In depth

Background of the changes

The proposal aims at modernizing the existing rules on VAT rates that have not been fundamentally changed for almost three decades. Member states will have more flexibility in setting up their VAT rates and meeting overarching EU priorities (e.g., the resilience of the healthcare system, the Green Deal and the digital transition).

The new rate structure

Under the new regime, member states must still apply a normal or standard rate of at least 15% and may apply two reduced rates of at least 5% to items covered by the list in Annex III of the VAT Directive. However, several Annex III categories now have a wider scope, while 10 new categories have been added. In addition, every member state may set a super-reduced rate (lower than 5%) and a 0% rate for products to cover basic needs, such as foodstuffs, medicines, pharmaceutical products, but also solar panels.

Supporting health systems

The strengthening of health systems is the central tenet of EU4Health, the EU's response to the COVID-19 pandemic. Lowering the VAT burden for this primarily VAT-exempt sector may support this goal. To this end, the scope of the two medical categories of Annex III is broadened, thus extending the possible use of reduced rates.

The revised category 3 of Annex III will include pharmaceutical products used for medical and veterinary purposes, including products used for contraception and female sanitary protection. Category 4 of Annex III will include items for use in healthcare in general, such as medical equipment, appliances, devices, items, aids and protective equipment. In addition, the inclusion of more items as essential aids has eliminated the current restriction on products for the exclusive use of persons with disabilities. A super-reduced or 0% rate will also become available for these categories.

Supporting the EU Green Deal

The proposal extends the scope of Annex III to environmentally friendly goods and services, such as solar panels, electric bicycles, waste treatment and recycling services. Member states will also be allowed to apply a reduced rate to the supply and installation of high-efficiency, low-emission heating systems that meet the criteria of environmental legislation. For solar panels, a rate of 0% may be set.

Reduced VAT rates or exemptions on fossil fuels and other goods with a similar impact on greenhouse gas emissions will be phased out by 1 January 2030. Reduced rates and exemptions for chemical fertilizers and chemical pesticides will end by 1 January 2032, to give small farmers more time to adapt.

Supporting the digital transition

The proposal provides the possibility of setting reduced rates for internet access services. By 2025, reduced rates will become available for livestreaming of reduced-rate cultural and sports events. Such services will then be taxed, for VAT purposes, where the virtual visitor is located.

Equal access to derogations

Member states have already obtained derogations to apply special rates for specific products, thus deviating from the provisions of the VAT Directive. This has resulted in a patchwork of country-specific derogations. Under the new rules, these derogations will remain in force. However, in order to ensure equal treatment of all member states, local derogations will become available to all other member states. This option must be exercised within a period of 18 months after the date of entry into force of the new directive.

In any event, reduced rates for fossil fuels and similar products are only allowed up to 1 January 2030. Reduced rates for chemical pesticides or chemical fertilizers must stop by 1 January 2032.

Avoiding revenue erosion

The new rules contain provisions limiting the proliferation of reduced rates. Member states may not use the Annex III categories all at the same time. The use of the two regular reduced rates is restricted to a maximum of 24 categories of the amended Annex III.

The use of 0% and super-reduced rates is also restricted to seven categories of the essential supplies of Annex III of the VAT Directive. Member states that have been using these rates for more than seven categories up until 1 January 2021 must limit their use to seven categories by 1 January 2032 or, should the definitive VAT regime be introduced at an earlier date, by that earlier point.

Recommended actions

The upcoming rules will likely lead to further fragmentation of VAT rates throughout the EU, thus adversely impacting business. On the other hand, opportunities may also arise, especially for the healthcare sector. The new legislation allows reduced rates for essential products in this mostly VAT-exempt sector, thus mitigating the VAT burden. The pandemic has demonstrated the critical importance of a robust healthcare system. Member states may now support the sector with a targeted VAT rate reduction. A discussion on this should begin before the memory of the pandemic fades away.