The European Commission has announced that it will refer the UK to the EU Court of Justice over the reduced VAT rate for the supply and installation of energy-saving materials, which includes solar PV and solar thermal modules.

The European Commission states that there is no provision in the VAT Directive to allow a universal application of reduced VAT rate for energy saving materials, and that the UK’s current application of a reduced VAT rate breaks EU law.

The reduced rate applies to installations of:

• Controls for central heating and hot water systems
• Draught stripping
• Insulation
• Solar panels
• Wind turbines
• Water turbines
• Ground source heat pumps
• Air source heat pumps
• Micro combined heat and power units
• Wood-fuelled boilers

The European Commission states that: “Member States themselves unanimously decided on the list of goods and services that could benefit from a reduced VAT rate, and they also insisted that this list be strictly applied, with no room for manoeuvre or interpretation.

“This is important to prevent competitive distortions in the Single Market and to ensure a fair and level playing field between all Member States.”

The announced court appointment has profound implications for the newly-launched Green Deal, which has already been criticised for high interest rates. The European Commission explained that although it supported the Green Deal, it does not believe that the reduced VAT rate will help the scheme reach its objectives.   

The European Commission added: “Economic studies have shown that reduced VAT rates are often not the best way to achieve policy objectives or change consumer choices. In the case of promoting energy efficiency, there are a number of reasons why a reduced VAT rate is not the most efficient way to deliver on this goal.

“For a start, it is difficult to define precisely these products, which can evolve and develop quite quickly, thereby creating uncertainty around the level of tax due. Moreover, a reduced rate does not target the population that needs it most, but instead is universally applied. In the case of energy efficient products, businesses are likely to represent a large proportion of those wishing to invest in them, in which case the VAT is deductible anyway. It is has been shown that frequently reduced rates are not fully passed on to consumers in the form of lower prices.”

The Commission goes on to state that direct subsidies would be a more efficient way of promoting energy efficient materials without breaking EU law.

The Treasury had previously argued that the lower VAT rate was legal under EU law because the Green Deal and ECO schemes were both social policies. Under EU law member states can only apply reduced VAT rates in the housing sector if it is part of a social policy.

Commenting on the news, an HMRC spokesperson told Solar Power Portal: “There has been no material change in the UK’s view since August last year. We remain of the view that the reduced rate for ESMs within residential buildings is within the scope of what is allowed under the VAT Directive.  However, the Government has announced its intention to withdraw this reduced rate from buildings used solely for a relevant charitable purpose as part of Finance Bill 2013.”