member States. For this purpose, each Member State will, every
six months, inform each of the other Member States of the amount of VAT deducted during the past
half year which the Member State of purchase is required to refund.

The amount to be notified represents the amount of VAT actually deducted, i.e. after application of the
proportion when the taxable person is engaged both in activities in respect of which VAT is deductible
and activities in respect of which VAT is not deductible, and after the limits on the right to deduct which
are in force in the Member State of deduction have been applied.

In this way, any Member State can establish the balance payable to or receivable from the other Member
States. These balances are actually paid at a later date, because they may still be adjusted as a result of
the verifications laid down by the Regulation. However, there is provision for the Member States, by
bilateral agreements, to derogate from the deadline laid down by the Regulation by setting other
deadlines or, in certain circumstances, by allowing the balance to be carried over until the following
period.

Verification measures

Under the present VAT system, each Member State is responsible for applying, monitoring and collecting
the tax, which goes directly into its national budget. One of the basic principles of this system is that the
VAT is deducted in the Member State where the tax was due and/or paid. A single Member State is
therefore responsible for verifying payment and deducting the tax.

The purpose of the present proposal is to introduce a derogation from the above principle for the cases
today covered by the Eighth Directive.

As a result, for the transactions concerned, the Member State of purchase will be responsible for verifying
that the VAT has been paid, whereas the Member State of deduction will be responsible for monitoring
the deduction of that tax.

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Like any other verification, this should be based on the knowledge which the tax administrations have
of their taxable persons, on how their reliability is assessed, the fraud risk that these taxable persons
represent and on thorough and efficient cooperation with the administrations of the other Member
States. Effective control in the Internal Market requires the establishment of common criteria for
assessing the fraud risk that a taxable person represents, rather than the routine forwarding of copies of
invoices which constitutes an additional burden for both taxable persons and administrations. The cases
which, on the basis of these common criteria, are identified as requiring more thorough monitoring,
would be of interest to all the administrations concerned. This would enable them, as a result of their
mutual interest in effective cooperation, to exploit to the full the information and experience they
possess.

Directive 77/799/EEC on mutual assistance enables the Member States concerned to exchange any
information they consider necessary in order to exercise their respective powers of inspection. Past
experience demonstrates, however, that the Member States are not yet making full use of the opportunities
provided by this Community instrument.

In view of this experience, and of the special nature of the proposed system, which seeks to improve the
operation of the present VAT system, the Commission is obliged to provide for additional verification
measures to accompany its introduction.

These additional measures reduce the simplifying effects of changing the deduction system and are only
acceptable in the short term. The length of time for which they are applied must be strictly limited to
the time required to improve cooperation between the Member States.

The Commission will regularly examine the use of these measures and their practical results for the
Member States. For this purpose, the Member States are required to provide the Commission with the
necessary information. The Commission will present to the Council, by the end of the second year in
which these measures are applied, a report on whether they are justified and necessary as part of its
monitoring of the cooperation between the Member States on verification, where necessary accompanied
by proposals repealing the said measures.

As regards the verification measures laid down by the present proposal, it is important to bear in mind
the nature of most of the expenditure for which refund requests are now made under the Eighth Directive
procedure.

Because of the rules for the location of transactions, most of these requests relate to general costs, such
as hotel and restaurant costs, costs connected with taking part in fairs and the vehicle and motor fuel
costs of international road transport operators.

It is therefore unlikely that the proposed system, under which these amounts will be set off against the
tax owed by the taxable person, will substantially increase the situations in which operators are entitled
to high tax credits, which usually require more monitoring by the administration.

Consequently, it is necessary to ensure that the verification measures proposed specifically for operating
the deduction system are not disproportionate to the risks of tax losses for the Member States.

The measures provided for by the Regulation result in several-stage verification and for each of the
stages establish the financial responsibilities of the Member States concerned.

This phased verification has a great advantage over the present system, since it does not require the
administration to take an ‘immediate and virtually final’ decision, as it the case today.

First, the administration of the Member State of deduction carries out an initial verification when it
receives the periodic return, the specific document and its annexes. Unlike the administration of the
Member State of refund under the present system, the competent administration will already possess
more precise data concerning the tax situation of the taxable person.

Clearly, the amount corresponding to the adjustments that are necessary following this initial verification
is not included in the amount of VAT which the Member State of deduction requires the Member State
of purchase to refund.

Next, the Member State of deduction provides the Member State of purchase with information, normally
in electronic form, concerning certain transactions for which a deduction under Article 17(3a) is made.

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When the Member State of purchase detects irregularities relating to the transactions for which the
deduction has been made, it must inform the Member State of deduction thereof within three months of
receiving the information. In addition, the Member State of purchase is not required to refund the
amount of VAT in question to the Member State of deduction.

It is up to the Member State of deduction to take the recovery measures it considers appropriate,
particularly in the light of the tax situation of the taxable person in question (filing of periodic returns,
payment of the tax due, other existing tax debts).

In addition, irrespective of the place where the VAT was paid, the Member State of deduction examines
whether the deduction made is justified, as part of the scheduled inspection of all the taxable person’s
activities.

Lastly, under the verification procedure laid down by this proposal there is nothing to prevent the
administrations from requesting information by utilizing the mutual assistance Directive procedure.

Also, the Commission is well aware of the fact that the non-harmonization of information that has to
appear on invoices is liable to pose problems. However, this problem already exists in normal
intra-Community trade (supplies/intra-Community acquisitions, intra-Community transport, etc.) the
only difference being, in the present case, that VAT is actually invoiced in the Member State of purchase.
The SLIM report also contains a recommendation to study this problem. The Commission will not fail
to act on this recommendation.

Pending the outcome of such work, the operation of the proposed system requires a minimum of
flexibility from the Member States. They have to ensure that a taxable person in possession of an invoice,
which mentions at least the information required by the Sixth Directive, is not prevented from exercising
his right to deduct.

Nevertheless, an administration has the right to request from the taxable person a translation of the
invoice entries in cases where it is unable to assess the business nature of the expenditure.

APPENDIX IV

to the opinion of the Economic and Social Committee

(In accordance with Rules 47 (3) of the Rules of Procedure)

The following amendments, which received at least one quarter of the votes cast, were defeated during
the discussion:

Amendment tabled by Mr Tosh and Mrs Williams

Point 4.2.4

Replace by the following:

‘4.2.4.
expenditure on accommodation, food and drink rather than being equated with luxury expenditure.’

The Committee believes that entertainment expenditure should be treated in the same way as

Reason

Entertainment expenditure is a legitimate business expense since the primary purpose of corporate
entertaining is to secure or increase business. While there is an element of private consumption, this
places it in the same category as expenditure on accommodation, food and drink. It should not be
treated in the same way as luxury expenditure which, by definition has no appreciable benefit for the
business.

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Result of the vote

Against: 51, for: 25, abstentions: 4.

Amendment tabled by Mr Lustenhouwer and Mr Regaldo

Point 4.2.7

Replace by the following:

‘4.2.6.1.
The Economic and Social Committee sees no compelling reason why passenger cars should
not be subject to the same flat-rate deduction as the other categories of expenditure dealt with in these
proposals and believes that this would make an important contribution to reducing the distortion of
competition and restricting the scope for fraud and legitimate manipulation.

4.2.6.2. Wide disparities between the rates of deduction permitted in different Member States would
place traders operating in those countries with low rates of deduction at a competitive disadvantage
with traders established in countries with higher rates of deduction and this would inevitably lead to the
development of complex systems for circumventing the rules, legally or otherwise.

4.2.6.3. Moreover, it should be borne in mind that VAT becomes payable when a car is first purchased
and at that point it is not possible to determine with any degree of accuracy what the ratio of business
to private use may be throughout its working life. This could vary from year to year and, in the absence
of a single flat-rate, that would give rise to the need for retrospective adjustments, thereby creating
additional complications for traders and national administrations alike.

4.2.6.4.
A flat-rate would also introduce a desirable measure of simplicity into the situation. For
instance, it would no longer be necessary for traders to keep records of, or for administrations to verify,
the percentage of business use or to distinguish between business use relating to taxable and non-taxable
transactions.

4.2.6.5.
The Economic and Social Committee would point out that, if the object of the exercise is to
simplify (and that is one of the Commission’s declared aims), then the procedures should be made as
simple as possible and it does not seem that this has been achieved by the present proposals. Where a
Member State exercises the option, it will still be necessary to verify at least approximately the percentage
of business mileage and it may be necessary to make retrospective adjustments. This will impose
additional work on both national administrations and traders, while creating an element of uncertainty
for the latter.

4.2.7.
and helicopters, should not be brought within the scope of these regulations.’

Logically, there seems to be no reason why other forms of private transport, such as aeroplanes

Reason

The present text was incorporated in the draft opinion as a result of an amendment approved by a
majority vote at the section meeting. As a result of this vote, the present point 4.2.7 replaces six
paragraphs drafted by the rapporteur.

The aim of this amendment is to restore the rapporteur’s original text because the present version does
not tally with the Commission proposals and would produce an incomprehensible opinion (on this
point).

Result of the vote

Against: 56, for: 39, abstentions: 8.