Communication from the Commission to the Council and the European Parliament on VAT rates other than standard VAT rates {SEC(2007) 910}
Date: 2007-07-05
Institutions: European Commission
Subjects: EU Member State, VAT, VAT rate, fiscal policy, single market, tax harmonisation, tax law, tax relief

COMMISSION OF THE EUROPEAN COMMUNITIES 

Brussels, 5.7.2007 
COM(2007) 380 final 

COMMUNICATION FROM THE COMMISSION TO THE COUNCIL AND THE 
EUROPEAN PARLIAMENT 

on VAT rates other than standard VAT rates 

{SEC(2007) 910} 

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TABLE OF CONTENTS 

1. 

2. 

3. 

3.1. 

3.2. 

3.3. 

3.4. 

4. 

4.1. 

4.2. 

4.3. 

5. 

Introduction .................................................................................................................. 3 

Main conclusions of the study on the impact of reduced rates .................................... 4 

Reflection on the way forward..................................................................................... 6 

General ......................................................................................................................... 6 

Subsidiarity .................................................................................................................. 6 

Internal Market imperatives ......................................................................................... 7 

Compliance cost for business....................................................................................... 8 

Invitation for a political debate .................................................................................... 9 

Balance between flexibility, internal market imperatives and simplification.............. 9 

Rates structure............................................................................................................ 10 

Maintenance of the status quo pending the outcome of the political debate ............. 12 

Conclusion.................................................................................................................. 13 

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1. 

INTRODUCTION 

The  current  VAT  rate  structure  was  adopted  by  the  Council  in  1992  as  part  of  the 
package  of  measures  considered  necessary  for  the  abolition  of  controls  at  frontiers 
and  the  creation  of  the  Internal  Market.  Under  this  system,  Member  States  are 
required to apply a single standard rate of at least 15% and may have a maximum of 
two  reduced  rates  set  no  lower  than  5%,  which  Member  States  may  apply  at  their 
discretion,  to  the  categories  of  goods  and  services  listed  in  Annex  III  to  Council 
Directive 2006/112/EC (the VAT Directive). In this respect, Member States remain 
free  to  apply  a  reduced  rate  to  a  whole  category  or  to  restrict  its  application  to  an 
(even very small) part of it. This basic structure, which applies to all Member States, 
is  complicated  by  the  plethora  of  different  temporary  derogations  granted  to 
individual Member States outside the general scheme.  

In 2003, the Commission tabled a proposal concerning the review of reduced VAT 
rates1,  resulting  in  Council  Directive  2006/18/EC  of  14  February  2006.  This 
Directive  foresees  the  third  prolongation  of  the  experiment  on  reduced  rates  for 
labour-intensive services till the end of 2010, and a possibility to apply a reduced rate 
on  district  heating  under  the  same  procedure  as  for  natural  gas  and  electricity.  No 
more  far-reaching  agreement  on  the  scope  and  level  of  reduced  rates  could  be 
reached. In particular, there was no agreement on the rationalisation of the structure 
of  the  reduced  rates  or  on  the  application  of  a  reduced  rate  for  the  whole  sector  of 
housing or for restaurant services, as proposed at that time by the Commission.  

However,  Council  Directive  2006/18/EC  included  a  request  to  the  Commission  to 
present to the European Parliament and to the Council, by the end of June 2007, an 
overall assessment report on the impact of reduced rates. This would cover locally-
supplied  services,  including  restaurant  services,  notably  in  terms  of  job  creation, 
economic  growth  and  the  proper  functioning  of  the  internal  market,  and  would  be 
based on a study carried out by an independent economic think-tank. 

The  study  contract  was  awarded  to  Copenhagen  Economics2.  The  study  mainly 
examined the impact of reduced VAT rates and of derogations, not only for locally 
supplied  services,  but  also  more  globally.  The  effects  on  income  distribution,  the 
informal  economy  and  on  compliance  costs  for  businesses  were  also  taken  into 
consideration.  

This  Communication  presents  the  main  conclusions  of  the  above  study,  provides 
material for discussion and explores ways forward in the field of reduced VAT rates. 
The Commission considers that the study provides a sound basis for such work. Ideas 
on the possible ways forward presented hereafter take as a starting-point the results 
of  the  study  but  also  take  into  account  the  current  complex  situation  and  political 
sensitivities. It is clear, however, that the need  to  simplify and rationalize  the level 
and  scope  of  reduced  rates  also  forms  a  guiding  principle  of  the  reflections.  The 
Commission's objective is to ensure equal opportunities for Member States as well as 

COM(2003) 397 final 

Copenhagen Economics ApS, Nyropsgade 13/1, DK-1602 Copenhague 

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more transparency, consistency and – above all - a smooth functioning of the internal 
market,  e.g. via fewer obstacles  to  cross-border economic activity and lower VAT-
induced  compliance  costs.  Moreover,  commonly  agreed  strategic  Community 
policies and priorities, such as those relating to the Lisbon strategy, play an important 
role. Finally, it is clearly necessary to fully respect the subsidiarity principle for such 
a sensitive issue that touches on Member States' fiscal sovereignty.  

2. 

MAIN CONCLUSIONS OF THE STUDY ON THE IMPACT OF REDUCED RATES  

A  summary  of  the  study's  results  is  further  elaborated  on  in  the  Commission  staff 
working document 'Main conclusions of the study on reduced VAT rates applied to 
goods and services in the Member States of the European Union'3 . The Annex to that 
working document contains the full Copenhagen Economics' executive summary of 
their study. The following points highlight the key results of the study, in particular 
from the point of view of potential policy implications. 

•  The study stresses that a single VAT rate is by far the best policy choice from a 
purely  economic  point  of  view.  A  move  towards  more  uniform  rates  has  thus 
considerable  advantages.  First,  a  less  complicated  rate  structure  would  generate 
substantial  savings  in  compliance  costs  for  business  and  tax  administrations. 
Second, it could reduce distortions in the functioning of the internal market. Third, 
it  is  likely  to  slightly  improve  "consumer  welfare"  compared  with  the  current 
situation. 

•  However,  there  may  be  specific  benefits  from  operating  a  reduced  VAT  in 
carefully  targeted  sectors.  Lower  VAT  rates  can  increase  overall  productivity 
and  thus  GDP,  as  well  as  tax  revenue,  in  a  Member  State  if  they  can  induce 
consumers to spend less time on do-it-yourself (DIY) activities and more time on 
their ordinary job. This behaviour would result in a shift of activities from DIY to 
the  formal  economy.  Locally  supplied  services  (and  restaurants)  are  industries 
where households have considerable scope for carrying out DIY and therefore the 
area where such a shift could thus take place. The argument for a reduced rate on 
locally  supplied  services  is  significantly  stronger  in  Member  States  with  higher 
marginal  income  taxes  and  higher  VAT-rates  and  for  some  sub-sectors  within 
locally  supplied  services  with  limited  need  for  formal  training  and  specialised 
machinery.  The  same  productivity  argument  holds,  albeit  to  a  lesser  degree,  if 
the 
lower  VAT  rates  can 
"underground"  economy.  Finally,  it  appears  that  different  VAT  rates  applied  to 
locally  supplied  services  are  of  no  concern  for  the  functioning  of  the  internal 
market. Services provided by restaurants and hotels are in-between, because they 
are mainly directed at domestic consumption, but may also affect distribution of 
tourism between Member States and may have a non-negligible impact in border 
regions. 

induce  consumers 

less  money  on 

to  spend 

•  Lower  VAT  rates  targeting  sectors  using  many  low  skilled  workers,  such  as 
locally  supplied  services,  financed  for  example  by  higher  VAT  rates  elsewhere 
can  create  permanent  employment  gains,  but  the  overall  gains  are  likely  to  be 

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minor.  The  net  gains  stem  from  the  fact  that  demand  for  low  skilled  workers  is 
likely  to  be  boosted  and  that  low  skilled  workers  face  more  difficulties  in 
obtaining a job than higher skilled workers, as a result of labour market rigidities. 
However,  the  gains  are  minor  because  the  targeted  sectors  account  only  for  a 
small proportion of the overall employment in low skilled sectors. So the increase 
in  low  skilled  employment  in  these  relatively  small  industries  is  nearly  entirely 
offset by decreases in other industries hit by the higher VAT rate.  

•  Besides  the  above-mentioned  efficiency  arguments  in  favour  of  reduced  rates, 
generally  the  argument  of  improving  equity  is  advanced.  In  this  respect,  the 
study  finds  that  for  the  improvement  of  income  distribution  in  a  Member  State, 
reduced  VAT  rates  are  effective  only  when  the  share  of  consumption 
expenditure  of  goods/services  subject  to  a  reduced  rate  (out  of  the  total 
consumption  expenditure)  differs  sufficiently  between  low  and  high-income 
groups  and  is  stable  over  time.  These  differences  are  the  largest  for  food. 
However, in this respect there are relatively large differences between countries. 
Reduced  rates  are  less  potent  in  countries  which  already  have  high  income 
equality.  Moreover,  in  certain  cases,  policy  goals  may  conflict  internally  (for 
example  if  the  objective  of  a  reduced  rate  is  to  promote  the  purchase  of  certain 
goods, it is possible that high-income groups benefit more from the reduced rate, 
which conflicts with the income equality goal).  

•  The  study  also  makes  a  strong  case  that  reduced  VAT  rates  create  significant 
compliance costs for business and tax authorities, partly at least because of the 
interpretations  which  have  to  be  made  in  respect  of  borderline  cases  which  are 
often costly and resource intensive.  

•  Other alternative policy tools, such as direct subsidies for particular activities, in 
the main achieve the same goals as reduced VAT rates with fewer costs. These 
subsidy  schemes  may  be  better  targeted,  better  designed  to  avoid  negative  spill 
over  effects  at  the  EU  level  and,  generally  speaking,  may  be  more  transparent. 
They  may  also  incur  fewer  compliance  costs  and  budgetary  losses.  However, 
compared  to  reduced  VAT  rates,  direct  subsidies  might  appear  less  secure  as  a 
permanent solution for the businesses concerned.  

•  The study recommends that Member States carefully examine all the options 
available  when  they  want  to  promote  the  consumption  of  specific  goods  or 
services:  often  other  tools  than  reduced  VAT  rates  are  more  efficient  and  less 
costly for the State budget, and this should be taken into account in the decision-
making-process. 

The Commission reads these results as confirming some usefulness in applying 
reduced rates to locally supplied services but only where such measures are very 
well targeted and specific market conditions are fulfilled. It has to be stressed, 
nevertheless, that effects on employment remain limited. Regarding restaurant 
services,  the  study  calls,  on  the  one  side,  for  caution  as  to  the  cross  border 
effects of a reduced rate, as such services in some case may form part of a more 
global  tourism  sector  that  is  open  to  competition  between  Member  States,  but 
indicates,  on  the  other  side,  a  rather  good  potential  for  a  reduced  rate  to  be 
effective. 

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3. 

REFLECTION ON THE WAY FORWARD 

The  results  of  the  economic  study  provide  a  very  detailed  and  sound  economic 
evaluation  for  assessing  the  usefulness  of  applying  reduced  VAT  rates  in  specific 
cases. The Commission remains convinced that the application of a single VAT rate 
to all goods and services would be an ideal solution from an economic point of view 
but recognizes that policy considerations will not allow for such a simple approach. 
It  observes,  moreover,  that  even  Denmark  having  opted  for  such  a  single  rate 
approach does allow exceptions to the principle. 

Therefore,  the  Commission  sets  out  hereafter  how  to  apply  the  results  of  the  study 
more  concretely  and  how  to  usefully  translate  them  into  operational  policy 
conclusions in order to provide input to the political debate to come. On this basis it 
seeks the views of the Council, the European Parliament and other interested parties 
on  a  possible  future  legislative  action  in  this  field.  The  objective  is  to  foster  a 
fundamental  debate  among  all  stakeholders  on  the  issue,  in  order  to  identify  a 
sustainable way forward which could be acceptable to all Member States and provide 
a step forward for the single market. 

3.1. 

General  

Although  reduced  rates,  as  they  diverge  from  the  standard  rate,  appear  to  create 
distortions  from  an  economic  perspective  and  may  affect  fiscal  neutrality,  they  are 
nonetheless  applied  in  all  but  one  Member  State.  Moreover,  there  appears  to  be  a 
wide range of reasons to explain why Member States have chosen the policy route of 
rate differentiation. It has to be acknowledged that Community legislation as it stands 
today is not based on a well structured or logical approach; but rather simply reflects 
the situation existing in Member States at the beginning of the 90s. It is logical that 
each Member State should be able to re-assess the value of its own reasoning against 
the  findings  of  the  study  and  taking  into  account  its  own  and  Community  policy 
objectives, such as those of the Lisbon strategy before engaging into a debate on the 
review of reduced rates. From a Community point of view the main parameters for 
further political reflection and debate are: 

•   

the support of the Lisbon strategy for growth, jobs and competitiveness. 

•   

the Internal Market imperatives; 

•   

the  degree  of  flexibility  that  can  be  offered  to  Member  States  under 

subsidiarity considerations to set reduced rates; 

3.2. 

Subsidiarity 

VAT  is  a  harmonised  tax  that  applies  to  supplies  of  goods  and  services  the  free 
movement  of  which  is  one  of  the  characteristics  of  a  true  Single  Market. 
Nevertheless,  VAT  has  never  been  a  fully  harmonised  tax  but  leaves  options  and 
derogations possible for Member States in a number of areas. This includes the area 
of  VAT  rates.  The  agreement  on  the  current  level  of  harmonisation  in  1992  was 
based  on  two  major  considerations:  (1)  what  was  considered  necessary  to  avoid 
distortions  of  competition  once  the  Internal  Market  came  into  being  (see  the  next 
section)  and  (2)  the  higher  degree  of  harmonisation  needed  for  the  so  called 

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"definitive"  VAT  system  based  on  taxation  at  origin.  This  objective  would  have 
called  for  a  far  greater  harmonisation  of  VAT  rates  than  was  possible  to  achieve 
either at the time or subsequently. Consequently, little if any progress has been made 
towards  a  "definitive"  system,  despite  the  relevant  Commission  proposals  having 
been made, and there is little expectation of achieving this objective in the short or 
even the mid term. The Commission has therefore in the meantime adopted a VAT 
strategy that has set other priorities. One of them is to offset the potential economic 
effects  of  VAT  rate  differentials  between  Member  States  by  changing,  where 
necessary, the place of supply rule for services to the Member State of consumption 
thus  ensuring  taxation  where  consumption  takes  place.  Against  this  background,  it 
appears to be no longer essential to maintain exactly the same level of harmonisation 
that  was  needed  in  1992.  There  are,  however,  limits  to  the  flexibility  that  can  be 
offered under subsidiarity considerations given that there are still risks of distortions 
or disproportionate compliance costs for internationally traded goods and services. 

The  study  confirms  the  view  defended  by  the  Commission  in  previous  Council 
debates  on  the  issue4,  in  particular  that  there  is  room  for  manoeuvre  to  grant  more 
autonomy  to  the  Member  States  in  setting  reduced  rates  for  local  services  which 
cannot be delivered from a remote location. On the other hand, there is little margin 
for manoeuvre for more autonomy for goods or services which can be supplied from 
a  remote  location  since  the  risk  of  introducing  differences  in  the  conditions  of 
competition through differences in VAT rates is not negligible.  

In  conclusion,  there  is  room  for  more  flexibility  to  be  given  to  Member  States 
but this flexibility needs to be balanced against the need to ensure the continued 
proper  functioning  of  the  Internal  Market  and  to  avoid  disproportionate  costs 
for business involved in intra-Community trade.  

3.3. 

Internal Market imperatives 

The  Internal  Market  requires  that  goods  and  services  can  be  traded  within  the  EU 
without  giving  rise  to  distortions  of  competition  or  to  costs  that  can  translate  into 
market  access  problems  (see  next  section).  Distortion  can  result  at  the  level  of 
companies and at the level of states. Companies are affected by distortions where the 
applicable  rate  impacts  on  their  capacity  to  sell  their  product  in,  or  to  citizens  of, 
another  Member  State.  Such  distortions  are  likely  to  arise  as  a  result  of  consumers 
having  the  right  within  the  internal  market  to  buy  in  other  Member  States  at  the 
prevailing  tax  conditions  or  to  buy  goods  or  services  via  distance  selling 
arrangements. Only the so-called local services have little or no cross border impact. 
According to the study, restaurant and hotel services are on the borderline in respect 
of their cross-border effects. In addition, VAT rates on inputs can influence costs at 
which business can offer their products where they are not able to fully deduct input 
VAT or where they are acting outside the scope of VAT. In a similar way Member 
States  themselves  might  suffer  from  rate  differentials  that  undermine  their  revenue 
raising capacity where citizens decide to buy cross-border to benefit from lower tax 
levels.  Nevertheless,  it  appears  that  a  certain  degree  of  rate  differential  can  be 

4 

In  particular  in  the  Non-Paper  prepared  in  February  2004  on  the  possibilities  of  granting  more 
autonomy  to  the  Member  States  in  deciding  the  VAT  rates  applicable  on  their  respective  territories, 
where this does not interfere with the proper functioning of the internal market. 

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tolerated and the Council of Ministers has so far accepted rate differentials both for 
the standard VAT rate and for the reduced rate subject to the observation of certain 
minimum  levels  and  a  number  of  special  tax  schemes  such  as  the  current  distance 
selling arrangements.  

It follows that Community legislation cannot expose Member States and/or business 
to distortions by not providing a framework for reduced rates. Indeed, although the 
application  of  reduced  rates  is  optional  for  Member  States  (which  could  therefore 
lead  to  very  high  rate  differentials  and  thus  significant  distortions),  in  reality  it  is 
notable  that  for  the  main  categories  of  goods  for  which  a  reduced  rate  is  possible 
(food, medicines, books and newspapers) a large majority of Member States apply a 
low  rate.  Member  States  and  the  Commission  will  therefore  have  to  analyse  the 
different candidates for further reduced rates to determine the level of distortions that 
can arise from their – optional – eligibility and to decide if such level of distortion is 
acceptable  especially  to  the  business  being  active  in  the  relevant  sectors.  Such 
discussion must base itself both on economic evaluation and political appreciation as 
potential distortions need also to be assessed as to their political acceptance.  

On  the  other  hand  it  should  not  be  overlooked  that  distortions  can  also  be  created 
between  different  similar  products;  therefore  it  appears  to  be  important  to  define 
categories  for  the  application of a  reduced rate in a coherent way reflecting clearly 
defined  (sub-)  sectors  of  activities  (e.g.  the  food  sector:  the  categories  should  be 
designed in a way avoiding subtle distinction between different kinds of food). Such 
categories need to be well defined to avoid distortions between the various products 
and differences in application, even at national level.  

In conclusion, any rate differential may lead to economic distortions but not all 
distortions  are  necessarily  incompatible  with  the  Internal  Market.  The 
consequences need to be assessed on a case by case basis whereas it is obvious 
that products that are locally traded do raise less concern. 

3.4. 

Compliance cost for business  

Compliance costs due to rate differentiation are a significant issue. A Swedish survey 
carried  out  by  the  Swedish  Tax  Board  on  compliance  costs  of  VAT  in  Sweden5 
shows  that  there  is  a  clear  correlation  between  the  costs  of  handling  VAT  in 
businesses  and  the  number  of  rates  of  VAT  to  be  handled.  The  cost  per  business 
increases  both  between  one  and  two  and  between  two  and  three  or  more  rates  of 
VAT6.  

Compliance  costs  are  the  mirror  of  non  harmonised  rules:  the  more  that  different 
rules are applied within the EU the more business has to spend to comply with the 
regulations  in  the  various  Member  States.  The  Lisbon  strategy  aiming  at  growth, 
more jobs and increased competitiveness of European business therefore stresses the 
need  for  a  true  internal  market  and  simplifications.  Being  subject  to  different  VAT 
rates  in  different  Member  States  clearly  creates  a  cost;  which  becomes  particularly 

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of 

costs 

Compliance 
http://skatteverket.se/omskatteverket/rapporter.4.584dfe11039cdb626980000.html 
The study indicates that a uniform rate of VAT in Sweden would entail a reduction of compliance costs 
by approximately SEK 500 million (or approximately EUR 54 million) 

Skatteverket, 

value-added 

2006:3B, 

Sweden, 

report 

tax 

in 

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burdensome  where  variations  of  applicable  rates  concern  not  just  a  few  goods  or 
services but hundreds or thousands of them with different definitions for the scope of 
each reduced rate. More transparency would reduce compliance costs for business in 
line with the Lisbon strategy and with the Communication on Action Programme for 
Reducing  Administrative  Burdens  in  the  European  Union7,  which  was  given  full 
support by Member States.  

Effectively, businesses need to know whether a reduced rate is applied in a particular 
case and if so at which level. This can be very cumbersome, especially when VAT is 
due  in  a  Member  State  where  the  business  is  not  established  and  can  also  cause  a 
barrier  to  starting  activities  in  other  Member  States.  The  Commission  has  received 
representations to this effect, clearly showing that companies give up doing business 
in  other  Member  States  for  this  reason  or  simply  because  of  fearing  the  expensive 
consequences  of  an  erroneous  application  of  rates,  even  in  good  faith.  Ultimately, 
this might also increase the positive effects on consumer welfare. 

A company selling the same goods in the 27 Member States will have to invest in a 
close  examination  of  the  level  of  rates,  on  top  of  the  administrative  costs  of  VAT 
obligations  in  the  different  Member  States,  such  as  VAT  registration  and  filing  of 
returns.  The  One-Stop-Shop  scheme  has  been  proposed  by  the  Commission  to 
remedy this latter problem and has been welcomed within the context of the Lisbon 
agenda  but  has  not  yet  been  adopted  by  the  Council.  Moreover,  even  at  domestic 
level,  a  lot  of  interpretation  problems  about  which  rate  to  apply  to  which  product 
result  from borderline  cases. This generates compliance  costs and liability  risks  for 
business  and  costs  for  tax  administrations  in  managing  and  controlling  the 
application of reduced rates. The Commission considers that these aspects should be 
carefully taken into account when reduced rates are discussed.  

In  conclusion,  flexibility  that  might  be  possible  in  allowing  a  wider  range  for 
reduced  rates  needs  to  be  balanced  by  measures  ensuring  transparency  and 
simplification to reduce compliance costs.  

4. 

INVITATION FOR A POLITICAL DEBATE 

4.1. 

Balance between flexibility, internal market imperatives and simplification  

There is a strong economic rationale for a uniform rates structure (one single rate per 
Member  State).  However,  the  study  also  argues  that  there  are  real  and  valid 
economic arguments for lower VAT rates in some very specific sectors. In view of 
the  present  situation  in  Member  States  and  the  political  reality  it  appears  to  be 
impossible to abolish reduced rates even if the study tells us that reduced rates is not 
the  best  way  to  deal  with  the  possible  regressivity  of  VAT.  Finding  the  right 
balance between political and economic imperatives is the main issue.  

7 

Communication  from  the  Commission  to  the  Council,  the  European  Parliament,  the  European 
Economic  and  Social  Committee  and  the  Committee  of  Regions  on  Action  Programme  for  Reducing 
Administrative Burdens in the European Union - COM(2007) 23 final. 

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4.2. 

Rates structure 

The  current  VAT  rate  structure  that  does  not  follow  any  clear  logic  is  clearly  not 
effective  from  an  internal  market  and  a  global  EU  business  competitiveness 
perspective. It is simply a result of past political negotiations. 

Taking into account the study results, the Commission could see some merit in a new 
architecture for reduced VAT rates in the Community. Such approach would need to 
take account of the following objectives:  

– 

– 

– 

– 

– 

the need to ensure equal treatment of all Member States, which means 
the ending of country specific derogations; 

recognition that in most Member States there is a strong political will to 
apply  very  low  reduced  rates  including  zero  rates  particularly  for 
social purposes8; 

recognition  of  the  increased  (economic  and  budgetary)  difficulties  for 
Member States to move products from one rate category to another 
because of the often very huge difference between the standard rate and 
a  reduced  rate  (in  most  cases  more  than  10  sometimes  more  than  15 
points); 

the  need  to  establishing  a  clear  logic  of  the  purposes  for  which  a 
reduced rate should be used; 

the  need  to  balance  increased  flexibility  with  a  reduction  of 
compliance costs. 

In  a  first  step,  the  Commission  would  like  to  obtain  the  views  from  the  European 
Parliament and the Council as to what extent they share these objectives. 

One of the ways – but certainly not the only one – to translate these objectives into 
more practical arrangements could be: 

•  to  allow  for  a  very  low  rate  for  goods  and  services  of  first  necessity  such  as 
food.  Obviously,  the  discussion  on  the  scope  for  such  a  rate  will  be  difficult 
(should medical treatment, social housing etc be included?) but it would offer the 
opportunity  to  limit  the  application  of  such  a  low  rate  (and  its  cost)  to  the  real 
basic needs of citizens and thereby to exclusively social considerations;  

•  in  addition, a  second  rate  could  be  used  for  other  purposes  that  are  not  basic 
needs  but  that  are  felt  deserving  of  preferential  treatment  for  other  reasons  (e.g. 
cultural  and  educational  reasons,  public  transport,  employment,  energy  and 
environment, etc). Obviously, such a scheme needs to remain optional to preserve 
Member  States  political  choices  and  to  preserve  the  possibility  to  apply  simpler 

8 

It is however to be taken into consideration that pursuant to Article 99 (2) of the VAT Directive, each 
reduced  rate  shall  be  so  fixed  that  the  amount  of  VAT  resulting  from  its  application  is  such  that  the 
VAT deductible can normally be deducted in full. 

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and more effective rate structures. However, as already explained, most member 
States do already apply two reduced rates in addition to the standard rate;  

•  to  limit  the  cost  of  a  three  rate  structure  both  for  tax  administrations  and  for 
businesses,  the  categories  of  goods  and  services  eligible  for  different  reduced 
rates  should  be  clearly  defined  in  order  to  limit  difficult  border-line  cases;  also 
Member States should only be able to chose a whole category for the application 
of a reduced rate and not only parts of it; to allow, nevertheless, a high degree of 
flexibility there should be a greater number of categories than today but each of 
them harmonised as to its content. 

Further reflection on the scope and underpinning policy goals of the categories to be 
included  within  such  a  structure  would  be  necessary:  should  the  application  of  the 
second rate be strictly limited or not;  and  should it also be applied to the complete 
housing  sector  (e.g.  as  a  fraud  combating  strategy),  restaurant  services,  children's 
clothes  or  baby  nappies,  for  example?  The  level  of  the  first  rate  would  have  to  be 
quite low, e.g. in the range of 0 to 5%. The level of the ‘intermediate’ reduced rate 
could be higher and set, for example, between 10 and 12%. The setting of the level of 
the rates could take the form of two rate bands or of two minimum rates.  

It is to be added that rate differentiation in certain categories of goods/services, such 
as books, appear to have a very direct Internal Market implication. Restaurants and 
hotels  are  in-between  as  such  implications  occur  in  the  context  of  tourism  or  in 
border  regions.  The  question  arises  whether  an  optional  system  of  reduced  rates  is 
acceptable  in  such  cases  or  whether  it  should  be  made  compulsory  to  avoid 
competition distortions.  

Another  issue  relates  to  the  effectiveness  of  using  VAT  reduced  rates  for  the 
promotion of certain goods/services. Typical examples of currently discussed ideas 
to use VAT as an incentive for a particular behaviour are: energy saving materials, 
energy efficient products, environmentally beneficial products, biomass, healthy food 
etc. In addition, in some Member States, baby diapers are considered to serve social 
goals. The Commission considers that there is a need to discuss the usefulness or not 
of the VAT instrument for such purposes and it strongly encourages the Council to 
organise this debate taking the findings of the study into account.  

From a purely technical point of view, it should be borne in mind that the level of a 
VAT rate – by its very mechanism – can only have an impact on purchases by final 
consumers. It will only indirectly affect the  behaviour of business  –  via changes in 
consumer  behaviour  -,  and  other  actors  that  dispose  of  the  right  to  deduct  VAT. 
Moreover, VAT does not allow to single out the tax treatment of a specific good that 
is used for the supply of a service: for example an energy saving material that is used 
in the course of the renovation of a building (which constitutes a service) will not any 
more be subject to a specific rate. In addition, it appears that problems arise from the 
need  to  exactly  define  the  category  of  product  to  be  promoted;  again,  compliance 
costs need to be factored in and may influence the choice of the most efficient policy 
tool. The Commission recalls, however, that the study finds that, generally speaking, 
reduced VAT rates are not the most effective policy tool in this context. 

From  a  political  point  of  view,  the  question  arises  that  if  such  incentives  are 
considered to be efficient should they – be made compulsory? It is recalled that the 

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study confirms the increased risk of distortion stemming from optional reduced rates 
on goods.  

Moreover, there is a question of fiscal coherence to be discussed: does it make sense 
to allow for a reduced rate for electricity and natural gas if we assume that this rate 
will  have  the  incentive  of  generating  more  consumption  while  we  want  to  reduce 
such consumption at the same time by promoting energy saving materials and energy 
efficient  products,  which  are  currently  taxed  at  the  standard  rate?  This  question  of 
coherence  needs  to  be  answered  also  as  regards  taxes  additional  to  VAT:  is  it 
meaningful to apply a reduced VAT rate to products that are at the same time subject 
to specific excise duties?  

4.3.  Maintenance of the status quo pending the outcome of the political debate 

As  has  been  explained  above  the  Commission  wishes  to  launch  the  debate  on  the 
future of reduced rates. This Communication as well as the results of the study are 
intended  to  form  the  basis  for  such  a  discussion.  The  Commission  would  expect 
indications  from  the  European  institutions  as  to  the  way  forward  and  the  key 
elements to be respected, by the end of this year (2007). On that basis it will work 
towards the presentation of legislative proposals at the end of 2008/beginning 2009 
to  allow  an  adoption  of  the  relevant  legislative  act  by  the  Council  in  time  before 
authorisation for Member States to apply specific arrangements for labour-intensive 
services will expire end of 2010.  

In  that  context,  the  Commission  would  like  to  recall  that  the  basic  rates  structure, 
which  applies  to  all  Member  States,  is  complicated  by  different  temporary 
derogations  granted  to  particular  Member  States.  These  exceptions  derogate  either 
from the level of the rate  fixed  by  the  rules (zero rates,  super reduced rates  of less 
than 5%), or they concern supplies which should be taxed at the standard rate (such 
as  the  intermediary  rates,  the  so-called  parking  rates  set  at  a  minimum  of  12  %). 
Whereas the derogations granted during the last enlargement have a precise deadline, 
those agreed earlier9 are allowed until the entry into force of the "definitive system" 
for intra-Community transactions. As the definitive system is unlikely to be adopted 
for  the  foreseeable  future,  these  transitional  arrangements  are  still  in  force,  until  a 
new  unanimous  decision  of  the  Council.  In  the  case  of  the  Member  States  which 
joined  the  EU  after  the  1st  January  1995  the  temporary  derogations  resulting  from 
the accession negotiations apply for a more limited period of time, i.e. in many cases 
only till the end of 2007.  

The  Commission  takes  the  view  that  derogations  coming  to  an  end  soon  should, 
with one or two exceptions, be temporarily prolonged until the end of 2010, i.e. 
the  date  of  expiry  of  the  experiment  on  the  application  of  reduced  VAT  rates  to 
certain labour-intensive services and the most likely date of entry into force of new 
arrangements  for  reduced  rates.  Derogations  cannot,  however,  be  prolonged  where 
they  conflict  with  the  proper  functioning  of  the  internal  market  and/or  with  other 
Community  policies  (e.g.  derogations  regarding  agricultural  input,  or,  coal,  coke, 
fuel, oil that are contrary to energy and environmental objectives) or where they are 
already  covered  by  general  provisions  on  rates  (e.g.  district  heating).  On  the  other 

9 

See articles 93 to 130 of VAT directive (Council Directive 2006/112/EC of 28.11.2006). 

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hand,  for  the  restaurant,  food,  pharmaceuticals’,  books  and  housing  sectors, 
derogations could be prolonged as a difference in treatment would provide unequal 
opportunities to Member States without any substantial justification and would create 
unacceptable tensions.  

The Commission, therefore, proposes to extend most of the derogations for Member 
States which joined the EU after 1 January 1995. 

5. 

CONCLUSION 

The  Commission  considers  that  a  new  framework  for  reduced  VAT  rates  should 
rationalise  the  use  of  reduced  rates,  create  more  transparency,  and  allow  for 
flexibility for the Member States whilst at the same time respecting the principle set 
out  in  Article  93  of  the  Treaty.  It  has  presented  some  thought  on  how  this  can  be 
achieved  but  is  aware  of  the  need  for  a  political  debate  to  define  the  orientation 
before a more detailed proposal can be elaborated. 

In this political debate, the Commission insists on the need to keep in mind that any 
change of a VAT rate applicable to particular goods or services, either an increase or 
a decrease, will impact not only on the sector concerned but also on other parts of the 
economy as well as on government budgets.  

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