2.2.2 A Common System of Value Added Tax

The choice was made in favour of the system of value added tax since, in contrast to cumulative systems, neither competition1 nor the free movement of goods and services within the common market2 are distorted in this system.

In the view of the Commission, a value added tax system attains maximum simplicity and neutrality if the tax is levied as generally as possible and if the system embraces all stages of production and marketing, and also the services sector, and it is therefore in the interest of the Member States and of the Common Market to adopt as its common system a value added tax which extends to retail trade.

The Commission proposed that harmonisation should proceed in three stages. First, Member States should abandon their multi-stage cumulative turnover taxes and replace them by a non-cumulative system of their choice. After that, these non-cumulative systems of choice should be replaced by a common value added tax system. The third stage should result in the abolition of intra-Community tax frontiers. For various reasons the European Parliament considered that there should be only one initial phase, instead of the suggested two, during which all Member States would introduce the common value added tax system. The Commission accepted this objection, and it subsequently submitted two (revised) draft Directives to the Council of Ministers.3

The First Directive of 11 April 1967,4 together with the Second Directive of the same date,5 instructed the Member States to replace the existing turnover tax systems with a “common system of value added tax”. This common system is described in Article 2 of the First Directive in the following terms:

“The principle of the common system of value added tax involves the application to goods and services of a general tax on consumption exactly proportional to the price of the goods and services, whatever the number of transactions which take place in the production and distribution process before the stage at which tax is charged.

On each transaction, value added tax, calculated on the price of the goods or services at the rate applicable to such goods or services, shall be chargeable after deduction of the amount of value added tax borne directly by the various cost components.

The common system of value added tax shall be applied up to and including the retail trade stage. (…)”

The above definition sets out the essential characteristics of a theoretical model to which the actual Union system aspires.6^,7 In all stages of production and distribution, tax is levied on all goods and services.

Although it is the purpose to tax only private consumption (through taxing private expenditure), the tax is collected by businesses and is also charged on expenditure by businesses. In principle, multiple taxation is avoided by allowing businesses to deduct the tax incurred on their purchases from the tax payable, i.e. the tax they collect from their customers. This system ensures that, regardless of the length of the production and distribution chain, the tax burden at any given moment is always equal to the tax charged by the last supplier. Therefore, the tax is borne only by the final consumer who, as he is not a taxable person, cannot deduct the tax.

The actual system of value added tax was set out in the Second Directive,8 which determined what transactions were subject to the tax, gave definitions for the expressions ‘territory of the country’, ‘taxable person’, ‘supply of goods’ and ‘provision of services’ and provided rules for determining the place of these taxable transactions. The Second Directive also included a definition of the basis of assessment (the taxable amount). Member States were free to establish their own standard rate of tax and to subject certain goods and services to increased or reduced rates. Imported goods should be taxed at the same rate as that applied internally to the supply of goods. Also, subject to consultation, the Member States were free to determine their own exemptions. In principle, a taxable person was authorized to deduct from the tax for which he is liable the value added tax invoiced to him in respect of his purchases and imports, where these goods and services were used for the purposes of his business. He was required to keep sufficiently detailed accounts and to issue invoices in respect of goods and services supplied by him to another taxable person. Some other specific measures were introduced as well.

The system established by the First and Second Directives fell short of the model described in Article 2 of the First Directive (see above). Member States could choose not to apply the VAT at the retail stage, only services listed in Annex B to the Second Directive were compulsorily subject to VAT, Member States were free to determine their own exemptions and within limits Member States could restrict or refuse deduction in respect of capital goods.9