The proposals mark the final stage of an overhaul of the VAT rules, which aims to create a single EU VAT area in order to slash the €50bn (£44bn) lost to VAT fraud each year in the EU.

The Commission says it aims to give member states more autonomy on rates, and on VAT derogations, while it also wants to address the problem of smaller companies suffering from disproportionate VAT compliance costs.

Businesses trading cross-border face 11% higher compliance costs compared to those trading only domestically, with smaller players hit hardest.  Under the proposals, more companies will enjoy the benefits of simpler VAT rules which are at the moment available to only the smallest firms. Overall VAT-related compliance costs will be cut by as much as 18% per year.

Pierre Moscovici, commissioner for economic and financial affairs, taxation and customs, said: ‘These proposals will give EU countries greater freedom to apply reduced VAT rates to specific products or services. At the same time they will reduce red tape for small businesses operating across borders, helping them to grow and create jobs. In short: common rules where necessary for the functioning of the internal market; and greater flexibility for governments to reflect their policy preferences through their VAT rates.’

Currently member states can apply a reduced rate of as low as 5% to two distinct categories of products in their country. A number of member states also apply specific derogations for further reduced rates.

In future, in addition to a standard VAT rate of minimum 15%, member states will be able to have:

• two separate reduced rates of between 5% and the standard rate chosen by the member State;
• one exemption from VAT (or 'zero rate')
• one reduced rate set at between 0% and the reduced rates.

The current, complex list of goods and services to which reduced rates can be applied would be abolished and replaced by a new list of products (such as weapons, alcoholic beverages, gambling and tobacco) to which the standard rate of 15% or above would always be applied.

To safeguard public revenues, member states will also have to ensure that the weighted average VAT rate is at least 12%.

The new regime also means that all goods currently enjoying rates different from the standard rate can continue to do so.

Under current rules, member states can exempt sales of small companies from VAT provided they do not exceed a given annual turnover, which varies from one country to the next. Growing SMEs lose their access to simplification measures once the exemption threshold has been exceeded. In addition, these exemptions are available only to domestic players, meaning there is no level playing field for small companies trading within the EU.

While the current exemption thresholds would remain, today's proposals would introduce:

• A €2m revenue threshold across the EU, under which small businesses would benefit from simplification measures, whether or not they have already been exempted from VAT;
• The possibility for member states to free all small businesses that qualify for a VAT exemption from obligations relating to identification, invoicing, accounting or returns;
• A turnover threshold of €100,000 which would allow companies operating in more than one member state to benefit from the VAT exemption.

These legislative proposals will now be submitted to the European Parliament and the European economic and social committee for consultation and to the Council for adoption. The amendments will become effective only when the switch to the definitive regime takes effect.

Chas Roy-Chowdhury, head of taxation at ACCA, said: ‘This may look at first sight as though the Commission has somewhat rowed back on earlier proposals for full freedom to set local rates.

‘However, in the context of the wider changes to the system, it is perhaps more sensible not to create an environment in which too much additional complexity around rates for cross-border traders is allowed to creep in, at least before the other mechanisms in the definitive regime package have been given time to bed in and been shown to work effectively.

‘In a dynamic tax environment there needs to be flexibility around the 12% rate, to take into account lower revenues in periods of recession.’

Roy-Chowdhury welcomed the simplification measures for SMEs, as supporting their ability to grow, but cautioned that there could be some complexity around the different national thresholds, meaning businesses will still need to be aware of their obligations when they do reach local registration thresholds.

Details of the EU’s action plan on VAT are here.