When it was adopted for the first time, in France in 1954, value added tax (VAT) was regarded as merely another tax on turnover or on consumption and did not attract the attention of other countries. It was only since 1962, with the publication of two reports ordered by the Commission recommending its adoption by all Member States, that its interest for the Community was understood. Acting on the basis of Commission proposals, the Council adopted on 11 April 1967 the first Directives on the harmonisation of the legislation of Member States concerning turnover taxes [see e.g. Directive 67/227].
In 2006, the original directives were repealed and replaced by a single directive on the common system of value added tax [Directive 2006/112]. The principle of the common system of VAT entails the application to goods and services of a general tax on consumption exactly proportional to the price of the goods and services. On each transaction, VAT, calculated on the price of the goods or services at the rate applicable to such goods or services, is chargeable after deduction of the amount of VAT borne directly by the various cost components. The common system of VAT is applied up to and including the retail trade stage. The tax is levied at each stage of an economic activity on the value added at that stage. It is paid by all those involved in the production and distribution of a product or service, but it is not an element in the costs of those intermediaries and does not appear as an item of expenditure in their accounts, as it is not they who bear the tax, but the end consumer.
The tax is proportional to the price of the products and services irrespective of the number of transactions, which have taken place at the stages preceding that to which it is applied. At the time of each transaction, the amount of VAT, calculated on the price of the good or service, is reduced by the amount of the taxes previously paid on the cost of the various components of the cost price. The total sum which changes hands at each stage in the production or distribution includes the VAT paid up to that point, but the amount of the tax is recovered at each sale, except for the final sale to the final consumer, who purchases the product or service for his private use. The tax is paid to the State by the vendor in each transaction. However, the latter does not bear the burden of the VAT, as his purchaser has advanced the full amount of the VAT to him. Tax paid at previous stages, on deliveries made or services rendered to the taxable person, and the tax paid on imports, is deductible from the turnover tax of that taxable person. Given this deductibility of taxes already paid, VAT is neutral from the point of view of domestic competition, i.e. it does not favour vertically integrated undertakings, as did the cumulative multi-stage taxes. But VAT is also neutral from the point of view of international competition, since it cannot favour domestic products. Calculation of the tax paid is easy, as it appears on all invoices and documents accompanying the product.
The directive on the common system of VAT established a package of common rules making it possible to define the scope of the tax and the method of determining tax liability, i.e. the territorial application of the tax, the taxable persons, the taxable transactions, the place of applicability of such transactions, the chargeable event, the taxable amount, the detailed procedures for applying rates of taxation, the exemptions and the special schemes. In European Community/Union jargon all these rules are known as "the uniform basis of assessment of VAT", and that basis is particularly important in that VAT is a basic source of revenue for the Union [see section 3.4]. Moreover, the directive on the common system of VAT harmonised the laws on turnover tax structures of the Member States in the fields of the provision of services, agricultural production, small undertakings and exempt activities and operations linked with importation, exportation and international trade in goods. Subject to Council approval, a Member State may introduce into its legislation special measures for derogation from the common system of value-added tax, either in order to simplify the procedure for charging the tax or to prevent certain types of tax evasion or avoidance, or in the form of an agreement with a non-member country or an international organisation.
Determination of the place where taxable transactions are carried out may engender conflicts concerning jurisdiction as between Member States, in particular as regards the supply of goods for assembly or the supply of services. Although the place where a supply of services is carried out must in principle be fixed as the place where the supplier has established his place of business, it must be defined as being in the Member State of the customer, in particular in the case of certain services supplied between taxable persons where the cost of the services is included in the price of the goods. Advertising, telecommunications, radio and television broadcasting and electronically supplied services, provided from third territories or third countries to persons established in the EU, or from the EU to customers established in third territories or third countries, are taxed at the place of establishment of the customer [see also sections 6.6.1 and 17.3.5]. Electricity and gas are treated as goods for VAT purposes [Directive 2003/96]. Supplies to dealers are taxable at the place of their business or fixed establishment for which the goods are supplied, whereas supplies to end consumers are taxable at the place of consumption of gas and electricity, which is usually the place where the customer's meter is located.
With the aim of more uniform application of the current VAT system and improved functioning of the internal market guidelines, an implementing Regulation sets out important aspects of the basic VAT directive, such as the definition of the taxable person, the place of supply of goods and services, and the special scheme for electronically supplied services [Regulation 282/2011].
Arrangements exist for the refund of value added tax to taxable persons not established in EU territory [Directive 86/560]. An electronic VAT reimbursement system is established for the refund of value added tax to taxable persons not established in the Member State of refund but established in another Member State [Directive 2008/9]. Under certain conditions, goods imported in the personal luggage of persons travelling from a third country are exempted from value added tax and excise duty [Directive 2007/74, see section 5.1.2].