When the first European VAT Directive was adopted by the European Union’s forbearer, the European Economic Community all the way back in 1967, the ambition was to establish a definitive system for the collection of VAT from trade between Member States. The directive put forward a plan to create a unified system for intracommunity transactions (cross-border flows within Member States) that would operate in a similar way to that of any sovereign state. 50 years on, we are still waiting for that dream to come to fruition and the reasons why are complex, but due mostly to a lot of political disagreement.
Where we are now
The current VAT system within Europe is based on the assumptions that were implemented as a transitional solution when the European Union, as we know it today, was formed back in 1993. This existing framework is seen to be complex and open to abuse and fraud from intracommunity EU transactions. One of the main reasons for this is that under the current rules, domestic and intracommunity transactions are treated differently – currently any goods or services may be sold free of VAT within the Single Market. Furthermore, VAT is reported and paid by the purchaser under a reverse charge mechanism.
A new ambition, for a 50-year-old dream
It’s no secret that the EU is desperately trying to combat VAT fraud. Each year Member States lose billions of euros in VAT revenue because of fraud and the inadequacies of its tax collection systems. The EU VAT gap, the difference between expected VAT revenues and VAT collected, currently stands at €151.5 billion – a figure which affects EU Member States’ and indirectly the EU budget itself.
The VAT gap within the EU was one of the main reasons the existing planned system of VAT reform, known as the ‘Action Plan on VAT: Towards a single EU VAT area’, was introduced back in April 2016. Following on from this, in October 2017, the European Commission proposed the main principles for the creation of a single EU VAT area.
Recently, on the 25 May 2018, the European Commission proposed the final technical details for the amendments to EU rules on VAT. Put forward as one of the final building blocks in the overhaul of the EU’s VAT system, its key proposals is the principle of destination. This principle outlines a new set of VAT rules that define the intracommunity, described in the proposed changes as intra-EU, trade of goods as a ‘single taxable supply’ – which ensures goods are taxed in the Member State where the transport of goods end. What this means, is that in case of intra-EU supplies, the supplier will charge and pay tax based on the VAT rate from the buyer’s country. A reverse charge mechanism, whereby a buying entity is responsible for reporting a VAT transaction, will be only possible if the buyer is a certified taxpayer because they are then a trusted party.
Currently, intracommunity supplies are VAT exempt, and it is this exemption that opens up the possibility of abuse to the system through the practices of carousel fraud.
Carousel Fraud Explained
In its simplest form, carousel fraud, which is also known as missing trader intracommunity VAT fraud, fraudsters import goods VAT-free from other countries, then sell the goods to domestic buyers, charging them the VAT. The fraudulent seller then disappears without paying the tax to the government.
Changing the logic of how VAT is applied within in the EU will be positive from the VAT collection perspective. On the other hand, it brings additional complexity for businesses operating across the EU. In the future, suppliers will need to monitor, interpret and implement within their business processes the regulatory and tax requirements of other EU countries.
The reform also envisages some administrative simplifications for reporting measures. Most notably introducing a one-stop-shop for different kinds of VAT reporting and removing the requirement for recapitulative statements, as the need for ensuring the administrative follow-up to the physical flow of goods will no longer be justified.
The EU is playing catch up to Latin American (and its own Member States)
The efforts detailed above refers to attempts at combating VAT fraud on an EU wide level. However, on a domestic level, many Member States are introducing measures aimed at improving and ensuring that tax collection is much more efficient. To name a few very recent examples, from the 1 July 2018:
- Italy – is gradually introducing real-time VAT control for certain categories of transactions, leading up to its final deadline of 1 January 2019, when e-invoicing will be mandatory for all domestic transactions.
- Hungary – is introducing the real-time reporting of invoice data.
- Poland – is launching the voluntary anti-fraud VAT split payments (learn more about split payments in this blog from our parent company, Sovos).
- Spain – is expanding the use of mandatory B2G e-invoicing to sub-contractors of Spanish public administrations.
These ideas and initiatives are of course to a large extent based on the success stories of Latin American countries, like Mexico, Brazil, and Chile, where VAT collection reached its peak after the introduction of clearance systems for the real-time monitoring of invoice issuance and tax reporting. The EU may still be dreaming, but it’s high-time it woke up and started playing catch-up with its own Member States, and the rest of the world. Can ‘reengineering’ of the VAT chargeability for intra-EU supplies really compete with technology-based enforcement? Only time will tell…
