Proposal for a Council Decision authorising the United Kingdom to introduce a special measure derogating from Article 21(1)(a) of Directive 77/388/EEC on the harmonisation of the laws of the Member States relating to turnover taxes
Date: 2006-09-28
Institutions: European Commission
Subjects: United Kingdom, VAT, derogation from EU law, electronic component, electronic device, mobile phone, optical medium, tax avoidance, tax harmonisation, tax system

COMMISSION OF THE EUROPEAN COMMUNITIES 

Brussels, 28.9.2006 
COM(2006) 555 final 

Proposal for a 

COUNCIL DECISION 

authorising the United Kingdom to introduce a special measure derogating from Article 
21(1)(a) of Directive 77/388/EEC on the harmonisation of the laws of the Member States 
relating to turnover taxes 

(presented by the Commission) 

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EXPLANATORY MEMORANDUM 

1)  CONTEXT OF THE PROPOSAL 

110 

•  Grounds for and objectives of the proposal 

Pursuant to Article 27(1) of the Sixth 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 value added tax: uniform basis of assessment, the Council, acting 
unanimously on a proposal from the Commission, may authorise any Member State to 
apply  special  measures  for  derogation  from  that  Directive  in  order  to  simplify  the 
procedure for charging the tax or to prevent certain types of tax evasion. 

By  letter  registered  with  the  Secretariat-General  of  the  Commission  on  10  February 
2006, the United Kingdom requested authorisation to introduce a measure derogating 
from  Article  21(1)(a)  of  Directive  77/388/EEC.  In  accordance  with  Article  27(2)  of 
Directive 77/388/EEC, the Commission informed the other Member States on 18 July 
2006  of  the  request  made  by  the  United  Kingdom.  By  letter  dated  19  July  2006,  the 
Commission notified the United Kingdom that it had all the information it considered 
necessary for appraisal of the request. 

120 

•  General context 

As a general rule, Article 21(1)(a) of Directive 77/388/EEC, in the version set out in 
Article  28(g)  thereof,  stipulates  that,  under  the  internal  system,  the  taxable  person 
supplying goods is liable to pay value added tax (VAT) to the treasury.  

The  United  Kingdom  would  like  to  apply  a  reverse  charge  procedure,  whereby  the 
taxable person to whom the supplies of goods are made becomes the person liable to 
account for the VAT to the treasury on the supply of the following goods: 

•  Mobile telephones 

•  Computer chips/microprocessors/central processing units  

•  Electronic storage medium for use with computers or any mobile telephone device 

or specified electronic devices. 

•  Electronic  devices  used  for  the  storage,  processing  or  recording  of  electronic  data 

such as: 

–  hand-held digital cameras and camcorders, 

–  hand-held digital audio players, such as MP3 players, 

–  hand-held digital video players and portable DVD players, 

–  wireless  devices  providing  e-mail,  telephone,  text  messaging,  web 

browsing and other wireless data access, 

–  hand-held computers, 

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–  handheld  or  portable  positional  determination  devices  for  satellite 

navigation systems, 

–  games  consoles  with  a  screen,  or  of  a  kind  used  with  a  television  or 

computer. 

The consequence of this measure would be that the price paid by the customer to the 
supplier for such products would not include an amount in respect of VAT. Instead, the 
customer would account for VAT on the supply in his own VAT return. According to 
the normal rules, he would also deduct this VAT in the same return. No tax would thus 
be paid on such supplies between fully taxable persons, and it would be the retailer, the 
final  link  in  the  supply  chain,  who  would  pay  the  whole  amount  of  VAT  to  the 
treasury.  In  this  way,  the  UK  wishes  to  derogate  from  one  of  the  basic  principles  of 
VAT:  the  system  of  fractioned  payment  whereby  each  taxable  person  in  the  supply 
chain pays a part of the final VAT due on the supply. 

•  The fraud problem in the United Kingdom 

Supplies of the products mentioned above have given rise to a very high level of tax 
evasion  in  the  United  Kingdom.  The  most  common  form  of  evasion  consists  in  the 
invoicing  of  supplies  by  a  supplier  who  is  registered  for  VAT  but  then  disappears 
without  paying  tax.  In  so  doing,  he  nevertheless  provides  the  customer  with  a  valid 
VAT invoice, allowing the latter to recover input VAT. The result is that the treasury 
does not receive VAT on the supply, but must give the next trader in the chain credit 
for input VAT as if it had been paid. 

This  has  developed  into  Missing  Trader  Intra-Community  Fraud  (MTIC),  which  is  a 
highly  sophisticated  and  well-organised  attack  on  the  VAT  system,  often  perpetrated 
by  organised  criminals.  It  exploits  an  opportunity  provided  by  the  transitional  VAT 
regime, under which supplies made by a supplier in one Member State to a customer in 
another  are  free  of  VAT  in  the  State  of  dispatch.  Instead,  the  customer  accounts  for 
VAT in the State of arrival (a reverse charge of the kind already described, but limited 
to the single supply). Where the customer disappears without accounting for VAT on 
the  supply  of  high-value  items  such  as  those  which  are  the  object  of  the  present 
request,  the  loss  of  revenue  can  be  significant.  In  addition,  the  persons  perpetrating 
such frauds often organise a series of supplies in which the same goods may circulate 
several  times  between  Member  States  (so-called  carousel  fraud).  In  this  way  the 
amount lost by the treasury may be many times the amount of tax on a single supply of 
the goods. 

Fraud of this kind is estimated to have cost the United Kingdom between GBP 6,750 
million and GBP 11,000 million since 2001. In recent years, the United Kingdom has 
witnessed  a  significant  increase  in  the  sophistication  and  complexity  of  the  fraud,  in 
response  to  various  interventions.  The  latest  published  estimates  put  MTIC  fraud  at 
between  GBP  1,120  million  and  GBP  1,900  million  in  2004/05.  However,  more 
recently operational indicators in the United Kingdom suggest that levels of fraudulent 
activity are increasing, despite increased efforts to tackle this type of fraud and the use 
of the instruments available to all Member States within Community legislation. 

In order to combat this criminal activity, the United Kingdom Government would like 

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to apply a reverse charge procedure. In its view, such a procedure would eliminate the 
fraud  described  above  by  removing  the  opportunity  for  profit.  If  no  VAT  is  charged, 
there is no scope for the potential 'missing' trader to abscond without accounting to the 
treasury for the VAT element of the price received from his customer. The procedure 
would be restricted to the range of goods identified as being the object of most MTIC 
fraud cases and would have the effect of preventing further significant revenue losses.  

Being  confined  to  a  small  range  of  goods,  the  proposed  system  would  not  have  the 
character of a generalised reverse charge mechanism, nor would it have the purpose of 
becoming one. The system would thus not bring any fundamental change to the current 
VAT system, based on the fractioned payment of the tax. 

At  the  same  time,  the  United  Kingdom  would  also  introduce  control  and  reporting 
obligations to ensure that information is available to provide assurance to the Revenue 
authorities  that  the  measure  is  operating  effectively.  These  might  be  similar  to  the 
current reporting requirements for the intra-Community supply of goods. 

For the purposes of simplification the United Kingdom would like to set a threshold of 
GBP 1,000 (approximately €1,480) below which supplies would not be subject to the 
reverse  charge.  This  would  alleviate  potential  difficulties  for  retailers  and  small 
business  customers.  At  the  same  time,  the  threshold  should  be  low  enough  to  avoid 
disaggregating of sales in order to avoid the reverse charge. 

•  The Commission’s view of the request 

When  the  Commission  receives  requests  in  accordance  with  Article  27,  it  examines 
these requests to ensure that the basic conditions for granting such requests are fulfilled 
i.e.  whether  the  proposed  specific measure  simplifies  procedures  for  taxable  persons 
or the tax administration or whether the proposal prevents certain types of tax evasion 
or avoidance. In this context, the Commission takes a cautious approach to ensure that 
derogations do not undermine the operation of the general VAT system. It was in this 
context  that  it  made  the  proposal1  in  2005  for  the  purpose  of  amending  Directive 
77/388/EEC as regards certain measures to simplify the procedure for charging value 
added tax and to assist in countering tax evasion and avoidance, and repealing certain 
Decisions  granting  derogations  which  would  allow  all  Member  States  to  apply 
derogations which had proven to be useful and effective. 

In particular, the Commission is normally reluctant to propose acceptance of a request 
to apply a reverse charge, since such a measure eliminates a central feature of the VAT 
system, namely fractioned payment. It is true that the special scheme for gold provided 
for  in  Article  26b  of  the  Sixth  VAT  Directive  could  be  described  as  an  established 
reverse charge. However, the application of these provisions are carefully targeted and 
limited in scope and size. 

•  Conclusion 

The  request  from  the  UK  attempts  to  use  Article  27  for  the  purpose  of  making  a 
fundamental  change  to  the  VAT  system  in  the  sense  of  a  generalised  reverse  charge, 

1 

COM(2005) 89 of 16.3.2005; adopted as Directive 2006/69/EC (OJ L 221, 12.8.2006, p. 9). 

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even if limited to a certain range of goods. It would mean that taxable persons in the 
sectors  concerned  would  effectively  have  to  deal  with  three  different  types  of  tax 
regime: 

•  The “classical” VAT system 

•  The  reverse  charge  system  for  B2B  supplies  where  certain  criteria  were 

fulfilled 

•  The intra-Community system. 

This would add an extra layer of difficulty to the accounting burdens already faced by 
business. Similarly, additional compliance burdens (verifying the nature of customers 
and  reporting  transactions)  would  be  imposed  on  all  businesses,  including  honest 
traders,  operating  in  the  areas  concerned.  Furthermore,  the  application  of  the  reverse 
charge  would  offer  new  fraud  opportunities  especially  at  the  final  consumption  level 
and would therefore need to be accompanied by appropriate control measures in order 
to  guarantee  that  final  consumption  will  not  escape  taxation  in  the  absence  of  a 
properly functioning fractioned payment system.  

While  recognizing  these  drawbacks  the  Commission  nevertheless  believes  that  the 
requests can still be regarded as satisfying the test required by Article 27. In fact the 
measure is likely to eliminate the currently experienced MTIC fraud situations and thus 
addresses  a  specific  type  of  fraud.  The  question,  however,  arises  to  what  extent  the 
measure remains proportional having regard to the relationship between the size of the 
fraud and non-fraudulent activity in the sector concerned. The scope of the measure is 
relatively broad, covering a large proportion of the electronic sector, but according to 
the information received from the United Kingdom the number of taxpayers concerned 
by the measure and the economic importance of their activities remains limited (some 
22,500 taxable persons out of a total of 1,900,000 VAT registered businesses). In view 
of  the  huge  amounts  of  VAT  receipts  at  stake  and  the  relatively  limited  increase  in 
burdens  for  the  legitimate  trade  a  broad  scope  of  application  still  appears  to  remain 
within the scope of Article 27. 

At  the  same  time  it  must  be  recognized  that  other  Member  States  experience  similar 
fraud  patterns  (involving  the  same  categories  or  other  types  of  goods)  and  that  they 
may seek similar derogations from Article 21 of the Sixth Directive. That could result 
in  a  variety  of  different  obligations  for  taxpayers  in  different  Member  States,  a 
situation  which  would  conflict  with  the  requirements  for  a  well  functioning  Internal 
Market. Therefore, the proposal granting the requested derogation must also define the 
key elements of the implementation of the reverse charge and must limit its duration in 
time  in  order  to  allow  for  an  evaluation  of  its  effectiveness  (both  as  regards  stated 
MTIC  fraud  and  in  preventing  final  consumption  without  VAT  payment)  and  its 
impact  on  the  functioning  of  the  Internal  Market.  The  proposal  allows  for  the 
authorisation of the reverse charge until 31st December 2009. 

139 

•  Existing provisions in the area of the proposal 

There are no existing provisions in the area of the proposal. 

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141 

•  Consistency with other policies and objectives of the Union 

The proposal is consistent with the overall objective to help Member States to combat 
fiscal fraud. 

2)  CONSULTATION OF INTERESTED PARTIES AND IMPACT ASSESSMENT 

•  Consultation of interested parties 

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Not relevant. 

•  Collection and use of expertise 

There was no need for external expertise. 

•  Impact assessment 

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The Decision proposal aims at combating VAT evasion and is likely to have a positive 
impact on VAT receipts. 

Nevertheless,  the  measure  will  have  a  negative  impact  on  businesses  since  the 
arrangements will be different from those applying for normal supplies of goods. This 
will introduce complexity in accounting for businesses which do not deal exclusively 
in the goods which are the object of the derogation. The control mechanisms envisaged 
will also impose additional obligations on the business sector concerned. It is therefore 
clear that this derogation fails the simplification test provided by Article 27 and only 
falls within the scope of preventing specific types of evasion. 

There is, of course, no guarantee that the measure envisaged by the UK will eliminate 
the fraud in question, which is why the Commission proposes a short time-scale for the 
derogation. 

While the impact of the measure will in any case be limited because of its scope, the 
effectiveness  of  the  measures  will  be  evaluated  by  the  UK  and  communicated  to  the 
Commission. 

3)  LEGAL ELEMENTS OF THE PROPOSAL 

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•  Summary of the proposed action 

Authorisation  for  the  United  Kingdom  to  apply  a  measure  derogating  from  Article 
21(1)(a)  of  the  Sixth  Council  Directive  77/388/EEC  as  regards  the  use  of  a  reverse 
charge  mechanism 
telephones,  computer 
chips/microprocessors,  electronic  storage  media  &  handheld  electronic  devices  used 
for the storage, processing or recording of electronic data. 

for  domestic  supplies  of  mobile 

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•  Legal basis 

Article  27(1)  of  the  Sixth  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 value added tax: uniform basis of assessment 

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329 

•  Subsidiarity principle 

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332 

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The proposal falls under the exclusive competence of the Community. The subsidiarity 
principle therefore does not apply. 

•  Proportionality principle 

The proposal complies with the proportionality principle for the following reason(s). 

This  Decision  concerns  an  authorisation  granted  to  a  Member  State  upon  its  own 
request and does not constitute any obligation. 

Given  the  clearly  defined  scope  of  the  derogation,  the  special  measure  appears  to  be 
proportionate to the aim pursued considering the scale and size of the losses concerned. 

•  Choice of instruments 

Proposed instruments: other. 

Other means would not be adequate for the following reason(s). 

Under Article 27 of the Sixth Council Directive 77/388/EEC on the harmonisation of 
the laws of the Member States relating to turnover taxes, derogation from the common 
VAT  rules  is  only  possible  on  the  authority  of  the  Council  acting  unanimously  on  a 
proposal  from  the  Commission.  A  Council  Decision  is  the  only  suitable  instrument 
since it can be addressed to an individual Member State. 

4)  BUDGETARY IMPLICATION 

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The proposal has no negative implication for the Community budget. 

5)  ADDITIONAL INFORMATION 

•  Review/revision/sunset clause 

The proposal includes a sunset clause. 

533 

E-5037 

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Proposal for a 

COUNCIL DECISION 

authorising the United Kingdom to introduce a special measure derogating from Article 
21(1)(a) of Directive 77/388/EEC on the harmonisation of the laws of the Member States 
relating to turnover taxes 

THE COUNCIL OF THE EUROPEAN UNION, 

Having regard to the Treaty establishing the European Community, 

Having  regard  to  the  Sixth  Council  Directive  77/388/CEE  of  17  May  1977  on  the 
harmonisation of the laws of the Member States relating to turnover taxes – Common system 
of value added tax: uniform basis of assessment2, and in particular Article 27(1) thereof, 

Having regard to the proposal from the Commission3, 

Whereas: 

(1) 

(2) 

(3) 

In  a  letter  registered  by  the  Secretariat-General  of  the  Commission  on  10  February 
2006,  the  United  Kingdom  requested  authorisation  to  introduce  a  special  measure 
derogating from Article 21(1)(a) of Directive 77/388/EEC as regards the person liable 
for payment of value added tax (VAT). 

In accordance with Article 27(2) of Directive 77/388/EEC, the Commission informed 
the  other  Member  States  by  letter  dated  18  July  2006  of  the  request  made  by  the 
United  Kingdom.  By  letter  dated  19  July  2006,  the  Commission  notified  the  United 
Kingdom  that  it  had  all  the  information  it  considered  necessary  for  appraisal  of  the 
request. 

The person liable for payment of the value added tax (VAT), under Article 21(1)(a) of 
Directive  77/388/EEC,  in  the  version  set  out  in  Article  28g  thereof,  is  the  taxable 
person  supplying  the  goods.  The  purpose  of  the  derogation  requested  by  the  United 
Kingdom  is  to  place  that  liability  on  the  taxable  person  to  whom  the  supplies  are 
made,  but  only  under  certain  conditions  and  exclusively  in  the  case  of  mobile 
telephones,  computer  chips/microprocessors,  electronic  storage  media  and  handheld 
electronic devices used for the storage, processing or recording of electronic data. 

(4)  Within that sector, a significant number of traders engage in tax evasion by not paying 
VAT to the tax authorities after selling the products. Their customers, however, being 
in receipt of a valid invoice, remain entitled to a tax deduction. In its most aggressive 
form,  the  same  goods  are,  via  a  'carousel'  scheme,  supplied  several  times  without 

2 
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OJ L 145, 13.6.1977, p.1. Directive last amended by Directive 2006/69/EC (OJ L 221, 12.8.2006, p. 9).  
OJ C , , p. . 

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(5) 

(6) 

(7) 

payment of the VAT to the tax authorities. By designating in those cases the person to 
whom the goods are supplied as the person liable for the VAT, the derogation would 
remove the opportunity to engage in that form of tax evasion. However, it would not 
affect the amount of VAT due. 

For the purposes of ensuring the effective operation of the derogation and preventing 
the  tax  evasion  from  being  shifted  to  other  products  or  towards  the  retail  level,  the 
United  Kingdom  should  introduce  appropriate control and reporting obligations. The 
Commission should be informed of the specific measures adopted, and the monitoring 
and overall evaluation of the operation of the derogation. 

The measure is proportionate to the objectives pursued since it is not intended to apply 
generally, but only to a specific high risk sector comprising certain carefully defined 
products  in  relation  to  which  the  scale  and  size  of  the  tax  evasion  has  resulted  in 
considerable  tax  losses.  Furthermore,  since  that  sector  is  a  small  one,  the  derogation 
cannot be considered equivalent to a general measure. 

The  authorisation  should  be  valid  only  for  a  short  period,  because  it  cannot  be 
ascertained with certainty that the objectives of the measure will be achieved, nor can 
the  impact  of  the  measure  on  the  functioning  of  the  VAT  system  in  the  United 
Kingdom and in other Member States be gauged in advance; moreover, the impact of 
the measure and its implementation on the functioning of the internal market will have 
to be properly assessed.  

(8) 

The  derogation  has  no  negative  impact  on  the  Community’s  own  resources  accruing 
from VAT,  

HAS ADOPTED THIS DECISION:  

Article 1 

By way of derogation from Article 21(1)(a) of Directive 77/388/EEC, in the version set out in 
Article  28g  thereof,  the  United  Kingdom  is  authorised  to  designate  the  taxable  person  to 
whom the supplies of the following goods are made as the person liable to pay value added 
tax (VAT): 

(1) 

(2) 

(3) 

(4) 

mobile  telephones,  being  devices  made  or  adapted  for  use  in  connection  with  a 
licensed  network  and  operated  on  specified  frequencies,  whether  or  not  they  have 
any other use; 

integrated  circuit  devices  such  as  microprocessors  and  central  processing  units  in  a 
state prior to integration into end user products; 

electronic  storage  medium  and  PC  cards,  such  as  Memory  Sticks,  CD-Rom  &  SD 
cards, for use with computers or with any of the devices referred to in points (1) and 
(4); 

electronic devices used for the storage, processing or recording of electronic data as 
follows: 

(a) 

handheld devices for recording or playing of sound and/or images;  

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(b)  handheld digital audio players, such as MP3 players; 

(c) 

handheld digital video players and portable DVD players; 

(d)  wireless  devices  providing  e-mail,  telephone,  text  messaging,  web  browsing 

and other wireless data access, and hand-held computers; 

(e) 

handheld  or  portable  positional  determination  devices  for  satellite  navigation 
systems 

(f) 

games consoles with a screen, or of a kind used with a television or computer. 

The  derogation  shall  apply  in  respect  of  supplies  of  goods  for  which  the  taxable  amount  is 
equal to or higher than GBP 1 000. 

Article 2 

The  derogation  provided  for  in  Article  1  is  subject  to  the  United  Kingdom  introducing 
appropriate  and  effective  control  and  reporting  obligations  on  taxable  persons  that  supply 
goods to which the reverse charge applies in accordance with this Decision. 

Article 3 

The United Kingdom shall inform the Commission where it has adopted the measures referred 
to in Articles 1 and 2 and shall by 31 December 2008 submit a report to the Commission on 
the overall evaluation of the operation of the measures concerned, in particular as regards the 
effectiveness of the measure and any evidence of the shifting of tax evasion to other products 
or to the retail level.  

This Decision shall expire on 31 December 2009.  

Article 4 

Article 5 

This Decision is addressed to the United Kingdom of Great Britain and Northern Ireland. 

Done at Brussels,  

For the Council 
The President 

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