26 April 2022
The European Union has finally enacted a long-awaited measure to grant member states more freedom to set reduced rates of VAT in their territory.
Currently, member states of the EU must set their standard rate of VAT at least 15 per cent but may also choose to apply one or two VAT rates below that level (known as reduced rates) to certain supplies. The EU restricts eligibility for those reduced rates to a specific list of goods and services set out in its VAT legislation.
Since 1979, the EU has set a minimum level for reduced VAT rates, meaning that governments in individual member states have not been allowed to create new reduced rates of VAT below 5 per cent. However, it also applied ‘standstill’ measures allowing individual countries to retain rates from zero to 4 per cent on particular products, either because those ‘super reduced rates’ had been in place before 1979 or before that country joined the EU’s VAT system. This has led to many anomalies in their VAT treatment between member states and few options to resolve them. For example, one member state might rely on the standstill rule to keep a zero-rate on an item that isn’t on the list of supplies eligible for a reduced rate, while others must tax that same product at their country’s full standard rate.
In 2016, the EU first announced plans to introduce a new reduced rate regime to give member states new powers to set reduced rates within agreed parameters. After lengthy negotiations on their design, these changes have just come into force. From 6 April 2022, the EU has expanded the list of goods and services eligible for reduced rates and, crucially, specified a limited range of supplies on which member states now have discretion to apply reduced rates below 5 per cent. Member states may now pick up to 24 items from that expanded list to tax at a reduced rate of 5 per cent or more. They may also choose up to seven items from a more restricted list to tax at a rate below 5 per cent, including at the zero-rate. This includes essentials such as food, pharmaceuticals, passenger transport, books and other publications, in hard copy or electronic form.
This is an important change for two reasons – firstly it gives member states much more latitude on how to tax these goods and services, whose VAT treatment can so often be a politically charged issue for national governments. It also frees the EU’s system of reduced VAT rates from its ties to the (now distant) past and allows reliefs, some of which have been frozen in time since 1979, to be reviewed and modernised.
Businesses supplying eligible goods and services around the EU can expect plenty of changes to VAT rates in domestic markets to appear in the coming months and years – for example, the Netherlands has already begun consulting on proposals to introduce a new zero-rate for solar panels, and more changes are likely to follow.
But what of the impact on the UK? The UK is no longer part of the EU’s VAT system, and since 1 January 2021 has not been restricted by the EU’s former rules on reduced rates. In that time, it has brought in new zero-rates on women’s sanitary products and electronic publications, along with a temporary VAT relief on installation of energy saving materials.
By allowing these items to be freely zero-rated, the EU has now done much to catch up with the UK, so most tweaks to reduced rates in the UK can no longer be described as a ‘Brexit dividend’. The UK government will now have to look more deeply into the VAT system to find beneficial reforms that are only possible outside the EU.