Towards a circular economy: VAT and the “resell model”

in Industry Insights, Tax, 08.11.2017

In our last article, we talked about the role tax can play in a circular economy: specifically, how we can shift away from an economy that taxes humans and towards an economy that taxes (material) resources. A next important step is to understand if and how circular business models actually affect the taxes paid by businesses and consumers, and the taxes received by the State: impacts that, à priori, can manifest themselves through changes in the amounts as well as the timing of taxes paid.

“In the future it is of critical importance to look in detail at the role of tax and how current rules incentivize companies to favor the linear model over a more circular business approach,” says Dr Jeannot Schroeder, circular economy expert, managing director of +ImpaKT, and co-president of the Circular Economy working group formed for the TIR study.[1]

In order to explore the impacts of changes in taxation approaches, we decided, together with Dr Schroeder, to dedicate parts 2 and 3 of this blog series to the modelling of the fiscal impacts of real-life circular business models.

The present article focuses specifically on the VAT impacts of the resell model, and also discusses what VAT incentives can be used to encourage circular business models.

Taxation in a linear vs. a circular supply chain

For historic reasons, approaches to taxation today are perfectly adapted to a linear economy. In a linear system the value captured by products is lost when their usage period has ended (waste generation), whereas a circular economy is designed to preserve the value embodied in products and components, and to capitalise on the full potential of resources.

In a linear economy, a supply chain has a finite number of stages and the added value is taxed at each stage of the supply chain.[2] In this scenario, there is no accumulation of taxes because of deduction rights – the final customer pays the tax. In a circular economy, the supply chain becomes a supply loop and is, in theory, never ending. Therefore taxing the added value will, again in theory, result in an accumulation of taxes on the same asset.

VAT implications for the resell model

One possible business model in a circular economy is the resell model – reselling used goods again and again. In this example, a business that sells books to consumers agrees to buy the books back from the consumers and then sells them again. The following graph illustrates the VAT implications of such a resell model on the different stakeholders (business, consumer, State). Assuming a VAT rate of 10 percent, the VAT flows look as follows:

*Simplification (realistically, this would be 37c and 28c because the buy-back price includes a fictional VAT of 30c/20c)

On the left side (t0-t1), we have the baseline scenario – a classic sales model. The business buys the book from a publisher for €5 and sells it to a consumer for €10 (excl. VAT). For the business, the transaction is VAT neutral. It needs to pay a VAT of 50 cents on the purchase of the book and collects a VAT of €1 from the consumer when selling the book. To simplify: of this €1, the business keeps 50 cents because it is in a tax credit position from the previous purchase, and the remaining 50 cents go to the State. As mentioned above, the transaction is always VAT neutral for the business because of deduction rights. The total VAT is always assumed by the final customer.

Starting from t2, the resell model starts. A resell business buys back the book from a consumer for €3 and resells it to another consumer for €7, buys it back again for €2 and resells it again for €5. This is where we would assume that the accumulation of VAT on the same book takes place. Let’s look at the transactions in detail.

The buy-back transaction from Consumer to Business is not VAT-taxable, since private individuals are not VAT registered. This means that the resell business has a cash flow advantage, as there is no VAT to finance at the purchase. Additionally, since the business pays no VAT on this purchase, no deduction rights are applicable in the following transactions.

Concerning the resale transactions (t3 and t5), the EU “margin scheme,” designed to avoid an accumulation of taxes on the same asset, comes into application. In Luxembourg, the applicable piece of legislation is Article 56ter VATL for second-hand goods. The used book in our example falling under the definition of a “second-hand good” and the business being a “taxable reseller,” the VAT applies not to the whole sales price but only to the gross margin (sales price minus buy-back price). As a result, the VAT paid in the first resale transaction (t3) amounts to 40 cents (=(7€-3€)*10%) instead of 70 cents (=7€*10%). In the second resale transaction (t5), the consumer pays a VAT of 30 cents instead of 50 cents.[3] This means that the VAT on the material resources included in the book is only paid once, and subsequent VAT is only applied to the added value created, i.e. the margin.

This example illustrates the desired principles of the tax scheme in action, i.e. the avoidance of an accumulation of tax on the same asset, and therefore the avoidance of repeated and significant increases of the purchase price of an asset for the final consumer as goods circle through the economy. To the extent that lower prices constitute incentives to buy, it could be argued that the existence of this tax scheme may encourage consumers to buy second-hand goods and, as a result, favour a more circular economy. It is of course very difficult to make definitive statements on cause and effect in this context, or on the motivations of consumers for purchasing one good over another, so generalisations are fraught with difficulty. But as the simple example shows, the fiscal framework in place relating to VAT for second hand goods does at least not appear to create negative incentives, incentives which would harm efforts towards a more circular economy.

However, the existing fiscal framework, in a more realistic setting, is incomplete. Indeed, to really move towards a more circular economy, we need to push our little thought experiment further and consider that the prolonged usability of goods requires repeated value preservation activities, i.e. maintenance and repair work, to enable circularity to happen in practice. And this is where the current fiscal framework does fall a little short. To correct this, and to further incentivise the reuse and resale of assets, we could therefore imagine a measure to extend the “margin scheme” so as to apply the VAT on the net margin (sales price minus buy-back price minus operating expenses linked to reselling the product) instead of the gross margin. This would allow potential costs for maintenance and repair to be taken into consideration, especially for goods more complex than a book, thereby really encouraging a circular economy.

As Jeannot Schroeder states, “this example shows that a detailed analysis of the tax impacts on a case by case situation is necessary in order to get a complete understanding of what needs to be changed to promote different circular business models.”

VAT rates as incentives

Another immediately obvious candidate area for using VAT to create a more circular economy is that of VAT rates themselves. A country which is often cited as exemplary in this context is Sweden, where a reduced VAT rate is applied to the repair of clothes, bicycles, leather goods, shoes, and linen. It needs to be noted however that Luxembourg has already introduced the same measure many years ago, applying a reduced VAT rate of 8% instead of 17%, and so have other EU countries. So far, no results on the effectiveness of this incentive are known to us.

In addition to perhaps making this measure more widely known, it could also be taken further. A super-reduced rate or an exemption on all services that are value-preserving and labour-intensive, like collection, maintenance, repair, remanufacturing, refurbishment, recycling, and upgrade of goods, could be considered.

In addition to a VAT rate reduction, (a part of) the labour costs for these kinds of services could be made tax deductible. In Sweden, 50% of labour costs for repair of large household appliances are tax deductible up to a certain limit,[4] and Austria is planning a similar measure.[5] This promises to have an even stronger effect on consumption behaviour than a reduced VAT rate, as long as the tax cuts are passed on to consumers (by lowering prices). However, since the measure in Sweden came into force only in January 2017, it is too early to talk about results.

Another way to stimulate consumer demand, aside from value-preserving services, would be to lower VAT rates applicable to circular products consisting of recycled/upcycled materials, products with a positive impact, and generally to cradle-2-cradle certified products. To avoid greenwashing, consistent criteria and checks need to be introduced of course.


As the above analysis and examples have shown, VAT is an area in which there exist a lot of possibilities to encourage a more circular economy. In our next article, we will take this analysis further, and look at a more complex circular business model – the product-as-a-service model – and analyse the fiscal implications (VAT and direct tax) on the different stakeholders.

Next up on the KPMG Blog:

[2]Except in certain cases at the sourcing of raw materials and at the disposal stage, because no remuneration is paid.
[3]The resell VAT amounts of 40 cents and 30 cents are a slight simplification. Technically, the buy-back price (€3/€2) is subject to a fictional VAT (30c/20c) which is never charged. However this fictional VAT will also be subtracted from the “gross margin VAT,” which therefore amounts to 37c/28c instead of 40c/30c.

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