VAT Reduced Rates? Save Your Energy


The CJEU rules that the UK’s reduced VAT rate for the supply and installation of energy-saving materials violates the EU VAT Directive. 
…Can we expect a new wave of cases on the legality of reduced rates?

On June 4, 2015, the Court of Justice of the European Union (CJEU) handed down the judgement of the second chamber in the case of European Commission v United Kingdom, C-161/14, (June 4, 2015) in which it declared that the UK has failed to fulfil its obligations to comply with the EU VAT Directive, and ordered it to pay all court costs.[1] The Commission brought infringement proceedings against the UK under the powers enumerated in Article 258 TFEU, following the UK’s rejection of both a formal notice and reasoned opinion from the Commission.  

The Decision 

The complaint from the Commission concerned a domestic provision of the UK VAT Act which applies the 5 percent reduced rate (as opposed to the standard UK rate of 20 percent) to the service of installing energy-saving materials in residential accommodation and supplies of such materials by a person who installs them.[2] The Commission, which is the executive body of the EU, contended that UK national law did not comply with the conditions laid down for the reduced rate of VAT, as stated in Categories 10 and 10a of Annex III to the EU VAT Directive[3]. Annex III  enumerates the goods and services to which EU Member States may apply reduced rates, including the provision, construction, renovation and alteration of housing, as part of a social policy (Category 10); and the renovation and repairing of private dwellings, excluding materials which account for a significant part of the value of the service supplied (Category 10a).

The UK argued that supplies of energy-saving materials and services involving the installation of such materials in housing were eligible for a reduced rate under Category 10 (i.e., as part of a social policy) because these supplies reduce the costs of improvements made to that housing. As heating and power are a substantial part of household expenditure, the reduced VAT rate allowed the maintenance of living standards, with respect to heating and power, at a reduced rate, and therefore addressed an obvious social need. 

Both the UK and the Commission agreed that, if the Court were to hold that supplies of energy-saving materials fell within Category 10a rather than 10, the reduced rate as applied to energy-saving materials would not comply with the exclusion for materials which account for a significant part of the value of the service supplied.

The Commission countered that a policy of promoting the use of energy-saving materials in general residential housing does not constitute a social policy. The reduced rate was applied without reference to social conditions and adopted without reasons of an exclusively social interest or, at least, a principally social interest. The Commission asserted that the reduced rate at issue was adopted to serve environmental policy objectives in the interest of society as a whole, unconnected with social policy housing. 

Reference was also made to differing translations of the applicable provisions in the VAT Directive.  The syntax in the German, French, Spanish and Italian versions make it apparent that the housing itself must be social in nature, rather than the provision, construction, renovation and alteration thereof. In the English translation, the placement of the comma after “housing” (see above) made the meaning ambiguous.

The CJEU found that the meaning in the former translations reflected the overall purpose and general scheme of the exemption, and therefore, the scope of Category 10 should be interpreted in that light. 

In assessing the translations, the CJEU held it was settled case-law that the wording of a version in any one language version cannot serve as the sole basis for the interpretation, nor would it override other language versions. Rather, “[W]here there is divergence between the various language versions, the provision must be interpreted by reference to the purpose and general scheme of the rules.” 

Next, the CJEU tackled the question as to what constitutes social policy, and how that limiting factor should be applied. Article 110 of the EU VAT Directive justifies reduced rates for “clearly defined social reasons”, or social reasons that are “well defined” as per Commission v Ireland.[4] (The EU VAT Directive however, does not actually define what qualifies as a social objective or policy, nor does it provide for the permitted breadth).

The CJEU stated that no social objectives are expressly stated in the UK legislation on the energy-saving reduced rate, and took the view, based on Commission v. Ireland that for the reduced rate to fall within Category 10, it must have been adopted for reasons of “exclusively social interest or, at least, for reasons of principally social interest.” 

The CJEU acknowledged the UK’s intention to improve the quality of housing, for the protection of health, was a social policy pursuant to its legitimate right to define a comprehensive social policy. However, “legitimate as that right may be,” the Court found that the extension of the right to all residential accommodation could not be described as essentially social. Applying a reduced rate to all supplies of services of installing energy-saving materials, irrespective of the housing concerned or the levels of income, age or other criteria of the occupants, failed the test of an exclusively social or principally social interest. 

Accordingly, the CJEU found that, in applying the reduced VAT rate for the energy-saving materials and their installation, the UK failed to fulfil its EU law obligation.

The UK must comply with the CJEU judgement and amend the VAT Act accordingly. 

Implications

The UK is not the only country to use its VAT system to incentivise or penalise activities – including for environmental reasons. Prominent VAT commentator,[5] Professor Rita de la Feria, Chair in Tax Law at Durham Law School, notes that some EU Member States are allowed to maintain existing reduced rates for environmental reasons on the basis of specific authorisations granted decades ago to pre-existing reduced rates. In the present case, however, Professor de la Feria agrees with the CJEU that the UK extended the scope of the reduced rate to advance an environmental agenda beyond the purpose of Category 10. 

According to Professor de la Feria, expanding the scope of reduced rates or exemptions is problematic for a number of reasons. First, such practices are incompatible with rate harmonisation, and create an unequal playing field for taxpayers from different EU Member States.  This undermines the principle of fair competition which is at the core of EU policy and the open market. Second, reduced rates erode both the national tax base and the EU tax base, (since a portion of nationally-collected VAT contributes to the EU Budget), as the expansion of reduced rates leads to grey areas and definitional problems, as well as opportunities for tax planning to benefit from the reduced rate. Only last year, for example, in HMRC v Pinevale Ltd [2014] UKUT 0202, the definitional problems of this reduced rate were the cause of litigation in the Upper Tribunal over whether polycarbonate roofing panels for conservatories constituted energy saving materials for purposes of the reduced rate. (The tribunal found for HMRC.) 

That said, Professor de la Feria also noted that the courts have found it necessary to extend an exemption or reduced rate beyond the scope that would be permitted under a strict, narrow interpretation of the letter of the provision, in order to promote the policy of neutrality, which is a defining aim of EU VAT policy as stated in the preamble of the VAT Directive – i.e., the principle that similar supplies should receive the same tax treatment, bear the same burden, so as to avoid market distortions. In European Commission v. United Kingdom however, (although there was no substantive discussion on these factors), she believed that the arguments in favour of strict interpretation rightly prevailed.

If a country such as the UK wishes to promote environmental policies, Professor de la Feria said, alternative means are available via environmental taxes, corporate income tax incentives, or even via other regulatory routes. “Not everything in public life has to be resolved via tax policy,” she observed. 

It might be prudent for governments to give greater thought to these alternative routes; European Commission v. United Kingdom may confirm that we have entered a period in which the European Commission and CJEU subject “reduced rate mission creep” to heightened scrutiny – a period that began earlier this year, when the CJEU ruled that France and Luxembourg could not extend the reduced rate for books to e-books in digital form.[6]

“My suspicion is that the EU Commission is getting more attentive to this issue,” said Professor de la Feria. “So we might be looking at a new wave of CJEU cases on VAT rates.” And, as established reduced rates are notoriously difficult to remove politically, the Commission’s pro-active interference may provide a means of improving EU VAT neutrality.  

By Max Schofield, Tax Editor.

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[1] European Commission v United Kingdom , C-161/14, (June 4, 2015). 

[2] Section 29A of the VAT Act 1994 applied to goods and services specified in Schedule 7A, Part 2, Group 2. 

[3] EU Directive 2006/112 of November 28, 2006, as amended and supplemented, establishes a set of common rules that establish key elements of the VAT system, which each EU Member State, including the UK, is required to transpose into domestic law. 

[4] Para.38, Commission v Ireland, C-108/11, (March 13, 2013). 

[5] See, e.g., de la Feria, R., Blueprint for Reform of VAT Rates in Europe, (2015), Intertax 43; and, de La Feria, R., EU VAT Rate Structure: Towards Unilateral Convergence, (2013), Oxford Centre for Business Taxation, Working Paper 13/05. 

[6] SeeEuropean Commission v. French Republic, C-479/13 (March 5, 2015) and European Commission v. Grand Duchy of Luxembourg, C-502/13 (March 5, 2015)