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Reforms in EU VAT: Lessons for Indian GST
December, 12th 2011

The EC believed that the 40-year-old tax regime was no longer suitable for the service-driven, technology-based economy.

In December 2010, the European Commission (EC) had adopted a Green Paper on the future of VAT in the European Union (EU). The Green Paper argued the case for a simpler, more robust and efficient VAT system that was tailored to a single market and had sought public debate on this very ambitious reform initiative, on the various parameters underpinning the initiative. The EC was of the belief that the 40 year old tax regime was no longer suitable for the service driven, technology based economy and hence the time was opportune for a reform of the VAT system. A three part series of articles earlier in this column had discussed the contents of the aforesaid Green Paper in detail and had concluded that as we progress on the path to a dual GST system in India, we need to closely watch the developments in the EU and benefit from the debate and discussions being carried on regarding the Green Paper.
Following a public consultations process on the Green Paper, the EC has last week adopted a Communication on the future of VAT in the EU (Communication), which is ostensibly pro-business and pro-growth. Given the economic crisis looming over Europe, the timing of the release of the communication is perhaps apt.

The Communication states that the financial crisis has exposed the Member States of the EU to a twofold economic policy challenge, namely to foster sustainable economic growth and to consolidate public finances and that taxation policies were an important lever for that purpose. Evidently, these policy challenges are relevant in the Indian context as well in that fiscal consolidation and economic growth imperatives equally underpin Indian economic policy choices. The Communication states that the response to the Green Paper has been overwhelming and has indeed confirmed the need for a broadbased debate on an appropriate VAT system for the present day economy.

The primary conclusion from the public debate is that the fragmentation of the common EU VAT system into 27 national VAT systems has been the main obstacle to efficient intra-EU trade and has prevented citizens from reaping the benefits of a genuine single market. Again, this imperative is extremely relevant from an Indian standpoint, given the various challenges that are present regarding the best way to design the dual GST in order to foster a common market in India for goods and services. The Communication states that while the Green Paper has generated great expectations for change, a fundamental overhaul of the VAT will inevitably be a long term project. It thereafter states that the purpose of the Communication, keeping in mind the above reality, is twofold:-

- to set out the fundamental features of a future EU VAT system which can continue to perform its function of raising revenues for the Member States while increasing the competitiveness of the EU.

- to list out the priority areas for further action in the coming year with a view to moving in the direction of the above objective.

The Communication thereupon lists out the overriding objectives that ought to reshape the vision of the new VAT system as follows:-

Simplicity:- the VAT must be made more workable for businesses and should relieve them of considerable administrative burden. It should encourage greater cross border trade, thereby enhancing growth. The business friendly VAT should facilitate a one stop shop approach for cross border transactions, standardization of VAT declarations / obligations and provide clear and easy access to details of all national VAT regimes through a central web-portal.

Fiscal consolidation:- the VAT must be made more efficient in supporting the efforts of the Member States at fiscal consolidation and sustainable economic growth. Broadening the tax base and limiting the use of reduced rates could generate new revenues for the Member States without the need for increasing the VAT rates. The Communication sets out the principles that would guide the review of exemptions and reduced rates.

Anti-fraud measures:- the new VAT system should address the issue of huge revenue losses on account of uncollected VAT and frauds. In 2012, the EC is expected to propose a quick reaction mechanism to ensure that Member States can respond better to suspected fraud schemes. Further, the EC will explore whether the current anti-fraud mechanisms need to be strengthened and will also explore the possibility of setting up a cross border audit team to facilitate multilateral controls.Apart from the aforesaid objectives, the Communication states that the original principle that was laid out in 1967 to establish a VAT system based on the principle of taxation in the country of origin was no longer achievable. It accordingly states that the destination based principle will underpin the new EU VAT system since it is the only pragmatic and politically achievable solution. The Communication acknowledges that no work was done in the EU towards progressing the agenda for a properly functioning destination based VAT system from 1993, given the initial commitment to the origin principle. Accordingly, the formal abandonment of this principle in favour of the destination principle will, as per the Communication, enable the EU to significantly accelerate its efforts at VAT reform. It is very instructive here in India to note the above comment. As is well known, the GST in India is predicated on the premise that it will be a destination tax which will operate seamlessly through the value chain in a manner that the tax is only borne by the ultimate consumer of goods and services.

Indeed, on a broader note, if we look at the purported objectives of introducing the dual GST in India, we can realize that they are not very different from those being considered by the EC for reforming the EU VAT. The broad objectives of simplifying the current indirect tax structure to enable India to become more competitive and operate as a single market, achieving uniformity in tax rates and procedures and increasing the tax revenues of the Centre as well as the States, while removing complexity and tax cascading, closely mirror the overriding objectives as listed out by the EC. Accordingly, we need to closely follow the developments in the EU and incorporate the best in class thinking relative to the ongoing VAT reform process. Following articles in this column will focus on the detailed contents of the above EC Communication.

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