Three hold EU to ransom over VAT rates

EU finance ministers failed once again to reach an agreement on reduced VAT rates on Tuesday, with three new member states blocking the deal.

The Czech Republic, Cyprus and Poland have been given until the end of the week to approve plans to extend the reduced rates for labour-intensive services until 2010.

But while the countries have not vetoed the agreement, there is confusion over exactly what they want to add to it.

The new member states had demanded equal treatment with the other EU countries following concerns that they would not be allowed to join the scheme, introduced in 1999 as an experiment.

But there was unanimous agreement on this issue among all 25 countries, with the new member states free to join the experiment provided they notify the European commission by March 2006.

The issue, in fact, appears to be about the legal basis of the VAT waivers agreed by the three countries.

Their existing reduced-rate VAT schemes were agreed in their accession treaties, and Warsaw, Prague and Nicosia fear that they will have to renegotiate these agreements in order to join the wider scheme.

Some of the sectors currently benefiting from VAT waivers in the three countries - such as construction - are already included in the existing scheme, but it is unclear whether their legal bases are the same.

But other sectors, such as restaurant food, which benefits from low VAT rates in Cyprus, are not included in the wider scheme, and could face a legal vacuum once their waiver expires in 2007.

France's calls for its own restaurant sector to be included in the scheme were ignored by the ministers, forcing President Jacques Chirac to renege on a 2002 election pledge.

Paris had been pushing hard for restaurants to be added, but was forced to bacjk down after Germany threatened to veto the entire scheme.

Berlin agreed the 2010 extension as long only as the scope of the scheme was not expanded further.

Chirac has refused to admit total defeat, however, claiming that the door is still open for restaurant food to be added at a later date.

Whether that will happen depends on the result of an independent assessment of the impact of the lower-rate scheme  - including the restaurant sector - to be carried out by an independent think-tank.

The commission will then make further recommendations on the extension or expansion of the scheme by June 2007.

But ministers will be under no obligation to discuss the scheme again until the latest extension runs out in 2010, and the general consensus is that the matter should be shelved for as long as possible.

In any case, a failure to agree to the scheme by Friday's deadline could lead to legal action from the European commission against the nine EU countries currently benefiting from the lower VAT rates.

Belgium, Greece, Spain, France, Italy, Luxembourg, the Netherlands, Portugal and the UK have technically been in breach of EU VAT rules since the start of the year, when the old scheme expired.

Tax commissioner László Kovacs agreed to give the member states time to reach an agreement, but said he would have no choice but to take action if that proved impossible.

Action would not be immediate, however, as long as the nine countries took rapid action to change their national laws to apply the standard minimum VAT rate of 15 per cent across all the affected sectors.

Small business groups representing the sectors covered by the reduced rate scheme - construction, hairdressing, home help and bicycle repairs, among others - welcomed the agreement to extend the scheme to 2010.

But they warned that jobs were at risk if the three member states failed to give their support.

"It is deeply disturbing that a handful of member states took the narrow-minded decision to block agreement on a scheme that has no impact on their own domestic markets," said Hans-Werner Mueller, secretary general of small business federation UEAPME.

"Small businesses in these vulnerable labour-intensive sectors would forced out of the market if there is an instantaneous hike in VAT rates, as consumers would be hit by 14 per cent price rises."

"The negative effects of such an outcome on employment in these sectors cannot be understated."

The EBC, which represents the construction industry, the sector likely to be the hardest hit if an agreement is not reached, warned of 250,000 job losses.

"It is a deplorable and dangerous double or quits game for Europe and the building sector," said EBC president Jean Lardin.

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