VAT Gap: Frequently asked questions

Value Added Tax (VAT) is a consumption tax, charged on most goods and services traded in the EU. The tax is levied on the 'value added' to the product at each stage of production and distribution. This means that VAT is charged when VAT-registered businesses sell to other businesses (B-2-B) or to the final consumer (B-2-C). VAT is intended to be 'neutral', in that businesses are able to reclaim any VAT that they pay on goods or services. Ultimately, the final consumer should be the only one who is actually taxed. Businesses are given a VAT identification number and have to show the VAT charged to customers on the invoices. The VAT system in the EU is governed by a common legal framework.

What is the VAT Gap?

Put simply, the VAT Gap is defined as the difference between the estimated VAT revenues that Member States expect to receive ('VAT Total Tax Liability' or VTTL) and the amount of VAT actually collected.

The VAT Gap measures the effectiveness of VAT enforcement and compliance measures in each Member State. It estimates revenue loss due to fraud and evasion, tax avoidance, bankruptcies, financial insolvencies as well as miscalculations.

How does this study fit in with the Commission's work to reform VAT in the EU?

The figures released in this year's study offer an important snapshot of the problems facing VAT collection in the EU and what needs to be done to improve revenues and fight tax fraud. Following the publication of the Commission's VAT Action Plan in April, we have worked alongside Member States to put in place immediate measures to tackle VAT fraud. We estimate that a move towards a definitive EU VAT regime based on the destination principle would reduce VAT fraud by 80% in the EU. The Commission believes that Member States should begin discussions on this important issue as a matter of urgency in advance of a Commission proposal in 2017 (see separate section).

What's new in the 2016 report?

Even though VAT revenue collection across EU Member States showed timid signs of improvement in 2014, the headline VAT Gap of €159.5 billion for the EU as a whole is still unacceptably high. The decline of €2.5 billion for 2014 compared to 2013 is down to a change in the way the data is analysed [see below] and economic factors such as positive economic tailwinds, stable VAT regimes and measures introduced against tax non-compliance.

Why did you use a ‘new’ methodology for this year's study and how does it work?

This study calculates the VAT Gap for each country on the basis of national accounts. It maps information on standard, reduced rates and exemptions onto consumption data, along with other information provided by Member States. This means that the quality of the VAT Gap estimates depends on the accuracy and completeness of national accounts data.

The updated method for estimating the VAT Gap estimation is due to new Eurostat standards. The methodology was adjusted in accordance with new definitions for key accounting elements which help to calculate VAT revenues. The new data made it both necessary and possible to update previous estimates for the years 2010-2013.

Why did the Commission sponsor this study?

The 2016 report follows up on last year's study and provides estimates for the VAT Gap for 27 EU Member States[1] for 2014 as well as revised estimates for the period 2010-2013. The aim of the study is to quantify the VAT Gap and to better understand trends in the EU in the field of VAT collection. This can then help to address policy measures to improve VAT compliance and enforcement, and the figures can serve as a yardstick to monitor progress in this area.

How does this study fit in with the European Semester?

Many European Semester recommendations call on Member States to improve tax compliance and their tax administration capacity. More should therefore be done to exchange and implement good practices in this area. A method to accurately and regularly provide an estimate of the VAT Gap is a tangible means to support the efforts required from Member States tax administrations towards a more efficient tax collection.

What input did Member States provide?

Nearly all Member States were involved in the creation of this study and report. The work incorporates numerous observations from Member States in an effort to include accurate data. Member States demonstrated their interest in developing a VAT Gap estimation tool to better understand the trends in the field of VAT collection - a positive signal of shared willingness to tackle the VAT Gap within the EU.

How big a problem is VAT fraud?

VAT fraud results from weaknesses in the current VAT system and the way in which tax administrations manage VAT collection. A recent study suggests that on average 36% of the VAT Gap is due to VAT fraud. As VAT is a major revenue source for Member States, VAT losses, including those due to VAT fraud, have a big impact on the State budget. The Commission's VAT Action Plan has already set out ways to make the EU's VAT system more fraud proof. Immediate efforts being undertaken by the Commission include efforts to enhance cooperation between Member States by supporting the sharing and joint analysis of information, improving tax compliance by cooperating with businesses to address fraud and supporting the modernisation of tax administrations to prevent and fight fraud.

What are the main findings of the 2016 Report on the VAT Gap?

During 2014, the overall expected VAT revenues for the EU-26 Member States[2] grew by about 3.3%, while collected VAT revenues rose by 4%. As a result, the overall VAT Gap in the EU-26 saw a decrease in absolute terms of about €2.5 billion, down to € 159.5 billion. As a percentage, the overall VAT Gap decreased by 0.7% to 14%. The median VAT Gap experienced the sharpest fall; down to 10.4% from 13.8%.

In 2014, 18 Member States decreased their VAT Gap, with the largest improvements noted in Greece, Estonia and Hungary. Eight Member States saw a moderate increase in the VAT Gap, with the largest deteriorations in Romania and Bulgaria. Member States’ estimated VAT Gaps ranged from 1.2% in Sweden and 3.8% in Luxembourg to 37.9% in Romania and 36.8% in Lithuania.

Why do we need a single VAT area and how will it work in practice?

The VAT system is a major and growing source of revenue in the EU, raising almost €1 trillion in 2014. But the VAT system has been unable to keep pace with the challenges of today's global, digital and mobile economy. It needs to be modernised because it is too complex for the growing number of EU businesses operating cross-border and leaves the door open to fraud.

The current system splits every sale across EU borders into a VAT exempt transaction in the country of origin, and a taxable purchase in the country of destination. It is like a customs system, but lacks equivalent controls and is therefore the root of a significant amount of cross-border fraud [see factsheet]. For example, missing trader fraud can occur when the importing company sells the VAT exempted imported goods, collects VAT, but disappears before passing on the VAT collected to tax authorities.

A robust single European VAT area would treat cross-border transactions in the same way as domestic transactions (i.e. cross-border trade will no longer be exempt from VAT), putting an end to the inbuilt weaknesses of the system. The current system is too fragmented and not in line with the needs of the Internal Market. It is no longer viable or realistic to base the EU system on 28 different VAT procedures. The current rules can discourage businesses from expanding their businesses across borders.

The creation of an EU-wide VAT system would support a deeper and fairer Single Market. It would also help to boost jobs, growth, and investment and competitiveness.

How would VAT be collected in future?

Today's Action Plan proposes a future VAT system where VAT is charged under the rules of the originating country on sales that are made across borders to another country in the EU, at the rate applicable in the country of consumption. The VAT on a cross-border sale (goods or services) would be collected by the tax authority of the originating country and transferred to the country where the goods or services are ultimately consumed.

Businesses that trade within the EU will be able to sort out their VAT far more simply and easily, via an online web portal in their home country. Otherwise, traders would have to register for VAT, file returns and make payments in every EU country where they operate. The online portal would also allow VAT to be collected by the country where the sale is made and transferred to the country where the goods are consumed.

In order to allow for a gradual transition, trustworthy businesses that are certified by their tax administrations, including SMEs, could initially continue to purchase goods free of VAT in another Member State and pay VAT in their own country.

What is the Policy Gap?

The 2016 Report also provides further information on the Policy Gap for the EU-27. The Policy Gap indicates the additional VAT revenue that a Member State could theoretically collect if it applied the same VAT rate to all goods and services.

The Policy Gap as defined above can in turn be broken down into the Rate Gap and the Exemption Gap. As the terminology suggests, the Rate Gap represents the potential revenue loss due to the existence of reduced rates, whereas the Exemptions Gap represents the potential revenue loss due to goods and services which are exempt from VAT in some Member States.

What are the main findings of the 2016 Report on the Policy Gap?

The Policy Gap ranges from a low of 12.4% in Malta, to a high of 59% for Spain. The EU-28 average Policy Gap is 43.3%.

The Policy Gap, in turn, can be broken down into the Rate Gap and the Exemption Gap. The latter, in all countries, is the larger of the two, ranging from the high of 50.5% for UK, to the low of 21.5% for Lithuania. The EU-28 average Exemption Gap is 34.6%. The Rate Gap, on the other hand, ranges from the low of under 1% in the case of Denmark, to the high of 17% in Ireland. The average is 8.7%.

The so-called "Actionable Policy Gap" combines loss from applying exemptions and reduced rates that is under control of national authorities. The average Actionable Gap is about 15.5%, varying from 2.2% in Denmark up to 29.9% in Cyprus.

The results suggest that better enforcement remains a key component of any strategy to improve the VAT system.

[1]Incomplete national accounts data mean that Cyprus has not been included in the study.

[2] Even if Croatia is for the first time included in the study, in order to ensure full comparability we must use the same base as in previous report: EU-26 member States (EU-28 without Croatia and Cyprus)

[1] EU-28 without Croatia and Cyprus.

[2] EU-28 without Cyprus.

MEMO/16/2909