European Union: VAT And Customs Unions - The Pros And Cons. An Update From Gibraltar

On 31 December 2020, the UK and Spain announced an agreement in principle under which Gibraltar would join the EU's Schengen Area. The EU and Britain will now negotiate a new treaty that is likely to take up to six months. The result is keenly awaited in Gibraltar not least by the business sector. Thus far positive assurances have been given as to how the border will work in practice.

It is almost five years since the UK referendum "leave" result. Britain exited the EU on 31 January 2020 but almost a year passed before the Withdrawal Agreement was finally signed. As a result Brexit was completed on 1 January 2021. Early indications suggest that some parts of the agreement are working well but challenges remain. These matters are of critical importance to Gibraltar and the surrounding campo.

The benefits of Gibraltar joining Schengen allowing the free movement of people are clear to see from a map showing the 26 countries involved. Treaty discussions are likely to include provisions relating to trading of goods between Gibraltar and the EU and other matters such as environmental concerns.

Gibraltar was never part of the EU's Customs Union but the treaty may include substantially similar clauses even if full membership does not result. As we await final details, it is perhaps useful to consider what allying with or even joining the Customs Union might mean. First, a quick look at Value Added Tax, or VAT, follows although speculation on its introduction locally is premature.

The term VAT is often used interchangeably with others such as Goods & Services Tax (GST) or even simple Sales Tax. However, it is important to remember that the EU's VAT is levied on a product wherever value is "added" – at every stage in its production to the ultimate point of sale. Apart from all 27 EU member states, VAT in some form is levied today by a further 150 countries worldwide.

Britain introduced VAT in 1973 upon its accession to the EEC, a predecessor to the EU. It replaced Purchase Tax and it is assumed that Brexit will not alter the status quo. Indeed, after income tax and national insurance contributions, VAT represents the third highest value revenue stream for HM Treasury.

VAT can be controversial. Advocates point out that unlike income tax, it raises revenue without "punishing" success or retained wealth. Based on consumption, a fairly constant revenue stream can be assumed by government and comparatively large amounts can be raised even at a low rate. VAT is relatively simple to manage with fewer compliance issues. Imposed across the board, although exemptions can be applied, it is a somewhat difficult tax to avoid.

Detractors on the other hand charge that VAT is regressive as it places a disproportionately greater financial burden on the less well off. This is because as disposable income falls, more is spent on necessities. VAT, they argue, can be difficult to understand as it requires calculation at different stages of goods' production and sales cycles. Compliance can be bureaucratic and expensive for businesses. Detailed records must be kept from the start and the incidence of VAT fraud is well known

One might think of the EU Customs Union as a unique structure but there is a long history of such arrangements. They can be defined as trade agreements between participating countries charging a common set of tariffs to the outside world whilst, crucially, allowing free trade between each other.

Past customs unions include the Zollverein established by several German States in the 19th century. Today there are more than a dozen currently in force worldwide apart from the EU.

Exhibiting broadly similar characteristics, these include the Caribbean's CARICOM and the Gulf Cooperation Council (GCC).

Britain left the EU's Customs Union as part of Brexit and Gibraltar never joined it. As with VAT, benefits can be derived from such arrangements although there are drawbacks.

The advantages of a customs union are clear. It allows free trade across member states and does away with the need for customs checks and regulation across its borders. Trade deals with external countries (or indeed other similar blocs) are more powerfully negotiated as part of a larger grouping. Membership can lead to ever closer ties between businesses in the union allowing for deeper cooperation, all the while in a tariff free environment.

Disadvantages can also result from customs union membership. Member states cannot negotiate separate trade deals on independent terms (although agreements may be reached assuming the common external tariff is respected). External tariffs can lead to increased costs on third countries. An example was the imposition of higher taxes on imports to the UK from the Commonwealth when Britain joined the EEC. At a national level, a customs union prevents a country allocating state aid to a domestic industry – a regular bone of contention in the EU to this day.

Gibraltar should benefit greatly from the forthcoming treaty and its terms are awaited with keen interest. Decisions on de facto or even full Customs Union membership still less the imposition of a VAT regime are for the future. In the meantime, a post- Brexit future awaits that could be somewhat rosier that might previously have been expected.

These are exciting times.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.