Proposal for a Council Directive amending Directive 77/388/EEC as regards reduced rates of value added tax .
Date: 2003-07-23
Institutions: European Commission
Subjects: EU situation, European tax cooperation, VAT rate, application of EU law, derogation from EU law, tax harmonisation, tax reform

COMMISSION OF THE EUROPEAN COMMUNITIES

Brussels, 23.7.2003
COM(2003) 397 final

2003/0169 (CNS)

Proposal for a

COUNCIL DIRECTIVE

amending Directive 77/388/EEC as regards reduced rates of value added tax

.

(presented by the Commission)

1.

1. 

2. 

3. 

4. 

5. 

2.

6. 

1

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3

4

EXPLANATORY MEMORANDUM

INTRODUCTION

In  its  2000  Communication,  the  Commission  defined  a  strategy  to  improve  the
operation of the VAT system in the internal market.1 The viable strategy it proposed
is based on four main objectives: simplification and modernisation of current rules,
more  uniform  application  of  current  legislation  and  a  new  approach  to
administrative cooperation.

The  Commission  proposed  a  phased  action  programme  to  make  concrete  and
essential improvements to the current system in the short term. It noted that a review
and rationalisation of the rules and derogations applying to VAT rules would have to
be  considered  in  the  medium  term  (point  2.10  of  the  Annex  setting  out  possible
measures).

In its 2001 report on reduced VAT rates,2 the Commission made it clear that the time
had come to look at the current structure of reduced rates as their complexity  was
the reason for most of the requests received by the Commission.

However,  there  are  no  plans  to  change  the  level  of  rates  during  the  period  in
which the new strategy is to be implemented. The minimum standard rate was set at
15% until 31 December 20053 and there would not appear to be any reason to reopen
the debate on this under this review of the scope of reduced rates.

This explanatory memorandum assesses the impact of the current structure of VAT
rates  on  the  functioning  of  the  internal  market  and  the  proposed  directive  which  it
accompanies  contains  the  changes  and  rationalisation  of  current  rules  and
derogations  which  the  Commission  considers  necessary.  Taking  Article  93  of  the
Treaty  as  its  basis  it  must  comply  with  the  objectives  set  out  there,  viz.
"harmonisation  of legislation concerning turnover  taxes, excise  duties and  other
forms  of  indirect  taxation  to  the  extent  that  such  harmonisation  is  necessary  to
ensure the establishment and the functioning of the internal market".

This  also  takes  account  of  the  report  which  the  Commission  is  required  to  make
every two  years to the Council so it can  review the scope of  reduced rates (second
subparagraph of Article 12(4) of the Sixth VAT Directive).

BACKGROUND

The  current  rules,  which  were  introduced  by  Directive  92/77/EEC,4  are  based  on  a
definition  of  minimum  rates:  15%  for  the  standard  rate  and  5%  for  reduced  rates.
Member  States  may  apply  one  or  two  reduced  rates  to  the  goods  and  services
contained  in  a  restrictive  list  (Annex  H).  A  large  number  of  specific  derogations

COM(2000) 348 of 7 June 2000.
COM(2001) 599 of 22 October 2001.
Council  Directive  2001/4/EC  of  19  January  2001  (OJ  L  22,  24.1.2001,  p.  40;  amending  OJ  L  26,
27.1.2001).
Council Directive of 19 October 1992 (OJ L 316, 31.10.1992).

2

                                                
allowing Member States or certain of them to apply different rules have been grafted
on to these basis rules. This has created an extremely complex situation which needs
to be reviewed.

7. 

8. 

The second subparagraph of Article 12(4) of the Sixth VAT Directive states that “on
the  basis  of  the  report  from  the  Commission,  the  Council  shall,  starting  in  1994,
review  the  scope  of  the  reduced  rates  every  two  years.  The  Council,  acting
unanimously  on  a  proposal  from  the  Commission,  may  decide  to  alter  the  list  of
goods and services in Annex H”.

However,  in  its  communication  in  2000  on  the  VAT  strategy,  the  Commission
broadened the discussion beyond a simple amendment of Annex H indicating that the
time  had  come  to  review  and  rationalise  the  rules  and  derogations  applying  to
reduced VAT rates.

2.1.

First Commission reports on reduced rates

9. 

2.2.

10. 

11. 

12. 

5

6

7

8

9

The Commission presented the first report on 13 December 19945 and the second on
13 November  1997.6  However  these  reports  did  not  cause  the  Commission  to
propose  a  general  review  of  the  scope  of  reduced  rates7  as  it  considered  that  there
was no real need to do so and that the matter should be addressed in its entirety in the
proposals on the adoption of the definitive VAT system.8

The last report of 22 October 2001

The  report  states  from  the  outset  that  under  the  new  VAT  strategy  greater
harmonisation  of  rates  could  only  be  considered  in  the  long  term.  However,  a
thorough review of the rules applying to reduced rates could already be undertaken
after  examining  and  drawing  conclusions  from  the  experimental  application  of
reduced rates to labour-intensive services.9 The report states that in order to prepare
for  such  a  review  the  current  structure  of  reduced  rates  should  be  re-examined,  no
new  derogations  be  introduced  and  abolition  of  all  or  some  of  the  derogations
currently applying should be considered. This is fully consistent with the objectives
of the new VAT strategy.

The failings of the internal market perceived by traders, particularly in the tax field,
as  a  result  of  differences  between  VAT  rates,  are  a  reality  that  must  be  taken  into
account.

The report was intended (point 64) to stimulate consideration by business circles and
Member  States  of  the  role  of  reduced  rates,  their  effectiveness  as  tools  of  various
Community or national policies and possible improvements or rationalisations. In the
interim, the Commission has received numerous submissions from different branches
of the economy setting out their analysis and requests.

COM(94) 584 final.
COM(97) 559 final.
The  only  change  made  concerned  the  reduced  rate  for  live  plants  and  flowers  (Council  Directive
96/42/EC of 25 June 1996 amending  Directive  77/388/EEC  on  a  common  system  of  value  added  tax
(OJ L 170, 9.7.1996, p. 34).
Article 28l and COM 328(96) final of 10 July 1996.
Directive 1999/85/EC of 22 October 1999 (OJ 277, 28.1.2002).

3

                                                
13. 

In the report (point 65) the Commission discusses one option which was designed to
launch a debate on the role of reduced  rates, their effectiveness as an instrument in
Community  or  national  policy  and  any  improvements  and  rationalisation  needed.
This  would  be  to  establish  a  structure  based  on  two  reduced  rates  (possibly  with  a
specific band for each category) applicable to individual lists of goods and services:10

– 

– 

a  reduced  rate  near  the  current  minimum  of  5%  for  a  shortlist  of  goods  and
services which are either basic necessities or fulfil a social objective (possibly
mandatory since the great majority of Member States already apply a reduced
rate to such goods and services);

a  higher  reduced  rate  applicable  to  a  list  of  goods  and  services  which,  for
historical  or  for  reasons  of  economic  expediency,  should  be  the  subject  of
differentiated  treatment  in  relation  to  the  goods  and  services  subject  to  the
standard rate or which fulfil other objectives.

14. 

The report concludes by pointing out the following factors:

(a)

the  properties  of  VAT,  and  in  particular  the  obligation  to  guarantee  its
neutrality;

(b)

the need to define clear criteria for applying reduced rates;

(c)

the long-term objective of further harmonisation of rates and rationalisation of
derogations.

The report is generally considered to faithfully reflect the situation concerning rates
in the European Union and there were no new developments in 2002.

Conclusions  of  the  experimental  application  of  VAT  rates  to  labour-intensive
services

This experiment was introduced by Directive 99/85/EC for a  period  of  three  years.
On 3 December 2002,11 the Council adopted a Directive extending by one year (up to
31 December 2003) the reduced rates applying to labour-intensive services in order
to  guarantee  continuity  and  legal  certainty  for  the  sectors  currently  eligible  for  the
reduced  rate  until  the  Commission  and  the  Council  had  completed  a  thorough
evaluation of the results of this experiment.

In  its  report  of  2  June  2003,12  the  Commission  evaluated  the  effectiveness  of  the
experiment  in  terms  of  job  creation  and  efficiency.  On  the  basis  of  assessment
reports  from  the  Member  States  which  took  part  in  this  experiment  it  would  seem
that no country can robustly demonstrate that this has had a positive impact on all the
sectors concerned in terms of job creation or efficiency. The reduction in VAT rates
appears to have had  very  little,  if  any, impact  on  prices.  Furthermore  the  reduction
has  been  generally  limited  and  its  permanent  nature  is  not  demonstrated  by  the

N.B.:  Member  States  currently  have  the  option  of  applying  one  or  two  reduced  rates  to  the  whole  of
Annex H.
Directive 2002/92/EC (OJ L 331, 7.12.2002).
Report by the Commission to the Council and the European Parliament on the experimental application
of reduced rates of VAT to certain labour-intensive services.
COM(2003) 309 of 2 June 2003.

4

15. 

2.3.

16. 

17. 

10

11

12

                                                
18. 

19. 

20. 

21. 

2.4.

22. 

3.

23. 

13

experiment.  It  is  therefore  concluded  that  a  reduction  in  VAT  rates  cannot  have  a
significant impact on demand.

Although there was an increase in demand in one sector, other significant measures
(such as reduction in social security contributions, tax relief or possible deduction of
indirect  tax)  were  also  introduced  in  the  same  period.  Moreover  the  measure  was
introduced at a time when the economic situation was sound and unemployment was
falling in all sectors of the economy.

These findings are in line with the conclusions of previous studies.13 Compared with
measures which directly target labour costs, the impact of a reduction in VAT rates
on employment always has a higher budgetary cost for each job created. According
to the report’s conclusions, for the EU as a whole, reducing labour costs creates 52%
more jobs at the same cost to the budget. Thus cutting VAT rates is a waste of budget
resources  which  could  more  usefully  be  deployed,  e.g.  by  reducing  labour  costs  or
providing financial support for job  creation, in a way that  would be  more  effective
and  cost  significantly  less  per  job  created.  The  results  of  the  experiment  therefore
need to be taken into account in considering the use of reduced VAT rates.

In the light of the foregoing, it is evident that the VAT treatment of labour-intensive
services should now be examined in the general debate on the scope of reduced VAT
rates.

Quite  separately  from  the  outcome  of  the  experimental  application  of  the  reduced
VAT  rate  for  labour-intensive  services,  the  Commission  would  strongly  encourage
Member States to do all they can to reduce the burden on labour costs, in particular
as  concerns  semi-skilled  or  manual  work;  specifically  by  a  reduction  in  taxes  and
other levies on labour.

the recent accession negociations

During  the  recent  accession  negotiations  the  Commission  proposed  to  the  Member
States  to  grant  derogations  for  certain  reduced  and  zero  rates  for  a  limited  period
only. All 15 Member States agreed to this strategy. Moreover, it is worth noting that
Member States were extremely reluctant to grant these transitional arrangements and
did not respond favourably to every individual request put forward by the  acceding
countries,  even  when  they  were  supported  by  the  Commission.  Against  this
background, the present proposal aims at ensuring a rationalisation of the transitional
derogations in force in the current Member States in order to avoid unequal treatment
between them and the acceding countries

RECENT CASE LAW OF THE COURT OF JUSTICE

The Commission has taken steps to ensure Community rules on reduced VAT rates
are correctly applied by bringing four cases before the European Court of Justice. As
a result the Court has clarified the scope of Article 12 of the Sixth VAT Directive.

See  Communication  SEC(97)  2089  final  of  12  November  1997,  which  referred  inter  alia  to  a  study
entitled Potential impact on employment creation of fiscal instruments (namely of a reduced VAT rate
for  selected  sectors),  by  Cambridge  Econometrics  Ltd  and  the  Institute  of  Employment  Research,
Warwick University, September 1996.

5

                                                
3.1

24. 

3.2.

25. 

3.3.

26. 

27. 

28. 

Judgment of 18 January 200114

In  this  case  the  Court  ruled  that  Spain  had  failed  to  fulfil  its  obligations  under
Article 12(3)(a)  by  applying  a  reduced  rate  to  the  supply  of  services  consisting  in
making available road infrastructure to users in return for payment of a toll.

In paragraphs 18 and 19, the Court laid down the following principle:

"It follows from Article 12(3)(a) of the Sixth Directive that the application of one or
two reduced  rates is an option  accorded  to  the  Member  States  as  an  exception  to
the principle that the standard rate applies. Moreover, according to that provision
the reduced rates of VAT may be applied only to the supplies of goods and services
specified in Annex H.

It  is  settled  case-law  that  provisions  which  are  in  the  nature  of  exceptions  to  a
principle must be interpreted strictly."

Judgment of 8 March 200115

In this case the Court ruled that "by maintaining in force a reduced VAT rate of 5%
applicable to transactions concerning the goods listed ... respectively covering wines,
machines  or  equipment  designed  for  research  into  alternative  forms  of  energy,  and
agricultural  foods  and  utensils,  the  Portuguese  Republic  has  failed  to  fulfil  its
obligations under Articles 12 and 28(2) of the Sixth Directive."

Judgment of 3 May 200116

The Court was asked for a ruling on the option for France to apply different rates to
medicinal  products  according  to  whether  they  are  reimbursable  or  not  under  the
social security system.17

In paragraphs 21 and  22  of  this judgment  the Court notes  that the introduction and
maintenance  of  a  rate  of  2.1%  for  reimbursable  medicinal  products,  whereas  the
supply  of  non-reimbursable  medicinal  products  is  subject  to  a  rate  of  5.5%,  are
permissible only insofar as they are consistent with the principle of fiscal neutrality
inherent in the common system of VAT and in compliance with which the Member
States  are  required  to  transpose  the  Sixth  Directive  (see  the  judgment  of
7 September 1999 in Case C-216/97 Gregg (1999), ECR I-4947, paragraph 19).

That principle in particular precludes treating  similar  goods,  which  are  therefore  in
direct competition with each other,  differently for VAT purposes  (see  to this  effect
the eighth recital in the preamble to the First Directive and the judgment of 11 June
1998, in Case C-283/95 Fischer, ECR I-3369, paragraphs 21 and 27). It follows that
the principle of fiscal neutrality also includes the other two principles, namely the
principles of VAT uniformity and of elimination of distortion in competition.

14

15

16

17

Judgment of 18 January 2001, Commission v. Kingdom of Spain, C-83/99, ECR 2001, I-00445.
Judgment of 8 March 2001, Commission v. Portuguese Republic, C-276/98, ECR 2001, I-01699.
Judgment of the Court of 3 May 2001, Commission v. French Republic, C-481/98. ECR 2001, I-03369.
The 2.1% rate applies to  medicinal  products  which  are  reimbursable  under  the  social  security  system
whereas other medicinal products are taxed at a reduced rate of 5.5%.

6

                                                
3.4.

29. 

4.

30. 

4.1.

31. 

Judgment of 8 May 200318

In this case the Court was asked to give a ruling on the option for France to apply a
reduced rate solely to the fixed part of the prices for gas and electricity supplied by
the  public  network  whereas  the  variable  part  (actual  amount  consumed)  remains
subject to the standard rate. In its judgment the Court was asked to clarify the scope
of  Article  12(3)(b)  in  the  light  of  the  principle  of  fiscal  neutrality  inherent  in  the
common VAT system.

In paragraphs 27 and 28 the Court states  that "in  any event,  there is  nothing in  the
text  of  Article  12(3)(b)  of  the  Sixth  Directive  which  requires  that  provision  to  be
interpreted as requiring that the reduced rate can be charged only if it is applied to all
supplies  of  natural  gas  and  electricity.  A  comparison  of  the  different  language
versions  argues  in  favour  of  an  interpretation  that  a  selective  application  of  the
reduced  rate  can  be  excluded,  provided  that  no  risk  of  distortion  of  competition
exists.

Moreover, since the reduced rate is the exception, the restriction of its application to
concrete and specific aspects, such as the standing charge conferring entitlement to a
minimum  quantity  of  electricity  on  the  account  holders,  is  consistent  with  the
principle that derogation of derogations must be interpreted restrictively."

All this case law is extremely useful for an  analysis  of measures taken  by Member
States  to  define  the  scope  of  the  reduced  rates  and  should  guide  the  review  and
rationalisation of Annex H.

VAT RATES AND THE INTERNAL MARKET

An analysis of the current structure of VAT rates and, in particular the scope of the
reduced rates, has revealed two factors which may hamper the proper functioning of
the  internal  market  and  create  distortion  of  competition:  the  optional  nature  of
applying reduced rates for Member States and the lack of common definitions for the
categories  in  Annex  H.  This  is  compounded  by  the  huge  number  of  specific
derogations granted to certain Member States but refused to others.

The most frequent complaints

The conclusions of the 2001 report are still relevant. It should be noted that the main
complaints from traders concern:

a)

b)

c)

d)

the optional nature of applying reduced rates;

the huge variations between reduced rates;

the fact that the zero and super  reduced rates continue to be  applied by  some
Member States but are refused to others;

the  lack  of  Community  definitions  for  categories  of  goods  and  services  in
Annex H, and its restrictive nature;

18

Judgment of 8 May 2003, Commission v. French Republic, C-384/01. Not yet published.

7

                                                
e)

f)

g)

the uneven way in which the reduced rates are applied as the option exercised
by one Member State does not oblige it to apply it to all goods and services of
the category or categories chosen;

the  conflict  between  the  principle  of  uniformity  of  rates  and  the  option  of
applying reduced rates to the whole or part of a category;

the  complexity  resulting  from  the  permanent  or  transitional  nature  of  the
derogations.

Very often traders are at a loss to understand how particular goods or services which
are not listed in Annex H can be eligible for a reduced, super reduced or zero rate in
certain Member States. The reason must always be sought in the specific derogations
negotiated at the time Directive 92/77/EEC on the harmonisation of VAT rates was
adopted or under the Acts of Accession of the new Member States.

The  time  has  now  come  to  review  all  these  situations  to  find  a  more  consistent
approach.

Contested differences in treatment

The current system is based on the definition of a minimum standard rate of 15% and
5% for reduced  rates. Member States may apply one or two reduced  rates to goods
and services included in a restrictive list (Annex H). This means that the same goods
or services are treated differently from one Member State to another.

Generally  speaking  there  is  no  evidence  that  this  system  has  created  serious
to  achieve  greater
distortion  of  competition  calling  for  radical  measures 
harmonisation of VAT rates.

However, there have been increasing questions and criticism from traders and some
Member States about certain specific derogations which are granted to some Member
States but not to others.

Restaurant services are one example. Under a transitional derogation they are subject
to  a  reduced  rate  in  eight  Member  States  whereas  current  Community  legislation
prevents  the  other  seven  from  introducing  such  rates.  This  situation  has  led  this
sector and certain  governments to approach  the Commission  in order to secure this
option for all Member States. The reduced rate for restaurants was also the subject of
arduous negotiations under the enlargement process culminating in authorisation for
Cyprus,  Hungary,  Poland  and  Slovenia  to  apply  reduced  rates  for  restaurants  until
31 December 2007.

The situation is comparable in the housing sector where various specific derogations
exempt many Member States from the obligation to restrict the reduced rate solely to
housing under social policy.

The rationale for such situations is becoming increasingly tenuous as there is no real
justification for perpetuating this state of affairs. There would seem to be two options
open:  either  abolish  such  derogations  and  apply  the  standard  rate  in  all  Member
States or extend the option to apply reduced rates to all Member States. In the sectors
in  question  no  complaint  has  provided  any  evidence  of  serious  distortion  of
competition necessitating the abolition of the optional application of reduced rates in

8

32. 

33. 

4.2.

34. 

35. 

36. 

37. 

38. 

39. 

these sectors. Consequently, there seems to be no reason not to extend this option to
all Member States.

4.3.

40. 

Contested practices in Member States

Traders regularly complain about certain practices in the application of the optional
reduced  rates  authorised  by  Annex  H  which,  although  not  prohibited,  make  it  very
difficult for companies to decide what rate applies to particular goods or services.

41. 

This will be illustrated by the following two examples:

42. 

43. 

4.4.

44. 

–  When  the  reduced  rate  for  labour-intensive  services  was  introduced  the
measures  taken  to  distinguish  between  repair  services  (subject  to  a  reduced
rate) and the supply of equipment (subject to the standard rate) were sometimes
so  complex  that  some  service  providers  have  simply  ceased  applying  the
reduced rate.19

– 

Reduced  rates  for  food  products  are  applied  at  different  rates  in  certain
Member States. These rules sometimes lead to incredible complexity.20

In many cases only an experienced tax expert can determine with any certainty what
rate  is  to  be  applied  by  comparing  legislation  and  the  exact  characteristics  of  the
products in question.

Such practices, although not illegal or jeopardising the principle of fiscal neutrality,
make the application of VAT extremely complex for companies  and unmonitorable
by the tax authorities.

The Commission's recommendations

It  is  not  the  Commission's  intention  to  call  into  question  the  optional  nature  of
reduced VAT rates.  It notes that there is no obligation on a Member State to apply
the same VAT  rate to  an  entire  category in  Annex  H  provided  this  does  not  create
distortion  of  competition.  Consequently  as  the  reduced  rate  is  the  exception,  the
limitation of its application to certain concrete and specific aspects is consistent with
interpreted
the  principle  under  which  derogations  or  derogations  must  be 
restrictively.21

Nevertheless,  in  a  desire  to  help  simplify  the  application  of  legislation,  the
Commission  recommends  that  Member  States  avoid,  in  defining  the  scope  of
reduced rates, from making distinctions which are so complex as to introduce a risk
of  error  where  companies  have  to  determine  which  rate  applies  to  products  they

19

20

21

In Belgium replacement of a front bicycle wheel is subject to the standard rate whereas replacement of
the back wheel is subject to the reduced rate because the labour component is greater.
In  France,  for  example,  the  reduced  rate  applying  to  food  products  applies  to  chocolate  only  under
certain very complex conditions. Products containing chocolate are subject to the standard or reduced
rate  according  to  their  form,  presentation  or  actual  composition.  Subtle  distinctions  have  also  been
introduced in Portugal: whereas fresh fish is subject to the reduced rate of 5%, if it is cooked prior to
being frozen it becomes subject to the standard rate of 19%; if it forms part of a ready made meal to be
taken away or consumed on the spot, it is subject to a rate of 12%.
See judgment of 8 January 2001, Commission v. Kingdom of Spain, C-83/99, ECR 2001 I-00445 and
judgment of 8 May 2003, Commission v. France, C-384/01, not yet published.

9

                                                
manufacture  or  sell.  Such  complexity  is  harmful  to  everyone  and  the  principle  of
uniformity of rates must be respected, with exceptions only where a clear distinction
can  be  made  between  the  goods  and/or  services  subject  to  a  reduced  rate  (or  two
different  reduced  rates)  and  those  subject  to  the  standard  rate.  This  must  not  of
course  lead  to  distortion  of  competition  between  the  goods  and/or  services  in
question.

The  Commission  will  of  course  continue  to  monitor  the  measures  introduced  by
Member  States  in  respect  of  rates  as  it  did  in  the  past  (see  the  cases  referred  to
above).

REVIEW AND RATIONALISATION OF RATES: THE PROPOSED STRATEGY

In formulating this proposal the Commission has continued along the lines mapped
out in its Communication of 2000 defining a strategy to improve the functioning of
the  VAT  system  in  the  single  market,  an  approach  confirmed  in  Tax  policy  in  the
European Union - Priorities for the years ahead.22

In so doing it is bound by the objective set for it in the Treaty, viz. the harmonisation
of  VAT  to  the  extent  necessary  to  ensure  the  establishment  and  functioning  of  the
internal market.

A  first  step  was  taken  in  1992  with  Directive  92/77/EEC  on  the  approximation  of
VAT  rates.  This  new  proposal  is  an  extension  of  that  approach,  building  on  the
degree  of  approximation  achieved  to  date  and  improving  the  present  VAT  rate
structure.

Objectives and constraints

As the Commission already indicated by way of introduction, it does not intend to
change the level of VAT rates during the period in which the new VAT strategy is
to be implemented.

Nevertheless, there must be a review and rationalisation of the structure of VAT
rates in order to strike a difficult balance between - often contradictory - objectives
and constraints.

45. 

5.

46. 

47. 

5.1.

48. 

49. 

50. 

The objectives are the following:

– 

– 

– 

Implement the new VAT strategy to improve the functioning of the common
VAT  system  in  the  internal  market:  the  objective  here  is  to  simplify  and
modernise current rules and to apply current legislation more uniformly;

Preserve  the  Community  acquis  on  rates  and  prevent  current  differences
widening rather than narrowing;

Reduce  inconsistencies  in  the  current  system,  i.e.  in  the  many  specific
derogations granted to certain Member States.

22

COM(290) FINAL, 23.05.2001. Point 3.1.1. of the Communication deals with VAT.

10

                                                
51. 

52. 

53. 

54. 

55. 

56. 

Under  the  principle  of  subsidiarity,  the  Commission  does  not  wish  to  impinge
upon  Member  States'  tax  competence  beyond  what  is  necessary  to  ensure  the
proper functioning of the internal market, and in particular as  regards the setting of
the VAT rates that they wish to apply.

However, it is clearly part of its job to put proposals to the Council for rules needed
to ensure the more efficient functioning of the internal market. The Commission has
therefore  decided,  as  a  significant  step  in  that  direction  to  focus  on  the
inconsistencies in VAT rates under the current system. The aim is to ensure a more
level playing field for all the Member States, including the new ones, and to put an
end  to  distortions  arising  from  the  fact  that  some  Member  States  are  allowed  to
charge reduced rates of VAT in certain sectors while others are not.

It is  important to  bear  in mind in this  connection  that  for  some  goods  and  services
taxed  at  the  place  of  consumption,  differences  in  national  rates  are  not  necessarily
incompatible  with  the  internal  market.  Examples  include  work  on  housing  or
supplies of gas or electricity. Conversely, given the prevalence of distance selling for
many  types  of  goods,  wide  differences  in  the  national  rates  can  cause  significant
distortions  of  competition,  particularly 
items  concerned  are  easily
transportable, like CDs, videos or other goods easy to trade across borders.

the 

if 

The  same  is  true  where  the  standard  rate  applies  across  the  board  and  there  is  no
scope for applying a reduced rate, but where derogations enable just a few Member
States to charge VAT at rates well below those in the rest of the Community. Some
of the goods concerned are again easily transportable items like children's clothing.

It is also important to ensure that reduced rates of VAT are not interfering with other
aspects of the internal market. Price comparisons across the Community have shown
that  consumer  prices  are  not  necessarily  lower  in  Member  States  applying  the
reduced rates, since companies can tailor their profit strategy depending on the rate at
which  VAT  is  charged  in  each  country.  This  suggests  that  reduced  rates  can  be  a
factor  in  corporate  profitability;  companies  trading  in  a  Member  State  applying  a
reduced or zero rate of VAT may be able to take higher profit margins, giving them
an advantage over competitors in other Member States.

The  scope  of  reduced  rates  must  therefore  be  carefully  defined  to  ensure  that  such
factors do not disrupt the operation of the internal market.

At  the  moment,  however,  VAT  rates  in  the  Community  remain  very  disparate  and
highly complex. Annex 1 contains an illustrative list of the  rates currently  applying
to certain categories of goods and services which it proposes should be rationalised.23

This  extreme  complexity  is  largely  due  to  the  fact  that  Member  States  were
concerned  to  avoid  changing  their  own  VAT  structures  as  little  as  possible  at  the
time Directive 92/77/EEC was adopted. This led to the adoption of Annex H which
reflects  these  different  national  realities  and  contains  a  number  of  specific
derogations which take into account the particular circumstances of certain Member
States.

23

For more details see Commission report of 22 October 2001 (COM(2001) 599 final) and the document
on VAT rates in the Member States of the European Community
http://europa.eu.int/comm/taxation_customs/taxation/vatindex_en.htm

11

                                                
57. 

58. 

59. 

60. 

61. 

62. 

63. 

The basic rules are, however, simple: there is a minimum standard rate of 15% which
applies in principle to supplies of goods and services subject to VAT and an option
for Member States to apply one or two reduced  rates which may not be lower than
5% but only to the goods and services listed in Annex H.

However,  a  large  number  of  derogations  which  were  accorded  to  some  Member
States - in some cases to most of them - in the negotiation of Directive 92/77/EEC or
in the Acts of Accession, but refused to others have been grafted on to these simple
rules. Most of these derogations are intended to ensure that pre-existing situations are
maintained:  they  are  confined  to  Member  States  which  applied  derogations,  at  a
specific date, to Community rules on VAT rates and authorise them to maintain, on a
transitional  basis,  these  derogations.  Their  main  objective  is  to  ensure  the  gradual
transition towards the application of these VAT rules. They allow either other  rates
lower  than  those  normally  applied  (zero,  super-reduced  or  parking  rate)  or
derogations from the scope of Annex H  (e.g. reduced  rate for  restaurants);  in  some
cases these two types of derogations are combined (e.g., a super-reduced rate of 3%
is applied to restaurants in Luxembourg).

Since  maintenance  of  these  derogations  had  been  authorised  solely  for  the
transitional  period  leading  up  to  the  introduction  of  the  definitive  system  of  taxing
trade  between  Member  States  (initially  scheduled  for  1  January  1996),  they  were
intended to apply for a very short period of time.

In view of the lack of progress made in the Council on the proposals presented by the
Commission to implement the 1996 programme, the Commission submitted, in 2000,
its  new  VAT  strategy  to  make  concrete  and  essential  improvements  to  the  current
system  in  the  short  term.  Since  it  appears  that  the  current  system  will  continue  to
apply for some time, it is essential to consider whether these derogations should be
maintained.

Finally, a thorough review of the current scope of reduced rates and derogations must
not  fail  to  take  account  of  the  Lisbon  Strategy  which  was  expanded  at  Göteborg.
The European Councils on 23 and 24 March 2000 and 15 and 16 June 2001 defined a
new  strategic  goal  for  the  Union  to  promote  sustainable  development,  increase
employment, introduce economic reform and social cohesion in a knowledge-based
society.

This  strategy  highlights  the  need  to  alleviate  the  tax  pressure  on  labour,  and
especially  on  the  relatively  unskilled  and  low-paid.  However  more  labour-friendly
tax reforms must also ensure healthy public finances. This objective can be attained
through  strict  control  of  or,  where  appropriate,  reduction  in  public  spending.  It
would, however, be extremely risky to reduce labour costs (by cutting direct taxation
and social security contributions) and extend the scope of reduced VAT rates yet at
the same time maintain a balanced budget.

It is essential to ensure Member States' budgetary equilibrium and to avoid creating
structural budget deficits or drastic reductions in public spending owing to the lack of
budget  resources  to  finance  it.  When  VAT  rates  are  reduced,  there  is  no  guarantee
that  the  final  consumer  will  benefit  from  a  corresponding  reduction  in  prices.
However, when a Member State decides to apply new reduced rates of VAT, it must
offset the resulting loss of budget revenue by levying other taxes (e.g. income taxes)
which will ultimately be borne by the taxpayer.

12

64. 

5.2.

65. 

The  greatest  caution  must  therefore  be  exercised  as  the  priority  agreed  under  the
Lisbon strategy was to reduce labour costs, not indirect taxation.

Broad outline of the proposal

In view of all these factors the Commission has decided to pursue a strategy based a
balanced approach for the whole of the European Union for the following reasons:

– 

– 

– 

The Commission is convinced that the reduction of VAT rates is not the best
way  of  encouraging  consumers  to  buy  or  use  certain  goods  or  services.
VAT,  unlike  excise  duty  for  example,  is  not  designed  to  change  consumer
behaviour. Although its main objective is to generate tax revenue, it is one of
several  instruments  used  by  Member  States  in  their  policies.  However,  a
reduction  in  VAT  rates  is  never  passed  on  in  full  in  consumer  prices.  Very
often  it  is  negligible  and  temporary.  An  economic  mechanism  based  on  the
premise  that  a  reduction  of  VAT  will  lead  to  a  reduction  in  prices  and,
consequently,  an  increase  in  demand  does  not  function  correctly  in  the  vast
majority  of  cases.  A  simple  comparison  of  prices  in  the  Community
demonstrates  that reduced  VAT  rates  do  not  necessarily  lead  to  lower  prices.
By way of example, Annex 2 contains a table comparing the level of prices of
certain products in the Member States and the relevant VAT rates.

VAT is a consumption tax and its main objective is to generate tax revenue:
each Member State uses this revenue according to its own priorities. It should
not  be  used  to subsidise  certain  particular  sectors.  At  the  moment  it  is  clear
from  many  of  the  requests  to  apply  reduced  rates,  that  one  of  the  main
objectives is to help a particular sector because of its social, cultural or  other
features or the particular problems it is experiencing.

If  reduced  rates  were  extended  to  new  sectors,  this  would  lead  to  a  lack  of
harmonisation in VAT rates. As the reduced rate is optional, Member States
are  offered  a  wider  range  of  rates.  Yet  it  is  vital  to  safeguard  the  degree  of
harmonisation already achieved through the application of the standard rate in
all or most of the Member States.

66. 

67. 

The  Commission  considers  it  appropriate  to  propose  the  simplification  and
rationalisation  of  rates  to  implement  the  strategy  to  improve  the  operation  of  the
VAT system in the internal market.

To achieve this objective the Commission has not taken up the approach it set out in
its 2001 report, namely to introduce a structure of two reduced rates (possibly with a
specific band for each category) applying to separate lists of goods and services.

It  had  considered  this  possibility  in  relation  to  the  experimental  application  of
reduced  rates  to  labour-intensive  services.  If  this  experiment  had  showed  that
reduced  VAT  rates  are  a  good  way  of  promoting  employment,  the  review  of  the
scope of reduced rates would have taken this into account to examine whether rates
could  be  used  to  achieve  other  objectives,  such  as  those  described  above  and,  if
necessary, be made mandatory.

However, the evaluation report on this experiment has not demonstrated a direct link
between a reduction in VAT rates and an increase in employment or a reduction in

13

the black economy. A reduction in VAT rates is not therefore expected to have more
tangible effects in other sectors.

Consequently,  the  optional  nature  of  reduced  rates  must  be  maintained  as  this  is
closely linked to Member States' budget choices and the organisation of their public
finances.  Member  States  will  therefore  continue  to  be  able  to  apply  a  reduced  rate
only  to  certain  categories  in  Annex  H  or  to  certain  of  the  transactions  concerned
within a category.

68. 

The  Commission  has  adopted  the  following  guidelines  to  simplify  and  rationalise
rates.

5.2.1. Rationalisation of Annex H

69. 

Rationalisation will be undertaken by:

– 

– 

not extending the option to apply reduced rates to new categories to which
the  standard  rate  already  applies  in  all  Member  States  and  which  already
guarantees a certain degree of harmonisation (band of between 15% and 25%).
The intention is not to take a backwards step by extending the scope of optional
reduced  rates  as  this  would  cancel  out  the  harmonisation  of  rates  already
achieved through the application of the standard rate.

extending the option for Member States to apply reduced rates only to the
categories  of  goods  and  services  for  which  specific  derogations  or  other
provisions  already  authorise  a  certain  number  of  Member  States  to  apply
reduced  rates  or  exemptions  and  where  this  has  not  been  found  to  hinder  the
proper  functioning  of  the  internal  market.  This  first  measure  concerns
restaurant services, housing and supplies of gas, electricity, and domestic care
services.  This  approach  will  enable  a  reduced  rate  to  be  applied  in  more
Member  States  and  should  encourage  more  uniform  application  of  reduced
rates. However it is not proposed to extend this option to categories of goods or
services  for  which  only  a  minority  of  Member  States  have  been  granted  a
specific derogation.

5.2.2. Annex H will become the only reference for any derogation from the standard rate

70. 

71. 

The Commission proposes to make Annex H the only and single list of categories of
goods and services to which rates other than the standard rate may be applied. These
changes  will  put  an  end  to  the  current  confusion  surrounding  the  scope  of  reduced
VAT rates in the European Union. It proposes to make the following changes:

The parking rate will be abolished. The parking rate applies to goods and services
not  included  in  Annex  H  to  which  certain  Member  States  applied  reduced,  super
reduced or zero rates at 1 January 1991.24 These Member States were authorised to
apply  reduced  rates  to  them.  These  are  therefore  measures  designed  to  ensure  a
gradual transition towards the standard rate and are of two types:

–  Member States which, at 1 January 1991, applied a zero rate or super reduced
rate  in  accordance  with  Community  legislation  may  continue  to  do  so.

24

Derogation negotiated when Directive 92/77/EEC was adopted or under the Acts of Accession.

14

                                                
Nevertheless, if they decide to cease applying such rates to goods and services
not  listed  in  Annex  H,  they  may  apply  a  reduced  rate  of  not  less  than  5%
(Article 28(2)( b)).

–  Member States which, at 1 January 1991, applied a reduced rate to goods and
services  not listed in Annex  H  and  which  must  cease  applying  this  rate,  may
continue to apply a reduced rate provided this is not less than 12% (Article 28
(2)(e)).

It is proposed that these transitional measures be  abolished having applied  for over
10 years.

72. 

Zero and super-reduced rates25 will be confined to the goods and services listed in
Annex H.

Directive  92/77/EEC  confirmed  that  zero  and  super-reduced  rates  could  be
maintained  as  the  status  quo.  These  measures  had  continued  to  apply  since  the
adoption  of  the  Sixth  VAT  Directive  in  1977.  They  apply  not  only  to  goods  and
services listed in Annex H but also to products ranging from children's clothing and
footwear, residential caravans and boats to motorcycle and bicycle boots and helmets
which are subject to the standard rate in Member States other than those to whom a
derogation applies.

Certain Member States (those which were required to raise their standard rate by 2%
in  1993,  i.e.  Luxembourg  and  Spain)  are  also  authorised  to  apply  reduced  rates  of
less  than  5%  to  the  products  listed  in  Annex  H  and  to  restaurants,  housing  and
children's clothing and footwear.

The  Commission  considers  that  it  is  not  appropriate  to  propose  the  complete
abolition  of  zero  and  super-reduced  rates  under  this  proposal  because  this  goes
beyond  the  objectives  defined  by  the  new  VAT  strategy  adopted  in  2000.  It  is,
however, convinced that the scope of the zero and super-reduced rates should be
confined  to  goods  and  services  listed  in  Annex  H  in  order  to  rationalise  and
simplify the current structure of rates in the Community.

Consequently, the zero or super-reduced rates currently applied by Member States
may  be  maintained  for  the  goods  and  services  to  which  all  Member  States  may
apply reduced rates. This will mean that Member States will continue to be able to
apply rates of less than 5% to food, medicinal products, housing, etc.

However, they will be required to cease applying zero and super-reduced rates to any
other goods and services which are not listed in Annex H.

This approach is perfectly in keeping, and is indeed the only that is truly compatible
with  the  policy  pursued  by  the  Commission  and  agreed  by  the  Council  during  the
negotiation of the Accession Treaties of the new member countries. Every derogation
granted to them in respect of VAT rates is of strictly limited duration: the last expires
on  1  January  2010.  Moreover,  they  related  almost  exclusively  to  the  goods  and
services  listed  in  Annex H  as  amended  by  this  proposal.  In  the  interests  of
consistency,  therefore,  this  first  step  towards  the  rationalisation  of  the  transitional

25

The super-reduced rate is any rate less than 5% but higher than 0%.

15

                                                
derogations already in force in the current Member States has to be taken now. The
candidate countries cannot be expected to have made an effort in vain. Moreover, it
is clear that, as  the derogations  granted  to them  relate to goods  and services  which
will be included in the new Annex H, they may exercise their option, as the current
Member  States  have  done,  to  apply  reduced  rates  in  these  sectors  even  after  the
derogation granted to them has expired.

5.2.3. Rationalisation  of  derogations  to  enable  certain  Member  States  to  apply  lower

rates in certain territories

73. 

6.

6.1.

74. 

Some Member States have been authorised to apply in certain territories rates lower
than  those  they  normally  apply  in  order  to  take  account  of  their  particular
geographical  situation  (insular  nature  or  remoteness).  These  provisions  are  only
justified if they are strictly limited to the local market. The Commission proposes to
rationalise them in order to define a clear legal basis for each of the derogations and
to restrict their scope to goods and services consumed in these territories.

COMMENTS ON THE ARTICLES

Article 1(1)

Article 1(1) proposes four changes to Article 12:

– 

The deletion of paragraph 3(b): the reduced rate for natural gas and electricity
is  currently  laid  down  in  Article  12(3)(b),  subject  to  prior  authorisation  from
the Commission. This amendment involves no real substantial change from the
current  situation.  It  is  merely  proposed  to  incorporate  it  in  a  new  heading  in
Annex H. This measure will put an end to the prior authorisation procedure in
the  interests  of  simplification  and  rationalisation  as  no  complaint  has  been
received and there is no evidence to the effect that the reduced rates applied in
seven  Member  States  have  distorted  competition.  In  addition,  the  proposed
directive on the place of supply of electricity and gas26 will ensure taxation at
the place of actual consumption by the customer and thus avoid any distortion
of  competition  between  Member  States  depending  on  whether  they  apply  a
reduced  rate  or  not.  The  proposed  amendment  to  paragraph  4  also  introduces
the  general  provision  that,  when  Member  States  apply  a  reduced  rate  only  to
certain supplies of goods or services, or certain specific aspects of them, they
must comply with the condition that the distinction must not lead to distortion
of competition. This general safeguard will accordingly ensure a similar level
of  security  to  the  current  situation.  Lastly,  this  measure  is  part  of  a  series  of
measures proposed with the aim of making Annex H the sole reference list for
the application of rates other than the standard rate. See also the comments on
the new Annex H.

– 

Two changes are proposed to paragraph 4:

– 

firstly, it is proposed to replace the period of two years for the review of
the scope of reduced rates by a period of five years. A review every two
years on the basis of a report from the Commission has not in fact been

26

COM(2002) 688 final of 5 December 2002.

16

                                                
– 

necessary:  experience has shown that a period of  two  years  is  too short
for genuine new factors to emerge.

Secondly,  a  new  second  subparagraph  is  proposed.  In  accordance  with
recent case law of the Court of Justice of the European Communities, it is
essential to clarify the option for Member States to apply a reduced rate
to  the  whole  or  part  only  of  a  category  in  Annex  H.  Implicit  in  that
option, as stated by the Court in its above-mentioned judgment of 8 May
2003, is the option to restrict the application of a reduced rate to concrete
and specific aspects of a supply of goods or services, since it is consistent
with  the  principle  that  derogations  or  derogations  must  be  interpreted
restrictively. Accordingly, a Member State may limit the application of a
reduced rate to concrete and specific aspects, such as the standing charge
conferring  entitlement  to  a  minimum  quantity  of  electricity  on  the
account  holders,  or  exclude  the  supply  of  alcoholic  beverages  from  the
reduced  rate applying to restaurant services. Nevertheless,  it  is  essential
to ensure that the application of different rates does not lead to distortion
of competition. It is therefore proposed that Member States be obliged to
provide the Commission, at its request, with the necessary information to
check whether that condition has indeed been met.

– 

The deletion of paragraph 6, introduced by the Act of Accession of Portugal,27
and its incorporation in the new Article 2(2)(c): on this basis, "the Portuguese
Republic may apply to  transactions  carried out in the autonomous regions of
the Azores and Madeira and to direct imports to those regions, reduced rates
in comparison to those applying on the mainland". It is proposed to rationalise
all the  specific exemptions granted  to certain Member States  on  geographical
grounds by laying down rules common to all of them. For further details, see
the comments on the new Article 28(2)(c).

6.2.

75. 

Article 1(2)

Article 1(2) makes two changes to Article 28: it replaces the current paragraph 2 and
deletes paragraph 6.

6.2.1. Replacement of Article 28(2)

76. 

77. 

Article 28(2) is restructured so as to incorporate the following amendments.

Article 28(2)(a) (zero and super-reduced rates)

The  rationalisation  of  the  specific  derogations  will  require  the  scope  of  zero  and
super-reduced rates to be strictly limited to the categories of goods and services listed
in  Annex  H.  A  new  subparagraph  to  this  effect  has  therefore  been  added  to  the
former text.

The specific derogation allowing Ireland to apply a lower rate of VAT to the supply
of  energy  products  for  heating  and  lighting  has  also  been  abolished.  This  requires
some  very  minor  adjustments  compared  with  the  current  situation.  The  supply  of
electricity,  gas  through  the  natural  gas  distribution  network  and  district  heating  is

27

Act of Accession: insertion of Article 12(6) allowing lower rates for the Azores and Madeira.

17

                                                
being  included  in  the  list  in  Annex  H.  The  supply  of  any  other  energy  product,
however,  must  be  subject  to  the  standard  rate  of  VAT.  For  further  details  on  the
addition of this new category, see the comments on Annex H.

78. 

Article 28(2)(b) (provisional super-reduced rate)

The new point (b) is a slightly amended version of the former Article 28(2)(c). This
short-term measure, very like the standstill measure allowing zero and super-reduced
rates to be maintained, can be also be maintained provided that its scope is limited to
the categories listed in Annex H. However, the option to apply that rate to restaurant
services,  children's  clothing,  children's  footwear  and  housing  has  been  abolished.
Note though that restaurant services and housing will now be included in Annex H.
Following the new amendment, consequently, only children's clothing and footwear
will no longer be eligible for the super-reduced rate.

79. 

Article 28(2)(c) and (d) (derogations for certain remote territories)

Some  Member  States  are  currently  applying  lower  rates  than  normal  in  certain
territories.  This  covers  exemptions  already  granted  to  Austria,28  Portugal29  and
Greece.30  France,  which  is  currently  applying  lower  rates  in  Corsica  than  on  the
mainland,  is  added  to  the  list.  In  the  case  of  France,  Greece  and  Portugal,  the
derogations were justified on the grounds of the geographical remoteness and insular
nature  of  the  regions  concerned.  In  Austria's  case,  only  two  communes  are
concerned,  Jungholz  and  Mittelberg,  where  the  specific  derogation  is  justified  on
account  of  their special  geographical situation (in a remote  mountain  area,  close  to
Germany).

It is proposed to group all the above derogations together in the new points (c) and
(d)  of  Article  28(2),  standardise  them  and  limit  them  exclusively  to  goods  and
services  giving  rise  to  consumption  in  those  territories.  The  current  point  (f)  is
accordingly deleted.

Two different measures are proposed:

Article 28(2)(c): In the case of island regions, it is proposed to authorise the Member
States  specified  to  apply  (standard  and/or  reduced)  rates  up  to  30%  lower  than  the
corresponding rates applied on the mainland. This 30% limit already exists in the text
of the current Article 28(2)(f) in respect of Greece.

Article 28(2)(d): In the case of Jungholz and Mittelberg communes, it is proposed to
maintain  the  authorisation  to  apply  a  second  standard  rate  lower  than  the
corresponding rate in other parts of Austria, provided it is no lower than 15%.

In  both  cases,  the  lower  rates  thus  applied  must  be  strictly  limited  to  goods  and
services giving rise to consumption in those territories. Recent experience has shown
that  the  current  derogations  can  give  rise  to  abuse:  for  example,  there  have  been
cases of businesses in the e-commerce and telecommunications sectors moving to the

28

29

30

Act  of  Accession,  Article  12(3)(a):  for  Jungholz  and  Mittelberg  (Kleines  Walsertal),  possibility  of
applying a second standard rate.
Act of Accession: insertion of Article 12(6) allowing lower rates for the Azores and Madeira.
Article 28(2)(f) relating to certain Greek islands, negotiated in Directive 92/77/EEC.

18

                                                
Azores and Madeira in order to apply the lower rates applicable there to services they
supply to final consumers throughout the Community. Steps must be taken to put a
swift  end  to  such  practices  as  they  are  a  misuse  of  the  derogations  which  were
granted  solely  to  allow  the  Member  States  concerned  to  take  account  of  the
remoteness and special geographical situation of those regions.

80. 

New Article 28(2)(e)

This  point,  which  concerns  the  rate  applicable  to  contract  work,  reproduces  the
former Article 28(2)(h) unchanged.

81. 

Deletion of the following provisions:

– 

– 

– 

Former  points  (b)  and  (e)  of  Article  28(2).  These  two  measures  allowed
Member  States  to  continue  applying  reduced  rates  to  goods  and  services  not
covered  by  Annex  H.  Their  deletion  makes  Annex  H  the  sole  reference  list
defining  the  scope  of  reduced  rates  and  other  derogations  from  the  standard
rate.

Point (g), requiring a review of the derogations provided for in Article 28(2)(a)
to  (f)  by  31  December  1994,  on  the  basis  of  a  report  by  the  Commission,  is
now obsolete.

Former points (i), (j) and (k) of Article 28(2): these specific derogations relate
to the categories of goods and services which have been added to Annex H and
are therefore obsolete.

6.2.2. Deletion of Article 28(6)

82. 

This was considered a temporary measure from the outset: the experimental nature of
the  introduction  of  reduced  rates  for  labour-intensive  services  required  a  definitive
decision to  be taken  following the  evaluation  of  the  results of  the  experiment:  they
would either be added to Annex H or deleted. The Commission's evaluation report of
2  June  2003  (COM(2003)  309),  based  partly  on  reports  produced  by  the  Member
States  who  took  part  in  the  experiment,  concludes  that  in  the  context  of  the
experiment concerning labour-intensive services, and taking account of the limitation
in  the  analytical  methodology  used,  it  is  not  possible  to  find  clear  evidence  of  any
favourable impact on employment or reduction of the black economy  following the
reduction  in  the  rate  of  VAT.  The  Commission  accordingly  proposes  not  to  adopt
this criterion for the revision of Annex H and to concentrate instead on improving the
functioning of the internal market.

The Commission has in the past expressed misgivings about the use of reduced VAT
rates as an instrument of job creation.  In  its communication  to  the Council entitled
Job creation: Possibility of a reduced VAT rate on labour-intensive services for an
experimental period and on an optional basis31 it pointed out that an initiative of this
kind  could  jeopardise  both  tax  neutrality  and  the  proper  functioning  of  the  Single
Market, while it was far from certain that any job-creating effects, e.g. the cut in rates
being  passed  on  in  lower  prices  to  the  consumer,  would  actually  materialise.  It
repeated  this  view  in  the  proposal  to  authorise  the  experimental  reduction  in  VAT

31

Communication SEC(97) 2089 final of 12 November 1997.

19

                                                
rates  on  labour-intensive  services,  and  a  number  of  Member  States  shared  its
misgivings.  In the  face of the  unemployment situation, however,  it  agreed  with  the
Council  that  those  Member  States  who  so  desired  should  be  allowed  to  try  out  the
effect of a targeted VAT reduction for labour-intensive services.

Unfortunately, no clear benefit has emerged from the reduction in the rate of VAT.
This  is  closely  linked  to  the  difficulty  in  finding  reliable  data  in  this  regard.
Nevertheless,  macro-economic  simulations  have  shown  that  a  reduction  in  labour
costs would create 52% more jobs at the same cost to the budget. The Commission
therefore prefers not to continue with this approach.

This  does  not,  however,  mean  that  the  standard  rate  of  VAT  need  necessarily  be
reintroduced  for  all  the  services  involved  in  the  experiment;  some  of  them  -  the
renovation  and  repair  of  private  dwellings,  and  window  cleaning  and  cleaning  in
private  housing  -  will  be  permanently  incorporated  into  Annex  H,  as  the  new
Category  10.This  is  part  of  the  process  of  rationalising  the  specific  derogations
currently available to some Member States.

The Commission is conscious of the need to permit Member States to take whatever
measures are possible to support families and elderly, sick and mentally handicapped
persons  and  therefore  proposes  to  integrate  the  domestic  care  services  currently  in
Annex K into Annex H.

Article 1(3) and (4)

Article 1(3) and (4) replace the current Annex H and delete Annex K. The changes to
Annex H are explained in detail below.

Annex K has to be deleted as a result of the deletion of Article 28(6).

New Annex H

Annex H has  been  rewritten  in  the  interests  of  rationalisation  and  simplification.  It
now  becomes  the  sole  point  of  reference  for  defining  the  scope  of  reduced,  super-
reduced and zero rates. The amendments made are as follows:

– 

– 

rationalisation of its structure;

rationalisation  of  certain  categories  through  the  necessary  corrections  and
clarifications;

– 

addition of three new categories.

The  introductory  sentence  has  also  been  reorganised  so  as  to  deliberately  draw  the
attention  of  Member  States  to  the  possibility  of  using  the  COICOP  codes,  a
classification  system  for  goods  and  services  developed  for  statistical  purposes  at
international level. The use of these codes to precisely define the categories in Annex
H is highly recommended in order to improve the functioning of the internal market.
The current reference to the Combined Nomenclature only actually relates to goods.

6.3.

83. 

84. 

6.4.

85. 

86. 

20

6.4.1. Rationalisation of the structure of Annex H

87. 

The  current  structure  has  been  slightly  modified  in  order  to  group  together
categories  of  goods  and  services  of  a  similar  nature.  Former  categories  12  and  13
(admission  to  sporting  events  and  use  of  sporting  facilities)  have  been  merged  and
put with similar categories (culture, leisure activities and sport). Following the same
line of thinking, the new headings have been put inside the current list and not just
tagged on the end.

6.4.2. Changes to existing categories

88. 

Category 4: equipment for the disabled The 2001 report noted that many requests
related  to  category  4  of  Annex  H,  which  covers  only  medical  equipment,  aids  and
other appliances normally intended to alleviate or treat disability. In particular, there
were  queries  about  whether  the  category  could  also  apply  to  chronic  illness.  There
seems  to  be  no  need  for  any  change  in  the  definition;  the  concept  of  disability  is
broad  enough  to  encompass  serious  or  chronic  illness  as  well.  On  the  other  hand,
equipment  or  apparatus specially designed  or  adapted  for the  disabled  (e.g., Braille
keyboards, specially adapted cars, etc.) were clearly not eligible for the reduced rate
even  though  they  logically  belonged  to  the  existing  category.  The  Commission
therefore proposes including them in category 4.

89. 

Category 10: housing

This amendment  is  essential  and  consists  of  a  major  extension  of  Member  States'
option to apply reduced rates in the housing sector. It simplifies and rationalises the
current, extremely complex situation.

In  the  2001  report,  the  Commission  stated  (point  48)  that  the  VAT  treatment  of
building  services  is  a  textbook  example  of  the  complexity  of  the  rules  on  reduced
rates.  In  principle,  under  the  first  subparagraph  of  Article  12(3)(a)  of  the  Sixth
Directive, the standard rate applies to supplies of goods and services connected with
buildings.  However,  the  legal  basis  for  applying  reduced  rates  provides  for  three
types of arrangement:

- The third subparagraph allows Member States wishing to do so to apply a reduced
rate  to  transactions  covered  by  category  9  of  Annex  H,  namely  the  supply,
construction,  renovation  and  alteration  of  housing  provided  as  part  of  a  social
policy.  This  limitation  has  proved  particularly  difficult  to  put  into  effect  and  has
given  rise  to  wide  divergences  in  practice  between  Member  States,  given  that  the
concept itself of a social policy on housing is not defined at Community level and is
therefore Member State responsibility. Moreover, the distinction between renovation
and alteration, on the one hand, and repair (not currently specified) is far from clear.

- Article 28(2) allows, for the duration of a transitional period and subject to certain
conditions, certain Member States to apply to housing - not otherwise defined - either
a  reduced  rate  lower  than  the  minimum  fixed  by  the  third  subparagraph  of  Article
12(3)(a), one of the two reduced rates laid down in that Article or a reduced rate not
lower than 12%.

- Article 28(6) (introduced by the Directive on labour-intensive services) provides for
the application of a reduced rate for a period of three years. That rate is not, however,

21

confined to social housing, applying instead to the "renovation and repair of private
dwellings,  excluding  materials  which  form  a  significant  part  of  the  value  of  the
supply".

Housing  is  currently  subject  to  the  reduced  rate  in  ten  Member  States,  while  the
restriction to social housing is applied in a variety of ways or not at all, by virtue of
any specific derogation. The problem with these specific derogations is that they are
reserved  for  the  Member  States  which  negotiated  them,  and  prohibited  to  others.
Moreover,  without  a  Community  definition  of  social  policy  on  housing,  the
restriction makes no sense and is totally ineffective.

In order to rationalise this complex and chaotic situation and improve the functioning
of the internal market, it is proposed to:

– 

– 

– 

delete the words "provided as part of a social policy";

add repair, maintenance and cleaning of housing;

add  rental  of  housing  insofar  as  that  service  is  not  exempt  under  Article  13.
Member States may allow taxable persons a right to opt for taxation in cases of
letting  and  leasing  of  immovable  property:  insofar  as  the  taxation  concerns
housing, it seems appropriate to give the Member State concerned the right to
apply the reduced rate. In this connection, Austria has negotiated and obtained
the  option  to  apply  a  reduced  rate  to  the  leasing  and  letting  of  residential
property:  with  a  view  to  rationalising  the  transitional  derogations,  that  option
should be extended to all Member States.

The  above  amendments  ensure  that  the  scope  of  reduced  rates  is  substantially
rationalised  and  that  it  embraces  categories  2  and  3  of  Annex  K  (renovation  and
repair  of  private  dwellings,  and  window  cleaning  and  cleaning  in  private
households).  In  accordance  with  the  principle  of  subsidiarity,  it  will  always  be  the
Member States' responsibility to define the scope of reduced rates: they will always
be able therefore to apply the reduced rate only to some of the transactions referred
to in Annex H.

These changes are unlikely to create distortion of competition to the detriment of the
smooth functioning of the internal market: the place of taxation of services relating to
immovable property is, in fact, always at the place where the property is located. All
providers of property-related services are therefore subject to the same conditions as
regards rates regardless of the Member State in which they are established.

90. 

Category 19: street cleaning, waste treatment, etc.

The scope of this category is too narrowly defined with the result that services of a
very similar nature are treated very differently as regards rates. For instance, whereas
street cleaning and household refuse collection are eligible for the reduced rate, there
is  no  reference  to  sewer  services.  Likewise,  the  reduced  rate  may  apply  to  waste
treatment, but not to recycling. It is proposed to remove these inconsistencies.

6.4.3. Addition of new categories

91. 

The option to apply reduced rates is extended to categories of goods and services
to  which  some  Member  States  are  already  authorised  to  apply  reduced  rates  under

22

specific  derogations and there has been  no  detriment to the smooth functioning  of
the internal market.

The following categories are added accordingly.

92. 

Category  12:  live  plants,  including  bulbs,  roots  and  the  like,  cut  flowers  and
ornamental foliage, and wood for use as firewood

The  addition  of  this  category  introduces  no  substantive  change  to  the  current
structure  of  the  reduced  rates.  Article  28(2)(i)  already  allows  all  Member  States  to
apply  a  reduced  rate  to  the  above  products.  This  provision  was  added  in  1996  by
Directive  96/42/EC  as  a  transitional  measure,  on  the  grounds  that  the  best  solution
was to extend the option to all Member States, provisionally, to apply a reduced rate
to  supplies  of  such  products.  The  reduced  rate  concerned  is  currently  applied  by
eleven  Member  States (in various measures). This  provision should  therefore  cease
to  be  transitional  and  the  category  permanently  incorporated  into  Annex  H.  This
measure rationalises and simplifies the current structure of the rates.

93. 

Category 14: restaurant services

Eight  Member  States  (Spain,  Greece,  Ireland,  Italy,  Luxembourg,  Netherlands,
Austria and Portugal) are already authorised to apply a reduced rate. The other seven
Member States, however, are not authorised to introduce this reduced rate.

During  the  accession  negotiations,  four  of  the  candidate  countries  were  also  given
permission  to  maintain  a  reduced  rate  for  restaurant  services  until  31  December
2007: Cyprus, Hungary, Poland and Slovenia.

The Commission is aware of the restaurant sector problem. There have been several
calls to apply the reduced rate for labour-intensive services to this sector. However, it
was  not  selected  by  the  Council  for  this  experiment.  Nevertheless,  the  current
situation must be rationalised as the grounds for it no longer pertain.

It  is  therefore  proposed  to  include  restaurant  services  in  Annex  H.  Restaurant
services  cover  not  only  traditional  restaurants,  but  also  catering  services  or  related
services,  to  provide  prepared  meals  or  the  services  for  their  distribution,  under  a
fixed-term  contract  between  a  catering  firm  and  a  principal  (companies,  public
authorities, hospitals, etc.).

The nature of the services concerned and the rules applicable to the place of taxation
mean that the risk of relocation is minimal. Moreover, accommodation in hotels and
similar  establishments  is  already  included  in  Annex  H.  The  addition  of  restaurant
services  can  therefore  be  considered  to  be  genuine  rationalisation.  Its  inclusion
should allow the  reduced  rate  to  be  applied  to  restaurant  services  in  more  Member
States  and  may  be  a  step  in  the  direction  of  more  uniform  application  of  reduced
rates.

94. 

Category 18: domestic care services

It is proposed that domestic care services which currently feature in paragraph 4 of
Annex K be included in Annex H. This means that a reduced rate could be applied
to, for example, home help and the care of the  young, the  elderly,  the sick  and the
disabled. In this way, the application of a reduced rate of VAT could be an essential

23

supplement to other actions already taken at national level to support families, and to
tackle,  for  example,  the  problems  related  to  an  ageing  population.  Taking  into
account the very local nature of these services, the extension of the application of the
reduced  rate  will  not  create  difficulties  for  the  proper  functioning  of  the  internal
market.  In  addition,  some  of  these  services,  where  they  are  provided  by  charitable
organisations  can  benefit  either  from  an  exemption  in  accordance  with  Article
13(A)(1)(g)  or  a  reduced  rate  in  accordance  with  the  current  category  14.  At  the
moment,  most  Member  States  exempt  or  apply  the  reduced  rate  to  some  of  these
services.

95. 

Category 20: the supply of electricity, gas and heating supplies

Article 12(3)(b) of the Sixth VAT Directive already provides for the application of a
reduced  rate  to  supplies  of  natural  gas  and  electricity.  However,  this  is  currently
subject to prior authorisation by the Commission to ensure that there is no likelihood
of distortion of competition.

Ireland is also authorised, pursuant to the third subparagraph of Article 28(2)(a), to
apply a reduced rate to certain energy products used for heating and lighting.

Seven Member States are currently applying a reduced rate to supplies of natural gas
and/or  electricity  and  there  have  been  no  reports  of  distortion  of  competition  in
relation  to  the  other  Member  States  applying  the  standard  rate.  Moreover,  the
taxation rules included in the proposed directive on the rules governing the place of
supply of gas and electricity will avoid any risk in future.

Inclusion  in  Annex  H  will  therefore  simplify  the  procedure  and  rationalise  the
current rules.

District  heating  is  added  because  it  shares  the  same  features  and  meets  the  same
requirements as the supply of electricity and of gas through the natural gas network.
The ban on applying a reduced rate to district heating appears to have led to unequal
tax treatment by comparison with gas and electricity. Yet all  three  forms  of energy
supply  operate  via  a  network  in  a  very  similar  manner.  As  such  networks  are
essentially  local  by  nature,  the  risk  of  distortion  of  competition  between  Member
States can be considered minimal, if not non-existent.

6.4.4. Reception of radio and television broadcasting services and the cultural sector

96. 

97. 

Article 13(A)(1)(q) currently exempts activities of public radio and television bodies
other  than  those  of  a  commercial  nature.  That  exemption  is  not  changed  by  this
proposed Directive.

On  the  basis  of  the  current  category  7  of  Annex  H,  the  reduced  rate  is  currently
applied  (under  various  measures)  by  six  Member  States:  Belgium,  Greece,  France,
Italy, Austria and Finland (on licence fees only).

Maintaining the reduced rate for radio and television broadcasting services while it is
not  authorised  for  services  supplied  by  electronic  means  has  been  very  carefully
examined  by  the  Commission  as  it  is  likely  to  result  in  a  problem  of  distortion  of
competition,  in  view  of  the  prospect  of  increasing  distribution  of  TV/radio
programmes via the Internet and, vice versa, of Internet services via television. If the
option  to  apply  a  reduced  rate  is  maintained,  this  may  lead  to  different  rates  of

24

taxation  within  the  same  country  of  the  same  service  according  to  its  mode  of
transmission  and  cause  substantial  differences  in  taxation  between  Member  States.
Distortion  might  occur  in  particular  in  rapid  growth  sectors  with  fierce  price
competition.  In  the  case  of  high-speed  Internet  access,  for  example,  there  is  strong
competition  between  ADSL  via  the  telephone  or  cable  television  networks.  These
services  are,  by  their  very  nature,  very  liable  to  create  cross-border  distortion  of
competition because they can be provided from anywhere in the world or in the EU.

The standard  rate is  already widely  applied to the  reception  of  radio  and  television
broadcasting services (ten Member States) and is mandatory for telecommunication
services and services provided by electronic means. When adopting the e-Commerce
Directive, the Council was already quite clear in its message: there can be no reduced
rate  for  services  provided  by  electronic  means.  The  Commission  has  accordingly
examined  whether  it  would  be  preferable  to  adopt  the  same  approach  on  the
reception  of  radio  and  television  broadcasting  services,  thus  ensuring  equality  of
treatment between the audiovisual, information technology and  telecommunications
sectors.

However, since the markets in question are emerging markets and it has not yet been
possible to identify actual problems of distortion of competition, the Commission is
not at this stage proposing to abolish the reduced rate for the reception of radio and
television broadcasting services. It will nevertheless monitor this sector very closely
and, if necessary, put forward appropriate proposals.

In  addition,  the  question  of  possible  distorsions  of  competition  within  the  overall
cultural sector, in particular between the different cultural media, will be examined in
detail,  since  complaints  have  been  voiced  concerning  apparent  unequal  treatment
within the sector.

In  any  case,  these  sectors  will  be  re-examined  in  depth  when  the  next  report  is
presented in 2008 reviewing the scope of reduced rates.

6.4.5

Other ongoing changes: reduced rate for certain postal services

98. 

In  its  proposal  for  a  Directive  amending  Directive  77/388/EEC  as  regards  value
added  tax  on  services  provided  in  the  postal  sector,32  the  Commission  proposed  to
insert in Annex H “Standard postal services relating to any addressed envelopes or
packages,  of  ordinary  correspondence,  direct  mail,  books,  catalogues  and
newspapers,  where  that  item  individually  weighs  no  more  than  2  Kg,  that  being  a
fixed ceiling for the purposes of exercising this option”.

The  Commission  considered  that,  even  if  at  a  purely  technical  level,  the  best  and
simplest  solution  would  be  to  tax  all  postal  services  at  a  uniform  rate,  it  was
important to allow the Member  States  to apply a reduced rate  in  order  to  minimise
the effect of an increase in prices for the final consumer as a result of the abolition of
the current exemption.

It should be underlined here that the main aim of the proposal in question is, first of
all, to abolish the exemption currently enjoyed by public postal services. The future
application of a reduced rate is only a consequence of abolishing the exemption.

32

COM(2003) 234 final of 5 May 2003.

25

                                                
The above proposal is currently before the Council and the reduced rate in question
will be incorporated in Annex H as soon as the other proposal is adopted. There is no
need, however, to propose any amendment in the context of the present proposal. It
would indeed be legally incorrect to include a reduced rate of VAT for these services
in  this  proposal  before  the  decision  to  abolish  the  current  exemption  for  postal
services has been adopted by the Council.

7.

99. 

100. 

101. 

102. 

103. 

CONCLUSION

The  proposed  revision  represents  an  important  step  in  the  improvement  of  the
common  VAT  system  with  a  view  to  improving  the  functioning  of  the  internal
market. It will greatly simplify VAT rates for the whole of the Union, yet safeguard
the  competence  of  Member  States  to  decide  the  VAT  rates  applicable  to  their
territories.  The  Commission  is  proposing  neither  to  change  the  level  of  VAT  rates
nor to abolish the optional nature of reduced rates.

This  step  is  a  long  way  from  fully  achieving  the  harmonisation  of  rates  started  in
1992 with a view to the completion of the internal market: other steps must follow in
due course.

An  initial  review  will  at  any  rate  take  place  as  part  of  the  revision  of  the  VAT
arrangements applicable to public authority activities, associated with the revision of
the system of derogations for certain activities in the public interest provided for in
Article 13 of the Sixth Directive.

A number of the existing categories in Annex H already concern goods and services
provided by public bodies or for which an derogation is allowed: VAT applies only
where  such  bodies  are  privatised  or  such  services  are  provided  by  undertakings
which do not meet the conditions for exclusion from the scope of VAT or derogation.
Provision is made for some reduced rates in this context.

This review is planned for 2004 to allow an impact assessment, designed to analyse
the economic, environmental and social impacts of a proposal, to be carried out. The
issue of the applicable rates of VAT must of necessity be taken into account in this
context.

26

ANNEX 1
List of rates currently applied to certain categories of goods and services which should be rationalised

GOODS AND SERVICES

B

DK D

EL

E

F

IRL I

L

NL

A

PT

FIN S

UK

Medical equipment

for the disabled

Real estate sector:

25

7

8

7

5.5

0

6

21

4

20

3

19

20

5

22

25

[ex]

[ex]

0

5

Social housing

12

25

(category 9 /Annex H)

8

7

16

4

7

5.5

13.5

4

19.6

10

3

15

19

20

[ex]

22

25

17.5

5

[ex]

5

0

Renovation and

633

25

16

18

734

13.536 10

3

637

20

5

22

25

17.5

repair  (category  2  /Annex
K)

21

5.535

19.6

20

15

19

19

538

33

34

35

36

37

38

Renovation and repair of private dwellings over five years old.
Building work to repair private dwellings.
Renovation and repair of private dwellings completed over two years ago.
Parking rate.
Painting and plastering to renovate or repair private dwellings over 15 years old.
Solely for the Isle of Man.

27

                                                
GOODS AND SERVICES

B

DK D

EL

E

F

IRL I

L

NL

A

PT

FIN S

UK

Building land

[ex]

[ex]

[ex]

[ex]

16

[ex]

20

[ex]

19

[ex]

[ex]

[ex]

[ex]

[ex]

Supply of new

21

[ex]

[ex]

18

7

19.6

19.6

13.539 10

15

19

[ex]

[ex]

[ex]

[ex]

0

17.5

buildings

16

20

17.5

Construction

21

25

16

18

of new buildings

Treatment of waste

21

25

and effluent

Cut flowers and plants:

8

[-]

16

4

7

7

13.540 10

3

19

20

5

22

25

17.5

19.6

15

5.5

[-]

10

3

19

10

19.6

13.5

20

19

19

5

0

22

25

17.5

0

Ornamental

6

25

7

8

7

5.5

13.5

10

6

10

12

22

25

17.5

6

19

39

40

Parking rate.
Parking rate.

28

                                                
GOODS AND SERVICES

Food production

B

6

DK D

EL

25

7

Hotels

6/[ex] 25

16

Restaurants

21

25

16

Water

Gas

6

25

7

21

25

16

Electricity

21

25

16

Wood for use as firewood

6

25

Wood for industrial use

21

25

7

7

E

7

7

7

7

F

IRL I

5.5

0

10

5.5

13.5

10

19.6

13.5

10

5.5

[ex]

10

16

19.6/

13.541 10

5.5

16

19.6/

13.542 10

L

3

3

3

3

6

6

NL

6

6

6

6

10

20

10

19

20

19

20

A

10

PT

FIN S

UK

5

17

25

0

10

5

8

12

17.5

12

22

25

17.5

5

5

5

22

25

0

17.5

5

5

22

25

22

25

5.5

5.5

16

13.543 10

12

19

10

19

22

25

17.5

4

8

8

8

18

8

8

8

8

18

16

19.6

21

20

15

19

19

22

25

17.5

10

20

41

42

43

Parking rate.
Parking rate.
Parking rate.

29

                                                
GOODS AND SERVICES

B

DK D

EL

E

F

IRL I

L

NL

A

PT

FIN S

UK

Telecommunication services:

-Telephone/fax/telex/etc.

21

25

[ex]

18

16

19.6

21

20

15

19

20

19

22

25

17.5

Pay TV/

Cable 
networks

TV

Licence fees

25

16

8

16

5.5

21

10

15

19

10

19

22

25

17.5

12

21

[-]

25

[ex]

[ex]

2.1

[ex]

4

[ex]

[ex]

10

8

[ex]

[ex]

Clothing:

Adults'

21

25

16

18

16

19.6

21

20

Children's

Footwear:

Adults'

Children's

21

21

21

25

25

25

16

16

16

18

18

18

16

16

16

19.6

0

19.6

21

19.6

0

20

20

20

12

15

3

15

3

19

20

19

22

25

17.5

19

19

19

20

20

20

19

19

19

22

22

22

25

25

25

0

17.5

0

30

ANNEX 2
Comparison of prices and VAT rates for certain sectors – 1999

The following table shows the European Union average (100) in the Member States corrected for purchasing power parities

B

DK

D

EL

E

F

IRL

I

L

NL

A

PT

FIN

S

UK

CATEGORY

Clothing

prices

rates

Children's
clothing

prices

rates

Children's
footwear

Prices

rates

Pre-recorded
(disks,
media 
CDs, 
audio
cassettes,  video
cassettes, etc.)

147

21%

102

25%

92

16%

101

18%

87

16%

103

72

20.6%

21%

120

20%

120

15%

76

17.5%

133

20%

71

17%

97

22%

125

25%

89

17.5%

92

20%

119

3%

98

19%

103

20%

88

17%

95

22%

103

25%

99

0%

81

20%

126

3%

105

19%

109

20%

67

17%

110

22%

98

25%

116

0%

117

21%

92

25%

118

16%

125

18%

103

16%

104

19.6%

128

21%

119

25%

111

16%

85

18%

77

16%

101

19.6%

61

0%

92

0%

31

Prices

rates

Hairdressing

Prices

rates

87

21%

90

21%

121

25%

82

16%

87

18%

95

16%

110

20.6%

100

21%

106

20%

85

15%

111

89

17.5%

20%

127

25%

101

16%

84

18%

103

7%

95

81

91

19.6%

12.5%

20%

124

6%

96

6%

124

20%

88

17%

62

17%

130

22%

107

25%

116

17.5%

119

22%

108

25%

120

17.5%

Source: Eurostat - EU level=100, 1999 data

Prices include VAT

32

2003/0169 (CNS)

Proposal for a

COUNCIL DIRECTIVE

amending Directive 77/388/EEC as regards reduced rates of value added tax

THE COUNCIL OF THE EUROPEAN UNION,

Having regard to the Treaty establishing the European Community, and in particular Article
93 thereof,

Having regard to the proposal from the Commission,44

Having regard to the opinion of the European Parliament,45

Having regard to the opinion of the Economic and Social Committee,46

Whereas:

(1) 

(2) 

(3) 

(4) 

44

45

46

47

48

Council  Directive  77/388/EEC  of  17  May  1977  on  the  harmonisation  of  the  laws  of
the Member States relating to turnover taxes - Common system of valued added tax:
uniform basis of assessment47 authorises Member States to apply one or two reduced
rates which may not be lower than 5% and  are  applicable only to a restrictive list of
supplies of goods and services.

It  also  stipulates  that  the  Council  should  review  the  scope  of  reduced  rates,  on  the
basis of a report from the Commission, every two years with effect from 1994.

In a communication in 2000,48 the Commission set out a strategy designed to improve
the way the VAT system works under the internal market. It proposed a viable strategy
geared to four main objectives: the simplification and modernisation of existing rules,
more  uniform  application  of  current  rules  and  a  new  system  of  administrative
cooperation.

The  Commission  has  accordingly  proposed  a  phased  action  plan  designed  to  bring
about,  in  the  short  term,  the  required  practical  improvements  in  the  current  system.
This will involve a review and a rationalisation of the rules and derogations applicable
to the reduced rates of VAT.

OJ C […], […], p. […].
OJ C […], […], p. […].
OJ C […], […], p. […].
OJ  L  145,  13.6.1977,  p.  1.  Directive  last  amended  by  Directive  2002/93/EC  (OJ  L  331,
7.12.2002, p. 27).
COM(2000) 348 final of 7 June 2000.

33

                                                
(5) 

(6) 

(7) 

(8) 

(9) 

In  any  case,  all  modifications  should  be  consistent  with  the  Community’s  long  term
objective of moving to a definitive VAT system, based on the principle of taxation in
the country of origin; this implies that there should be a continuation of the approach
towards approximation of VAT rates.

The  latest  Commission  report  of  22  October  200149  concluded  that  the  scope  of
reduced  rates  needed  to  be  reviewed  following  the  evaluation  of  the  experiment
involving the application of reduced rates of VAT to labour-intensive services.

The Commission's evaluation  report of  2  June  2003,50  which  is  based  on  the  reports
produced by the Member States which took part in the experiment on reduced rates for
labour-intensive  services,  concludes  that,  as  a  result  of  the  experiment,  it  is  not
possible to clearly identify any favourable impact on employment or a reduction in the
black economy.

In  view  of  the  inconclusive  results  of  the  experiment  to  apply  reduced  rates  in
labour-intensive  services  and  the  need  to  improve  the  functioning  of  the  internal
market, the current structure of the reduced rates of VAT needs to be reviewed.

The review must go beyond a revision of the scope of the rates, the inclusion of new
categories  or  the  clarification  of  existing  categories,  and  be  extended  to  the  various
specific  derogations  applicable  to  them,  with  a  view  to  their  simplification  and
rationalisation.  It  must  also  include  appropriate  measures  to  enable  a  definitive
decision to be taken on the VAT rate for labour-intensive services.

(10) 

In the interests of legal certainty, it must first be specified that Member States have the
option  to  apply  a  reduced  rate  to  only  a  part  of  a  category  of  supplies  of  goods  or
services listed in Annex H, provided that the application of that reduced rate does not
give  rise  to  distortion  of  competition  and  that  the  Commission  has  the  necessary
information at its disposal to check that no such distortion exists.

(11)  The period  of  two  years  for  the  review  of  the  scope  of  reduced  rates  should  also  be
replaced by a period of five years. Experience has shown that a period of two years is
too short for genuine new factors to emerge.

(12)  Member States should be afforded equal opportunity to apply reduced rates in certain
areas and to rationalise the numerous derogations currently applying to rates so as to
avoid potential distortion of competition.

(13)  The list  of supplies of goods  and services qualifying for  reduced  rates of VAT  must
therefore  be  revised  so  as  to  incorporate  categories  of  goods  and  services  to  which
some  Member  States  apply  a  reduced  rate  under  specific  derogations  without  any
discernible detriment to the smooth functioning of the internal market.

(14)  The derogations applying to rates must also be revised to maintain only those relating
to goods and services eligible for reduced rates so as to produce a single reference list
for the application of rates other than the  standard  rate.  This  represents  a  substantial
simplification  and  rationalisation  of  the  structure  of  VAT  rates  designed  to  improve
the functioning of the internal market.

49

50

COM(2001) 599 final of 22 October 2001.
COM(2003) 309 final of 2 June 2003.

34

                                                
(15)  The  derogations  granted  to  take  account  of  the  geographical  situation  of  certain
regions must be standardised and strictly limited to the goods and services giving rise
to consumption in those territories.

(16)  Directive 77/388/EEC should be amended accordingly,

HAS ADOPTED THIS DIRECTIVE:

Directive 77/388/EEC is hereby amended as follows:

Article 1

(1)

(a)

(b)

(c)

(2)

(a)

Article 12 is amended as follows:

Paragraph 3(b) is deleted.

Paragraph 4 is replaced by the following:

"Each  reduced  rate  shall  be  so  fixed  that  the  amount  of  value  added  tax  resulting
from  the  application  thereof  shall  be  such  as  in  the  normal  way  to  permit  the
deduction  therefrom  of  the  whole  of  the  value  added  tax  deductible  under  the
provisions of Article 17.

Member States may apply a reduced rate within a given category of Annex H only to
certain  supplies  of  goods  or  services  or  only  to  certain  specific  aspects  of  a  single
supply of goods or services provided that the application of different rates does not
cause distortion of competition.

The Member States must send the necessary information to the Commission, on its
request, to check that this condition has been met.

On  the  basis  of  a  report  from  the  Commission,  the  Council  shall,  with  effect  from
2004,  review  the  scope  of  the  reduced  rates  every  five  years.  The  Council,  acting
unanimously on a proposal from the Commission, may amend the list in Annex H."

Paragraph 6 is deleted.

Article 28 is amended as follows:

Paragraph 2 is replaced by the following:

"2. Notwithstanding  Article  12(3),  points  (a)  to  (e)  shall  apply  during  the
transitional period referred to in Article 28l.

(a) Derogations  with  refund  of  the  tax  paid  at  the  preceding  stage  and  reduced
rates  lower  than  the  minimum  rate  laid  down  in  Article  12(3)  in  respect  of  the
reduced rates, which were in force on 1 January 2003 and which are in accordance
with Community law, and satisfy the conditions stated in the last indent of Article 17
of the second Council Directive of 11 April 1967, may be maintained.

The  derogation  laid  down  in  the  first  subparagraph  may  relate  only  to  supplies  of
goods or services of one of the categories listed in Annex H.

35

Member  States  shall  adopt  the  measures  necessary  to  ensure  the  determination  of
own resources relating to these transactions.

(b) Member  States  which,  under  the  terms  of  Article  12(3),  were  obliged  to
increase their standard rate as applied at 1 January 1991 by more than 2%, may apply
a reduced rate lower than the minimum laid down in Article 12(3) in respect of the
reduced rate for supplies of categories of goods and services specified in Annex H.

Member States may not introduce derogations with refund of the tax at the preceding
stage on the basis of the first subparagraph.

(c)
The following Member States may apply VAT rates up to 30% lower than the
corresponding  rates  applied  on  the  mainland  to  supplies  of  goods  and  services  in
certain remote island regions which give rise to consumption in those territories and
to goods directly imported into those regions:

(i) France: Corsica;

(ii)  Greece:  the  departments  of  Lesbos,  Chios,  Samos,  the  Dodecanese  and  the
Cyclades,  and  on  the  following  islands  in  the  Aegean:  Thasos,  Northern  Sporades,
Samothrace and Skiros;

(iii) Portugal: the autonomous regions of the Azores and Madeira.

(d) Austria  may  apply  to  supplies  of  goods  and  services  in  the  communes  of
Jungholz and Mittelberg which give rise to consumption in those territories a second
standard rate which is lower than the corresponding rate applied in the rest of Austria
but is not less than 15%.

(e) Member  States  which,  on  1  January  1993,  were  availing  themselves  of  the
option provided for in Article 5(5)(a) as in force on that date, may apply to supplies
under a contract to make up work the rate applicable to the goods after making up.

For  the  purposes  of  applying  the  first  subparagraph,  supplies  under  a  contract  to
make  up  work  shall  be  deemed  to  be  delivery  by  a  contractor  to  his  customer  of
movable  property  made  or  assembled  by  the  contractor  from  materials  or  objects
entrusted to him by the customer for this purpose, whether or not the contractor has
provided any part of the materials used."

(b)

3)

4)

Paragraph 6 is deleted.

Annex H is replaced by the text in the Annex to this Directive.

Annex K is deleted.

Article 2

Member  States  shall  bring  into  force  the  laws,  regulations  and  administrative  provisions
necessary  to  comply  with  this  Directive  not  later  than  31  December  2003.  They  shall
forthwith communicate to the Commission the text of those provisions and a correlation table
between those provisions and this Directive.

36

When Member States adopt these measures, they shall contain a reference to this Directive or
shall  be  accompanied  by  such  reference  on  the  occasion  of  their  official  publication.  The
methods of making such reference shall be laid down by the Member States.

This Directive shall enter into force on the twentieth day following that of its publication in
the Official Journal of the European Union.

Article 3

Article 4

This Directive is addressed to the Member States.

Done at Brussels, […]

For the Council
The President

37

ANNEX H

LIST  OF  SUPPLIES  OF  GOODS  AND  SERVICES  TO  WHICH  REDUCED  VAT
RATES MAY BE APPLIED

When  they  transpose  the  following  categories  into  their  national  legislation  Member  States
may  use  the  COICOP  classification  codes  or,  in  the  case  of  goods,  the  Combined
Nomenclature in order to accurately define the category in question.

Description

Catego
ry

1

2

3

4

5

6

7

8

9

The supply of foodstuffs (including beverages, but excluding alcoholic beverages) for
human and animal consumption; live animals, seeds, plants and ingredients normally
intended  for  use  in  the  preparation  of  foodstuffs;  products  normally  intended  to  be
used to supplement or replace foodstuffs

The supply of water

The  supply  of  pharmaceutical  products  of  a  kind  normally  used  for  health  care,
prevention  of  diseases  and  treatment  for  medical  and  veterinary  purposes,  including
products used for contraception and sanitary protection

The  supply  of  medical  equipment,  aids  and  other  appliances  normally  intended  to
alleviate  or  treat  disability,  for  the  exclusive  personal  use  of  the  disabled,  and
apparatus  and  electrical,  electronic  or  other  equipment  and  means  of  transport,
designed or specially adapted for the disabled

Repair of such goods.

Child car seats

Transport of passagers and their accompanying luggage

The  supply,  including  on  loan  by  libraries,  books  (including  brochures,  leaflets  and
similar printed matter, children's picture, drawing or colouring books, music printed or
in  manuscript  form,  maps  and  hydrographic  or  similar  charts),  newspapers  and
periodicals, other than material wholly or substantially devoted to advertising matter

Admission  to  shows,  theatres,  circuses,  fairs,  amusement  parks,  concerts,  museums,
zoos, cinemas, exhibitions and similar cultural events and facilities

Reception of radio and television broadcasting services

The supply of services by or royalties due to writers, composers and performing artists

Admission to sporting events and use of sporting facilities

10

The  supply,  construction,  renovation,  alteration,  repair,  maintenance  and  cleaning  of
housing. The rental of housing insofar as this service is not exempted under Article 13

38

11

12

13

14

15

16

17

18

19

20

The supply of goods and services of a kind normally intended for use in agricultural
production but excluding capital goods such as machinery or buildings

The supply of plants' bulbs, roots and the like, cut flowers and ornamental foliage and
the supply of wood for use as firewood

Accommodation provided by hotels and similar establishments including the provision
of holiday accommodation, letting of caravan sites and caravan parks

Restaurant services

The supply of goods and services by organisations recognised as charities by Member
States and engaged in welfare or social security work, insofar as these supplies are not
exempt under Article 13

The  supply  of  services  by  undertakers  and  cremation  services,  together  with  the
supply of goods related thereto

The  provision  of  medical  and  dental  care  and  thermal  treatment  insofar  as  these
services are not exempt under Article 13

Domestic  care  services  (e.g.  home  help  and  care  of  the  young,  elderly,  sick  or
disabled).

The  supply  of  services  in  connection  with  sewage,  street  cleaning,  refuse  collection
and  waste  treatment  or  waste  recycling  other  than  the  supply  of  such  services  by
bodies referred to in Article 4(5).

The supply of electricity, gas through the natural gas distribution network and district
heating

39

IMPACT ASSESSMENT FORM

IMPACT OF THE PROPOSAL ON BUSINESS WITH SPECIAL REFERENCE TO
SMALL AND MEDIUM-SIZED ENTERPRISES (SMEs)

TITLE OF PROPOSAL

Proposal for a Council Directive amending Directive 77/388/EEC as regards reduced rates of
value added tax

DOCUMENT REFERENCE NUMBER

THE PROPOSAL

1.

Taking  account  of  the  principle  of  subsidiarity,  why  is  Community  legislation
necessary in this area and what are its main aims?

The  VAT  rules  governing  reduced  rates  need  to  be  amended  to  improve  the
functioning  of  the  internal  market.  In  its  2000  communication  (COM  (2000)  348
final), the Commission set out a strategy to improve the operation of the VAT system
in  the  internal  market.  It  proposed  a  phased  action  programme  to  achieve  concrete
and essential improvements to the current system in the short term. It indicated that
the rules and derogations applying to reduced VAT rates would have to be reviewed
and rationalised. VAT rates in the Community are extremely disparate. However, the
basic rules are simple: a mandatory minimum standard rate of 15% and the option for
Member States to apply one or two reduced rates of not less than 5% but solely to the
goods  and  services  listed  in  Annex  H.  A  number  of  derogations  granted  to  some
Member  States  -  in  some  cases  to  most  of  them  -  in  the  negotiation  of  previous
Directives  or  the  Acts  of  Accession  but  refused  to  others  have  been  grafted  on  to
these simple rules.

The  Commission's  proposal is to simplify  and rationalise the  rates.  It  proposes  that
Annex  H  be  rationalised  to  include  all  the  categories  of  goods  and  services  that
qualify for reduced rates and that the specific derogations allowing a rate other than
the  standard rate for  other categories  of  goods  and  services  be  abolished.  This  will
improve the functioning of the  internal market  and preserve the Community acquis
already achieved.

THE IMPACT ON BUSINESS

2.

Who will be affected by the proposal?

–  Which sectors of business? All sectors which may be concerned: i.e. those where
the  reduced  rates  can  be  applied  and  those  where  they  cannot  because  they  are
excluded.

–  Which  size  of  business  (what  is  the  concentration  of  small  and  medium-sized

firms? All.

40

–  Are there particular geographical areas of the Community where these businesses

are found? NO

3.

What  will  business  have  to  do  to  comply  with  the  proposal?  Nothing  in  particular.
Businesses must comply with national legislation introduced by their Member State
to  amend,  where  appropriate,  the  applicable  VAT  rates  in  order  to  transpose  the
Directive.

4.

What economic effects is the proposal likely to have:

–  on employment?

The  evaluation  report  on  the  experimental  application  of  reduced  rates  for
labour-intensive  services  concluded  that  it  was  impossible  to  identify  with  any
certainty any beneficial impact on employment or a reduction in the black economy
as a result of reducing VAT rates under this experiment. This proposal is  therefore
unlikely to have an economic effect on employment.

–  on investment and the creation of new businesses?

VAT  can  be  deducted  by  business  and  any  change  in  rates  is  unlikely  to  have  an
impact on the creation of new businesses.

–  on the competitiveness of businesses?

The proposed review of the scope of reduced rates is unlikely to have a direct impact
on  the  competitiveness  of  businesses.  VAT  is  a  tax  on  final  consumption.
Nevertheless,  it  may  reduce  the  costs  in  correctly  applying  different  rates  of  VAT
through the simplification of rates it proposes.

–  On consumers?

Annex H has been amended to include some new categories on a permanent basis;
the impact on consumers will depend on whether individual Member States decide to
exercise their freedom to apply a reduced rate, and ultimately on how firms pass on
that  reduction  to  their  customers.  The  results  of  the  experiment  involving  labour-
intensive  services  suggest  that  in  most  cases  the  cuts  were  neither  wholly  -  nor,  in
particular , permanently - passed on to consumers.

The  proposal  to  abolish  zero,  super-reduced  and  parking  rates  for  goods  not
listed in Annex H affects only a small number of sectors and Member States. We can
assume that the effect on prices as a whole will be slight and often negligible, and in
any case only temporary. A comparison of current prices suggests that there should
be  enough  margin  for  manoeuvre  to  absorb  the  increase  in  VAT  without  a
concomitant increase  in prices.  The  removal  of  the  exemption  for  tax-free  shops  is
instructive:  on  1  July  1999  tax  relief  on  intra-Community  sales  was  replaced  by
taxation  at  the  standard  rate,  but  consumer  prices  remained  the  same.  The  industry
was  able  to  absorb  the  introduction  of  the  tax,  in  other  words,  without  loss  of
viability.

5.

Does the proposal contain measures to take account of the specific situation of small
and medium-sized firms (reduced for different requirements, etc.)?

41

NO

CONSULTATION

6.

Many  economic  sectors  have  notified  the  Commission  that  they  would  like  to  be
added to the  list  of supplies  of  goods  and  services  which  qualify  for  reduced  VAT
rates. The report of 22 October 2001 on reduced VAT rates (COM (2001) 599 final)
contains a list of the sectors in question. All these applications argue that a reduced
rate  is justified in a particular  sector in view  of  its  culture,  social  or environmental
importance or the particular problems it faces.

IMPACT ON MEMBER STATES

The proposed amendments will not have any impact on own resources.

7.

Impact of amending Annex H on the Member States

The proposal  does not call into question  the  optional nature  of  reduced  VAT  rates.
No  Member  State  will  suffer  any  budgetary  loss  as  a  result  of  the  proposal:  any
reduction in the rates applying following the addition of new categories will continue
to be  their  sole responsibility.  If  the  rate of  VAT  applying  to  a  service  or  goods  is
reduced,  the  economic  impact will be a  loss of  revenue  for  a  Member  State.  There
will be no inflationary impact.

If  a  reduction  in  VAT  rates  is  reflected  in  prices,  they  may  fall.  In  practice  the
experiment  involving  labour-intensive  services  has  shown  that  a  reduction  in  VAT
rates is never reflected fully or permanently in prices. Demand is therefore unlikely
to change significantly.

8.

Economic effects of abolishing the zero, super-reduced and parking rates for goods
not listed in Annex H of the Sixth VAT Directive

This measure concerns only a small number of Member States.

An increase in VAT rates will put direct upward pressure on prices. VAT is paid by
the consumer and any increase in VAT is likely to be passed on, at least in part, in
prices. The impact on demand will depend on the magnitude of price elasticity and
degree to which this increase in VAT is passed on to prices. The impact on demand
will be neutral (not passed on to prices and/or very low price elasticity) or negative
and demand will fall (increase in prices with high price elasticity).

Generally speaking, the proposal to abolish the zero, super reduced and parking rates
for  goods not listed in  Annex H of the Sixth VAT Directive will have a  fairly  low
(overall) and, often negligible, impact on the general level of prices. This effect will
only be temporary. In the case of certain Member States the level of current prices
for the goods concerned compared to those in other Member States shows that there
is  some  capacity  for  absorbing  for  this  increase  in  VAT  without  causing  prices  to
rise. Consequently, the proposal is unlikely to have an inflationary impact and, if it
did, it would be low and be only of a temporary nature.

42