EU Finance ministers agree on reduced VAT rate proposal

Amendment of the VAT Directive aims to support climate change goals and abolish preferential treatment of environmentally harmful supplies by 2032.

The Council of the European Union reached a political agreement on 7 December 2021 for the adoption of a directive aiming at modernising and harmonising the rules for the application of reduced VAT rates. According to the proposal, as part of the European Green Deal, Member States should be given the possibility to contribute to a climate-neutral and green economy by means of applying additional reduced rates on environmentally friendly supplies while, at the same time, preparing the phasing out of the existing preferential treatment of environmentally harmful supplies. The amendment is also addressing possible future crises (i.e. pandemics, humanitarian crises or natural disasters) and Member States entitlement to respond swiftly to such exceptional circumstances.

Until now, Member States

(1)           should apply a standard rate of no less than 15% for all goods and services (no maximum rate is not regulated),

(2)           may apply a reduced rate of no less than 5% to goods or services listed in Annex III of the VAT Directive, and

(3)           may apply a special rate even under 5% as derogation (for historical reasons and under certain conditions)

According to the proposal, all Member States would be entitled to apply, in addition to the two reduced rates above 5%, one or two rates below 5% or equal to zero (with right of deduction) to some of the categories of goods and services listed in Annex III in line with the goals of the amendment (environmental commitment, flexibility in critical situations); e.g. goods and services considered to cover basic needs; solar panels; medicines, pharmaceutical products, health and hygiene products. The amendment also aims gradual abolition of reduced VAT rates or exemptions on fossil fuels and other goods with a similar impact on greenhouse gas emissions, as well as chemical fertilizers and chemical pesticides.

Simultaneously Member States should limit the application of the various reduced rates to a maximum of:

• 24 of the categories referred to in Annex III in the case of reduced rates of more than 5%;
• 7 of the categories eligible for a rate of less than 5% (Member States which currently apply derogating rates to more than 7 categories will have until 1st January 2032 to be compliant).

The updated rules will be sent to the European Parliament for its consultation on the final text by March 2022. Once formally adopted by Member States, the legislation will come into force 20 days after its publication in the Official Journal of the European Union, but the Member States will have effectively by 2030 and 2032 at the latest to have their legislation and applicable rates aligned with the new rules.