The practical and technical difficulties of abolition of the Eighth directive examined by Dennis Holly, Technical Director of Liaison VAT.
Published in the November 2001 issue of Tax Adviser.
Theoretically the recovery of Value Added Tax (VAT) incurred in other member states through the normal VAT return – instead of by a cumbersome recovery mechanism – is a sensible idea. However there needs to be unanimous agreement by member states to remove different technical interpretations of the Sixth VAT directive [Directive 77/388] in their countries. There must be harmonisation of the treatment of VAT recovery on cars, their repair and maintenance, entertainment, accommodation and luxury goods. Furthermore, a number of administrative problems need addressing, such as the definition of an invoice for VAT purposes.
British businesses trade more and more with the rest of the European Union (EU) - over half of United Kingdom (UK) trade is with our European partners. They incur VAT in EU countries where they are not established for VAT purposes and therefore are unable to recover the cost by deduction against VAT charged to customers.
If this VAT is not recovered from the local tax authorities it is passed on to customers in increased prices and the market is distorted by this ‘hidden’ taxation – contrary to the underlying principles of the EU.
At present this is supposedly dealt with by the Eighth directive [Directive 79/1072], which enables organisations to reclaim VAT using special procedures.
Unfortunately the way this directive is implemented varies across Europe. Some countries apply it correctly and refunds of tax can be readily obtained. Others make the procedures so complex and deal with matters so slowly that it takes several years to obtain any entitlement.
This has resulted in the growth of specialised agencies that obtain the refunds on a business’s behalf – or an acceptance that it is too difficult to obtain a refund, so none is sought.
Abolition of the Eighth directive
The variety of interpretations of the Eighth directive and the difficulties of businesses obtaining refunds was recognised by the European Commission as long ago as June 1998. It issued a proposal to allow recovery of VAT incurred in one member state to be made in another where the business was registered for VAT.
This is an apparently sensible solution to the problem. Any VAT incurred could be claimed using the local VAT return in the same way as for input tax incurred in that country.
However, the commission realised that each member state had different rules about VAT which could not be claimed as a deduction -- ‘blocked’ in UK parlance -- especially related to cars, entertainment and luxury goods. It therefore made a number of proposals to harmonise the rules across the EU.
As this would require unanimous agreement of the members it was always going to be a difficult process. Furthermore it suggested a number of ways in which taxation authorities could monitor the processes to ensure compliance with the rules and to counter any attempts at evasion.
It also proposed, somewhat optimistically, 1 January 1999 as the date by which the new system would be implemented! It was no surprise that the timetable slipped in much the same way as the removal of the UK’s derogation for zero-rating was supposed to have been removed a number of years ago.
Change of approach by the European Commission
In April 2000, the new Commissioner with responsibility for VAT, Frits Bolkestein, announced a change of approach in dealing with the reform of VAT in the EU. Instead of major reforms, the new strategy of the Commission was to be directed towards simplification and a more uniform application of the rules already in place so as to encourage more cross-border trade.
One of the three proposals involved the simplification of the refund rules. Abolition of the Eighth directive was once again high on the agenda in the same format as the proposal of 1998.
In November 2000 a proposal was made for a new directive on the harmonisation of the conditions laid down for invoicing which dealt with one of the issues making the abolition of the Eighth directive so complex.
Under the present regime there are 15 sets of legal rules in the EU for what an invoice should show to provide satisfactory evidence for a VAT deduction. It was not realistic to expect a Greek business, preparing a local return in Athens, to know whether a UK invoice or indeed any from another member state, had all the requirements needed in that country to support a claim.
So the intention was to have a minimum number of entries required across the EU, and if these were properly provided, a foreign invoice would be valid evidence for VAT recovery. Extra conditions could be imposed by any particular state, but it was the designated minimum that allowed a reclaim of VAT.
The Commission’s original intention was to introduce the new rules on invoicing with the abolition of the Eighth directive – all this to be in place by 1 July 2001!
This proved yet another unrealistic target in view of the difficulties in getting all member states to agree to the same system requiring significant compromise, and time to negotiate. Furthermore it would be extremely difficult for firms to get revised systems in place on such a short time scale. Agreement by 1 January 2002 may be possible, but at the time of writing intergovernmental agreement has not yet been possible and it may well be that business will have to adapt to the new rules in a very short period of time.
Different rules in different countries
Most member states and business are in agreement that a revised and simplified refund scheme for VAT incurred in countries where a firm was not established is vital. The political will appears to be there, but what are the sticking points on the proposals?
The primary one is the lack of common rules in the EU on the treatment of VAT incurred on the purchase or lease of cars with the related costs of fuel, repairs and maintenance. Similarly there are different treatments of VAT on expenditure on food, drink and accommodation across the community, with most countries restricting VAT recovery on these costs, even when used for business purposes.
The proposals are meant to provide a simple way of dealing with passenger cars and any private use of them. Unfortunately simplicity is not a feature of the scheme. Broadly if a car is used for mixed purposes, member states should grant a deduction of at least 50 per cent of the VAT connected with use of the car. If private use is less than ten per cent, full deduction will be given, and if non-business use is more than 90 per cent no deduction at all will be given.
The UK has a number of concerns, no doubt matched by similar worries in the other member states. Its main concern is the loss in revenue, especially related to the removal of the total block on input tax recovery on the purchase of cars and the removal of the 50 per cent restriction on deduction of VAT on expenditure on lease cars.
There are further problems including the measurement of business/non business use – many EU countries treat home-to-work travel as business in stark contrast to the UK where it is held to be non-business. The bad news for traders is that there would also be irrecoverable input tax on repairs and maintenance where at present there is full recovery.
There is also to be a flat rate deduction for VAT on expenditure on accommodation, food and non-alcoholic drink although hotels and restaurants etc. are excluded. The actual figure is likely to be 50 per cent.
Again there are differences of opinion within member states as to whether this expenditure relates wholly to business activities. The UK says it does and allows 100 per cent deduction of VAT at the moment. Other countries say it does not and that there is private benefit to the employer and thus a restriction needs to be made. Whatever figure is agreed, UK business is likely to be disadvantaged.
Not surprisingly no deduction will be allowed on luxury goods, amusements or entertainment in line with the Sixth directive. However it is not clear how these terms will be defined, after all, one man’s necessity is another person’s luxury!
The Commission does not want to interpret the definition of luxury goods, but wants its VAT committee to act as a regulatory body to ensure consistent treatment. This is another area where countries will need to reach a compromise, to which all states must agree, if the harmonisation of rules can be achieved so as to allow the Eighth directive to be repealed.
These are the technical issues, but what of the practical difficulties tax authorities will encounter in each country in order to police the changes?
How to claim your refund
It is essential to ensure that the correct VAT is recovered and that there is no abuse of the system.
The administrative changes proposed mean that the amount of VAT eligible for deduction would be determined by the rules of the member state of registration rather than that where the expenditure is incurred. In theory recovery of VAT on expenditure on accommodation in France would be possible by a UK-registered person without a fixed establishment in France, not by a local business.
Conversely, a French registered person would not be able to recover VAT on similar expenditure incurred in the UK, but the UK business could. This highlights the underlying need to harmonise rules so as not to distort the market.
If a business were registered in more than one state, recovery would be allowed in the country in which the expenditure is ‘used’. Where direct attribution of costs such as on overheads is not possible, it is proposed that recovery occurs where a business has established its seat of ‘economic activity’.
This latter term is not defined in the Sixth directive and agreement on its meaning will have to be made so that there are not 15 definitions across the EU, which will certainly lead to disputes, not simplification.
Now the bureaucracy
Deductions would be claimed on the normal VAT return. Presumably an extra box will be needed in the UK. It is proposed that a supplementary document would also need to be submitted where a declaration of the VAT claimed from each country would be detailed.
This could be similar to Form VAT 21 submitted by government departments and agencies which details VAT recovery under the contracted out services rules.
In support of the claim, invoices and import documents will have to be submitted. It is hard to see how this is a simplification as the amount of documentation required is similar to the present. If claims are made under local rules there should be no need to submit evidence. In the UK, for example, it should be sufficient to hold it on site, available for Customs and Excise scrutiny if requested.
This of course raises a further issue about compliance and strengthens the need for harmonisation. If there is different technical treatment of claims across the EU without the abolition of the directive, we have the nightmare scenario of businesses’ VAT staff having to be aware of VAT rules throughout the EU. They could be visited by VAT officers who need the same knowledge, with appeals being heard by tribunals which must have the same necessary expertise, and, of course, by judges au fait with more than just UK VAT.
Payments across borders
Last, but not least, is the need for agreement between governments about how they will monitor the treatment of their VAT in another country. It would be realistic to expect VAT adjustments between countries to be done at Treasury level with payments moving between governments.
However, those countries already reluctant to make repayments of VAT in their own countries, preferring to set refunds against future output tax, may be difficult to convince that they need to make payments to another country.
If payments were agreed on a micro level is it possible that a German VAT officer would directly raise a query about a claim in the UK and actually carry out a visit to Britain? At present this is not possible, in theory, as the two countries’ tax authorities would need to liaise through country liaison officers. However, why not? There is hearsay that such visits by German officers in France have already taken place!
Like so many matters concerning the EU, it is extremely difficult to implement change, no matter how well-intentioned. The abolition of the Eighth directive will help industry considerably and is in line with the underlying ethos of the community in removing barriers to trade.
However, the need for unanimity on the details across the union and the negative side-effects in a number of countries will delay the necessary changes. It may only be when qualified majority voting is introduced on tax matters that change will happen.
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November 2001 by