EU countries losing out on €151 billion due to 'Vat gap'

24 November 2017

Apart from Brexit, businesses also need to keep an eye on the progress of European Commission proposals aimed at tackling Vat fraud across the EU, writes BDO's Ivor Feerick.

Brexit isn’t the only EU change that will disrupt businesses that export. Very soon after the dust settles on Brexit, new and somewhat more onerous Vat rules will be introduced throughout the remaining 27 European Union member states.

These proposed changes stem from the European Commission’s focus on tackling the ‘Vat gap’, an estimated €151.5 billion of Vat receipts that EU member states lost out on in 2015 alone, which equates to a massive 12 per cent of expected annual EU Vat revenues.

It is estimated that more than 80 per cent of this ‘gap’ arises from Vat fraud on intra-community supplies of goods.

Tackling the Vat gap will involve the introduction of the most significant reforms to the cross-border Vat regime since the inception of the European single market in 1993.

The biggest change will be a Vat charge on cross-border supplies of goods to other businesses (i.e. B2B). This would result in additional annual Vat revenue of over €1.3 billion for Ireland (that's 9.94 per cent of expected Vat revenues) based on the 2015 VAT gap report released by the Commission.

Needless to add, this would be very welcome news for Minister Donohoe as he seeks to ensure Ireland’s future annual tax revenue exceeds its outgoings.

The Vat gap figure is calculated by comparing the annual Vat revenues reported by each of the 28 EU Member States with Vat revenues expected from each country based on national consumption figures extracted from localised government accounts.

While there is some justification for some of the Vat gap identified by comparing the figures outlined above - such as insolvencies, Vat not being charged on inter-group supplies by businesses in Vat groups, clerical errors - the overwhelming reasons for the discrepancies identified include Vat fraud, Vat evasion and Vat avoidance arising from aggressive Vat planning.

To put the Vat gap in perspective, it should be noted that Britain’s gap of €22.210 billion for 2015 is more than €10 billion above its net annual contribution to the EU coffers. On the other hand, Ireland’s Vat gap of €1,319 billion in 2015 increased from a figure of €1.106 billion (8.76 per cent of expected Vat revenues) in 2014.

Although the proposed new Vat rules are generally regarded as positive, as they will ensure better Vat compliance, less Vat fraud and more revenue for governments, they will initially cause major disruption for businesses. However, the good news is there is plenty of time to prepare.

“Businesses will have to familiarise themselves with Vat rates applicable to their supplies across all the EU member states in which their customers are established”

Under the new legislation, an Irish business that supplies goods cross-border to a business in another EU country would be required to charge (local) Vat at the rates pertaining in the customer’s country. Using current Vat rates, this would mean charging a French business customer 20 per cent French Vat on supplies of goods and a Dutch customer 21 per cent Dutch Vat, with an obligation to account for any non-Irish Vat charged on a single Vat return to be filed online with the Irish Revenue Commissioners.

Similar ‘in country’ obligations will arise for businesses in other member states making B2B cross-border supplies.

Tax authorities across the EU will then be obliged to remit any tax collected by them to their counterparts in each of the other 27 (following Britain's exit) tax authorities.

The proposed new system will put the tax authorities in the EU in a much better position to counter Vat fraud as they will have collected Vat arising on the supplies and can use best in class technology to identify unusual trading and rebuff any unwarranted claims for repayment or credit.

The proposed new system, to be introduced in 2022, will result in increased working capital requirements to enable business to manage the negative Vat cash flows for periods between the payment of the Vat on the cross-border purchases and the receipt of credit or repayment of this Vat from their local tax authority.

A consequence of these proposals will be that, unlike the current scenario in which it is up to the buyer to declare any ‘in country’ VAT arising, businesses will have to familiarise themselves with Vat rates applicable to their supplies across all the EU member states in which their customers are established.

While the proposed change in Vat legislation has yet to be agreed by all EU member states, it is expected to be welcomed by more member states than not.

In the circumstances, as Brexit will continue to be the main focus for the next 12-18 months, it would be wise for businesses to keep a watching brief on the progress of this initiative in the run-up to 2022. Otherwise, when the dust is settled on Brexit, there may be a whole new wave of disruption.

Ivor Feerick is a Partner with BDO Dublin's Indirect Tax department and the Chair of BDO International's VAT Centre of Excellence. 

Originally published by the Sunday Business Post.