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EU Proposes To Extend VAT Reverse Charge Mechanisms

Tuesday, March 13, 2018

The European Commission (EC) has proposed that the reverse charge mechanism on a defined list of goods and services, provided for in Article 199a(1) of the VAT Directive, and the Quick Reaction Mechanism (QRM) in Article 199b(1), should be extended beyond December 31, 2018, to tackle VAT fraud, until the new "definitive VAT regime" is introduced.

Typically VAT fraud occurs when a supplier pretends to have transported goods to another member state but the goods are in fact consumed VAT-free locally. It also occurs when a client of a cross-border transaction purchases goods or services VAT-free and charges VAT without remitting the VAT collected to tax authorities while his/her customer can deduct it, known as missing trader fraud. In addition, other types of fraud can arise, e.g. fraudsters claiming to be taxable persons to obtain goods intended for final consumption VAT-free.

The purpose of the measures in Articles 199a and 199b is to allow member states to quickly tackle missing trade fraud, through enabling member states an option of applying the reverse charge mechanism for listed supplies (in Article 199a) and by offering a faster procedure for the introduction of the reverse charge mechanism in case of sudden and massive fraud (Article 199b) – the so-called Quick Reaction Mechanism.

The application of a reverse charge is intended to tackle missing trader intra-Community fraud, which manipulates EU place of supply rules on intra-community trade. Exports between member states are zero-rated while domestic transactions are standard rated. Fraudsters often import small, high-value goods into a member state and resell the goods at a discount to the domestic market, collecting the VAT and disappearing before remitting the sum. By switching the obligation to account for VAT from the seller to the recipient, the reverse charge is intended to ensure that another trader's VAT is never passed up the supply chain, removing the requirement for the supplier to collect and remit VAT, and thereby eliminating the potential for missing trader fraud and other permutations of the scheme.

Prior to the introduction of the QRM in Article 199b, a member state that wanted to counteract VAT fraud through measures not provided for under EU VAT legislation would have to formally request a derogation to do so. The EC would then draw up a proposal and submit it to the European Council for unanimous adoption before the measure to counteract the fraud could be implemented. The lag in the approval of such was said to be costing member states significant revenues.

With the QRM, member states are permitted to not wait for the conclusion of this formal process to apply anti-fraud measures. Instead they are able to temporarily apply a reverse charge to the affected supplies.

The Commission was required to provide an overall assessment report concerning the effects of the mechanism. This was released on March 8, 2018, "Report from the Commission to the Council and the European Parliament on the effects of Articles 199a and 199b of Council Directive 2006/112/EC on combatting fraud."

The report's findings

The report includes feedback on the efficacy of the mechanism and a review of the compliance costs on businesses.

It found that member states generally consider the reverse charge mechanism a very effective and efficient tool in fighting VAT fraud. "Due to the introduction of the reverse charge mechanism the fraud decreased significantly or disappeared in the defined sectors. This view is also shared in the replies received from the consulted business stakeholders," the Commission said. "Regarding the QRM included in Article 199b of the VAT Directive, although it was never used, most member states consider that it remains a useful tool for exceptional cases of VAT fraud."

The Commission stated: "The measures included in Articles 199a and 199b of the VAT Directive are limited in time and expire on December 31, 2018. Based on this feedback from member states and stakeholders it appears that if the measures are not prolonged, member states would be deprived of an efficient tool to fight VAT fraud."

The report concluded: "Taking into account the above elements and since the definitive VAT regime [discussed below] would solve the problem caused by the VAT exemption linked to the intra-Community supply of goods, whereby the customer obtains the goods without having to pay the VAT to the supplier, the prolongation of both measures based on Article 199a and the QRM of Article 199b should be limited until the definitive regime enters into force or for another limited period of time. The Commission will therefore issue an appropriate legislative proposal in the second quarter of 2018 prolonging the existing measures."

The definitive VAT regime

The EU's plans for a definitive VAT regime were set out in October 2017. The plan aims to reduce fraud, estimated to cost member states EUR50bn per year, by EUR40bn, in particular by centering tax rules around the destination principle – that supplies should be taxed where they are consumed or effectively enjoyed, under that territory's domestic rules.

The cornerstones of the definitive regime are:

  • To tackle fraud, VAT should be charged on cross-border trade between businesses. Currently, this type of trade is exempt from VAT, providing an easy loophole for unscrupulous companies to collect VAT and then vanish without remitting the money to the relevant country's government;
  • The "One Stop Shop" should be expanded. A smaller version – the Mini One Stop Shop – was introduced in 2015 to support the Commission's efforts that year to require the collection by registered persons of value-added tax on business-to-consumer supplies of broadcasting, telecommunications, and electronic services to consumers in the place of consumption. Under the plans, it will be simpler for companies that sell cross-border to deal with their VAT obligations; traders will be able to make declarations and payments using a single online portal in their own language and according to the same rules and administrative templates as in their home country. Member states will pay VAT to each other directly, as is currently the case for electronic services.
  • Invoicing rules should be simplified to allow sellers to prepare invoices according to the rules of their own country even when trading across borders. Companies would no longer have to prepare a list of cross-border transactions for their tax authority (the so-called "recapitulative statement").

The plan also introduces the notion of a Certified Taxable Person – a category of trusted business that will benefit from much simpler and time-saving rules. Provided that companies – small or big – meet a set of criteria, they can get a certificate allowing them to be considered throughout the EU to be a reliable VAT taxpayer. A business can become a Certified Taxable Person by applying to their national tax authorities and proving compliance with a set of sufficiently harmonized and standardized pre-defined criteria including: regular payment of taxes, reliable internal control systems, and proof of solvency. The status of Certified Taxable Person will be mutually recognized by all EU member states.

Four "quick fixes" were also proposed, to come into force by 2019. These short-term measures were explicitly requested by member states to improve the day-to-day functioning of the current VAT system until the definitive regime has been fully agreed and implemented. These will include:

  • Simplification of VAT rules for companies in one member state storing goods in another member state to be sold directly to customers there. This simplification is limited to Certified Taxable Persons who will no longer need to register and pay VAT in another member state when they store goods there;
  • Simplification for those elements of a chain transaction which do not involve the physical movement of goods, for example when goods are sold via several traders, but physically the goods move directly from the original seller to the final buyer. This simplification is also limited to Certified Taxable Persons;
  • New harmonized and uniform rules for Certified Taxable Persons to enable them to more easily provide proof that goods have been transported from one EU country to another; and
  • Clarification that, in addition to proof of transport, the VAT number of the commercial partners recorded in the electronic EU VAT-number verification system (VIES) is required for the cross-border VAT exemption to be applied under the current rules.

The Commission is also pursuing other proposals, including: a proposal for a modernized system of setting VAT rates, to give greater flexibility to member states as regards VAT rates; a proposal to reinforce administrative cooperation between member states; and proposals to simplify VAT for SMEs, looking at how to ease VAT obligations for small- and medium-sized enterprises.