The rules on rates of value added tax (VAT) as currently set out in Council Directive 2006/112/EC (the VAT Directive) aim to preserve the functioning of the internal market and avoid distortions of competition. The rules were designed over two decades ago based on the origin principle. They generally provide for a standard rate not being lower than 15% and a maximum of two reduced rates not being lower than 5%. The Directive however also provides for certain supplies to qualify for exemption, some even with a right to input tax deduction (effectively a zero rate).
Furthermore, a number of EU Member States benefit from special VAT rate arrangements that include reduced rates of below 5%, more than two reduced rates and an extended list of supplies where a 0% rate is applicable.
This has resulted in an urgent need for modernisation of the VAT rate regime and, during December 2021, the EU Council reached agreement on a proposal to update EU rules on rates of VAT.
The updates ensure Member States are treated equally and are given more flexibility to apply reduced VAT rates and exemptions with deductibility of VAT. This has been achieved by updating and modernising the list of goods and services for which reduced VAT rates are allowed (Annex III of the VAT directive), considering also the digital transformation of the global economy. However, to prevent a proliferation of reduced rates, whilst applying reduced VAT rates on the qualifying supplies remains optional on each Member State, the Council decided to limit the number of items to which reduced rates could be applied by Member States.
In an endeavour to achieve an equal VAT rate treatment between all Member States, the Council has also decided to open to all Member States any existing derogations that allow some Member States preferential VAT rates on certain supplies.
Changes to VAT rates as part of the Green Deal
The proposals put forward by Council also have the aim to phase out preferential treatments for environmentally-harmful goods. Furthermore, special reduced rates are being allowed on certain new items with an aim to encourage greener practices. Therefore the aforementioned Annex III has been extended to, inter alia, include certain services linked to waste treatment and recycling, transactions linked to electric bicycles, as well as certain supplies linked to solar panels.
Also on this point, the Council agreed to phase out reduced VAT rates or exemptions on fossil fuels and other goods with a similar impact on greenhouse gas emissions, by 1 January 2030. Reduced rates and exemptions for chemical fertilisers and chemical pesticides will end by 1 January 2032, to give small-scale farmers more time to adapt.
Future proofing the Directive's VAT rate provisions
In April 2020, the European Commission published a decision helping Member States affected by the COVID-19 pandemic to temporarily suspend customs duties and VAT on protective equipment, testing kits or medical devices such as ventilators.
As a result of the experience gained during the course of the COVID-19 pandemic, the Council is also proposing the addition of a new provision in the VAT Directive that will seek to address possible future crises by enabling Member States to respond swiftly to exceptional circumstances, like pandemics, humanitarian crises or natural disasters.
Next steps
The proposed VAT rates regime has now been submitted by the Council to the European Parliament for its consultation on the final text by March 2022. Once formally adopted, the legislation will come into force 20 days after its publication in the Official Journal of the European Union, allowing Member States to apply the new system as of that date.
From a Maltese perspective, the changes being proposed should not require any changes to special provisions currently in place in relation to food for human consumption, supply of water by a public authority and pharmaceutical products.
However, because the changes at an EU level are being made by means of a Directive, these changes would still need to be transposed into Maltese law before they are effective in Malta. In this regard we understand that the authorities should be publishing the necessary amendments to reflect such changes in Maltese law in the next few months. The new rules should grant Member States a wider flexibility in applying different VAT rates to implement and/or enhance domestic economic, social and environmental policy measures.
How we can help
VAT is moving ever closer to a definitive regime and we see legislation being constantly updated so that the VAT being levied is that of the jurisdiction of consumption rather than that of the jurisdiction of the supplier.
Therefore, if you are involved in transactions where your customer is established in another EU Member State, these changes could have an impact on the VAT rate you would need to levy and report in your Maltese One Stop Shop return.
Therefore, do feel free to get in touch with us if the above changes could have an impact on transactions that for VAT purposes, would be taking place in another EU Member State.
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