Modifications to EU VAT sourcing rules.

• Author: Duncan, Harley
• Position: Value added tax

Recent discussions of tax reform in the United States have identified a value-added tax (VAT) as a possible vehicle for closing fiscal gaps and enhancing the reliability and efficiency of the U.S. tax system. In more than 150 countries, including Organisation for Economic Co-operation and Development (OECD) member countries, experience has shown that a VAT can be an important part of the fiscal structure in developed countries, which have seen the backbone of their economies shift from manufacturing to service-oriented businesses, most notably with expanding use of the internet and information technologies. As the oldest and most developed in the world, the European Union VAT system is often used as a model for countries implementing a VAT, and a study of the EU system could influence any future U.S. VAT.

The EU is in the process of fundamentally modifying the structure of its VAT and adapting it to the business models of the 21st century. In 2010, the EU began modifying the sourcing rules for services to provide for taxation at the place of consumption, as opposed to taxation at the supplier's location or point of production. The process should be finalized in 2015, when the rules for sales to individuals and households will change to mandate taxation of telecommunications, broadcasting, and electronically supplied services where the customer is established, as opposed to where the supplier is established. These new sourcing rules have already inspired legislative amendments in Norway and Switzerland, among other countries.

This item discusses the basic principles of the EU VAT; the existing sourcing rules for sales of telecommunications, broadcasting, and electronically supplied services to businesses and individuals; the modifications being made to those rules; and what those modifications could mean for future changes to the EU VAT.

Basic Principles of the EU VAT

The EU VAT is a harmonized system in which a member state may apply different VAT rates, exemptions, and interpretations of VAT law within the limits of the EU legislation. The EU VAT is a broad-based consumption tax on all goods and services that is fractionally collected at each stage of consumption and is designed as a tax that does not rest on business inputs (i.e., businesses receive a credit for VAT paid on purchases against VAT collected on sales). The burden of the tax is on the final customer, and as with U.S. retail sales taxes, businesses collect the EU VAT on behalf...