The government has confirmed that it will fight the European Commission over VAT on energy saving materials (ESM).

In June (see this link), the Commission said that if the UK did not move to raise VAT from 5 per cent to 20 per cent on energy efficiency goods and services within two months, it may refer the matter to the European Court of Justice.

The move caused consternation in industry because of the implications it would have on programmes such as the Green Deal.

At the time Treasury indicated it would challenge the Commission, and last week a coalition of companies which would be affected by a higher VAT rate urged the government to “robustly defend” its postion. The Commission’s deadline is now up and HMRC announced today that it has responded, and will defend the UK’s VAT relief. HMRC posted a briefing note here on its next steps.

The note says that the EC has commenced these proceedings on three grounds:

i) That there is no specific provision in EU law to allow a reduced rate for ESM;

ii) That the EU provisions on which the UK relies as the legal basis for the reduced rate (Category (10) of Annex III to the Principal VAT Directive) only apply where introduced ‘as part of a social policy’, whereas the UK’s relief for ESM has been introduced as part of an environmental policy;

iii) That the UK’s relief is too wide as the EU provisions on which it relies apply only to housing, which does not include buildings used for a relevant charitable purpose.

HMRC said that government “reluctantly” accepted the third point and had already made provision for it in this year’s Budget. It will legislate so that charitable buildings will likely have to pay the higher VAT rate from August 2013 and wants stakeholder feedback on the move. However, it will defend its position on the other two grounds.

The timetable for EC action, and what would happen if the UK loses, is not yet clear. The Green Deal launches in October.