chapter 7 Treatment of Agriculture

Alan Tait
Published Date:
June 1988
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“And I shouldn’t wonder,” I said, for I was in a thoughtful mood, “if even herrings haven’t troubles of their own.”

“Quite possibly, sir.”

“I mean, apart from getting kippered.”

“Yes, sir.”

“And so it goes on, Jeeves, so it goes on.”

—P.G. Wodehouse, “Jeeves and the Song of Songs,” in Very Good, Jeeves! (Penguin Books, 1979), p. 74

Agriculture poses special problems for vat. In most countries, farmers are not easy to handle as taxpayers. For the most part they tend not to keep accounting books or, if kept at all, do not maintain them adequately.1 In developing countries, they may not be well organized and may be located in places where the tax administration cannot reach them easily or even enforce the tax law with certainty. Their methods of farming are frequently rudimentary and even their culture can frustrate attempts to apply a vat (or indeed, any tax), and make it rather impractical. There are a few striking exceptions from this general statement and, in a few countries, farmers are assumed to be like any other trader and are dealt with wholly inside the usual vat legislation (for instance, in Chile, Denmark, New Zealand, Sweden, and the United Kingdom). However, vat legislation usually tries to ensure that most farmers and fishermen do not have to make any vat return and do not have to deal with the tax administration.

The treatment of agricultural activities under a vat has been the object of protracted discussions within the EC. Basically, the EC has recognized the difficulties that most farmers face in handling the normal system of vat or even the simplified system available to small enterprises. Moreover, it has been accepted that agriculture is, in most countries, clearly difficult to deal with and politically sensitive.

The problems that agriculture faces are similar to those of small businesses. However, in farming, not only are many sales for cash and records of sales not kept; frequently, all records are poorly kept, which not only frustrates the authorities but also can work to penalize the farmer in compliance costs and in wrongly calculated vat liabilities. In addition, farmers frequently produce and sell many products, and their products can be liable to different vat rates (cereals, wine, cattle, and Christmas trees, for instance); their inputs are bought sporadically (for example, fertilizers and seeds or new equipment) and can also be liable to different rates of vat. Sometimes farms are mixed with other taxable activities, for example, rooms rented for bed and breakfast, rental of caravan sites, provision of farm services, processing farm output, and transport of animals. Are thoroughbred stud farms or market gardens regular businesses or farming?

Possibly the best way to review these issues is to look at the EC’s treatment of farming, and follow this with a discussion of other countries’ treatment, and the preferred, or “last.” solution.

The EC Common Flat Rate for Agriculture

The basic intent of the EC treatment is to try to make sure that the farmer is left alone in peace and that he is not disturbed by government paperwork or visits from vat inspectors. It tries to anticipate the difficulties of dealing with farmers and does so by pushing the burden back onto farm suppliers and forward onto purchasers of farm output.

The EC’s Sixth Directive provides a common flat rate scheme for farmers2 to use, where the normal rate or the simplified scheme for small undertakings gives rise to difficulties. The farmer does not need to register for vat nor does he need to issue an invoice (see below). He is compensated for the vat he pays on his inputs by a flat rate increase in the price he charges his customers. This percentage is a flat rate relief for all farmers and none are put at a competitive disadvantage in passing forward the increase; it can be claimed by the purchaser of the farm output as a credit against his (the purchaser’s) vat liability. In this way, only the seller of farm inputs (fertilizers, seeds, and equipment) and the purchaser of farm output are registered for vat. The farmer has, normally, no vat responsibility.

The Commission of the EC is responsible for monitoring the appropriateness of the flat rate compensation (for the vat charge on farm inputs) determined by each member state. The flat rate compensation is fixed using a common method of calculation set out in the Sixth Directive. The computation is based on the national accounts figures for the preceding three years. Basically, this involves taking the figure for the total output directly derived from agricultural production; inputs consist of the total value of current inputs needed to achieve this production and the value of the gross fixed asset formation in all the specified agricultural activities. The ratio of vat on inputs to farm output represents the flat rate compensation percentage (the last column of Table 7-1 shows some of the compensation rates).

Table 7-1.Summary of Agriculture Under VAT for Selected Countries, 1982–86
RegisteredVAT Rate

(In percent)
Opt OutInput VATPurchaser Credit


(In percent)
BelgiumX2.0 (wood);6.0 (food)2.0

FranceX7.0 (food);10.0 (wine)X

Turnover F 300,000 (US$53,809)

Claimed from Government even if opt out
3.5 (eggs, poultry, pigs); 2.9 (wine, fruit, vegetables); 2.4 (other food)
Germany, Fed. Rep, ofX6.5 (food); 13.0 (wine, beverages)X7.5

Iceland2X11.0 (wholesale); 25.0 (retail)
Ireland0.0 (vegetables); 1.0 (cattle, pigs); 10.0 poultry, fish)Principal inputs exempt from vat and refunds on capital goods2.2
ItalyX2.0 (cereals); 8.0 (poultry, wine); 15.0 (milk, cattle); 8.0 (other)As small business2.0
NorwayXStandardAs small tradersX
PortugalZero rated
SwedenXStandardAs small tradersX
United KingdomXStandard but most food is zero ratedX
Western Hemisphere
ArgentinaExempt (unprocessed);18.0 (processed)Principal inputs exempt from tax
BrazilPrincipal inputs exempt from tax
ColombiaZeroFertilizers and seeds zero rated
UruguayXExempt (some unprocessed); 12.0 (bread, meat, beverages); 20.0 (processed)Principal inputs exempt from VAT
Asia and Pacific
New Zealand1XStandardX
PhilippinesExemptFertilizers and seeds exempt
Source: Various country reports.

Approximately one third of all firms registered are farmers.


Source: Various country reports.

Approximately one third of all firms registered are farmers.


Any changes in the flat rate applied in a member country must be agreed with the Commission to ensure that there is no significant subsidy to the agricultural sector by overcompensatitig farmers for vat on inputs.

Problems with the Flat Rate Compensation

The Commission has identified certain minor problems in relation to the flat rate compensation scheme:

(1) Obviously the flat rate cannot compensate all farmers accurately. Spanish studies show that, depending on the particular type of farming, the vat paid on final production could vary from 1.1 percent (for olives) to 5.7 percent (for intensive market gardening); vat paid also varies by region from 2.9 percent (in Andalucía) to 4.7 percent or more (in Navarra, Aragon, Castilla-Léon, and Murcia).3 A flat rate vat allowance of 4 percent clearly only achieves rough justice.

(2) Some member states extend the rate to any farmer no matter how large or small his enterprise. If the flat rate is realistic, large farmers will probably opt for the normal system since their vat inputs on purchases of capital equipment will make the flat rate unattractive. If the flat rate is generous, they may stay in the flat rate system. The Commission is of the opinion that the flat rate scheme should be confined to small traders—the ceiling being established by reference to criteria relating to turnover or quantities produced per hectare.

(3) Member states differ in their treatment of the disposal of capital goods. Some states exempt such sales by flat rate farmers, others include the disposal of such goods as part of the basis for calculating the flat rate compensation. In the latter case, the Commission suggests that the ratio for calculating the flat rate should be

(4) Problems are raised by the inclusion or noninclusion of direct exports by flat rate farmers when compensation is calculated. Some countries authorize the farmer to collect flat rate compensation for his vat on inputs on a basis that includes exports. Others exclude this possibility. Both arrangements present difficulties. States that authorize farmers to obtain compensation for direct exports both encourage farmers to export and relieve them of input tax—but the cost of the export to the foreign customer is increased by the flat rate percentage. States that do not authorize compensation for exports keep the export price down, but at the same time farmers are not encouraged to export, and if they do they may not be compensated for input tax previously paid. This is a dilemma. The Commission suggests that direct exports by farmers should qualify for compensation and that the foreign customers, provided they are in the EC, or have reciprocal arrangements for vat (for example, Austria), should be able to claim refunds under the vat Eighth Directive4 for the flat rate amounts they have paid.

(5) The status of the flat rate is ambivalent. It is not a vat rate, but it is treated as such for deduction of input tax purposes by those who buy from farmers. It provides “rough justice”; if properly calculated, it provides adequate compensation for input tax to the “average farmer.” So clearly, some gain and others lose, although year in and year out, a balance is probably achieved.

Article 25 of the Sixth Directive states that flat rates may not be used to obtain refunds for farmers greater than the vat charges on inputs. This provision has two objectives: (a) to prevent distortion between member states and (b) to protect the payment of “own resources” to the Commission. In practice, it is the latter objective that is honored. This is explained below.

The EC is financed by payments by member states of all customs duties and a percentage (maximum 1.4 percent in 1986) of the vat theoretical base. These amounts are legally due to the Community (its own resources) and are merely collected on its behalf by member states. Since balancing the Community budget is usually difficult and always contentious, the Commission is strict in obtaining compensation from states where the vat system does not, in certain sectors, yield the full amount. This has been the case, for instance, with the flat rate scheme for farmers in the Federal Republic of Germany. In 1984, following a revaluation of the green rate of the deutsche mark, the German authorities decided to use the flat rate vat mechanism to compensate farmers for the losses they suffered. This special aid was an addition of 3 percent to the flat rate. This move was attacked by the Commission because (a) it reduced the Community’s “own resources” yield since more input tax was created, leading to a reduction in net vat yield, and (b) it created a distortion in the treatment of farmers as between member states. In the event, Germany pleaded that the flat rate mechanism was the simplest method of compensating farmers both for input tax and losses due to the revaluation of the green deutsche mark; the authorities claimed that it was possible to calculate the loss in own resources to the Commission and to make a compensatory payment. This argument was accepted, and Germany was allowed to derogate from Article 25 of the Sixth Directive, provided the own resources account was corrected.5 This incident demonstrates that the flat rate mechanism can be an administratively simple mechanism for compensating farmers for more than input tax, for instance, as a subsidy. It does mean, of course, a reduction in the net yield of vat.

Although there is no evidence of flat rate compensation schemes for farmers leading to fraud, there is always the temptation for the farmer and his customers to conspire to increase the invoice price (hence the input tax deduction), but to settle in cash for a lower price. Of course, there should be legal penalties for such behavior.

Agricultural Invoices

Any claims for flat rate compensation by a registered purchaser must be supported by a proper invoice. As is usual in vat control, the invoice is retained by the trader for inspection by revenue officials if required.

The unregistered farmer is not normally required to issue the invoice. This invoice is generally a matter for the registered purchaser, who must prepare and retain the invoice himself and give the farmer a copy, which the farmer retains.6 The invoice must specify the net purchase price and the flat rate addition as well as the total price. An unregistered farmer, who accepts an invoice made out this way, recognizes the sale and validity of the flat rate addition to the price.

If there is a subsequent adjustment in the price or the sale is canceled, the appropriate vat adjustment must be made and documented by the unregistered farmer (not by the registered purchaser) obtaining another invoice or destroying the old one. Failure to do so may leave the farmer liable for the tax involved and for penalties.

Sales by registered farmers to other registered persons are subject to the same requirements as sales by any other registered person.

There are no provisions in the vat law for sales made directly by one unregistered farmer to another. If, however, the sales are of live cattle, sheep, or pigs and are made through a livestock mart or by auction, the seller can be entitled to the flat rate addition, since the mart or auctioneer will normally be a registered trader. Livestock marts, livestock dealers, and livestock auctioneers are deemed for vat purposes to be simultaneously buying and selling live cattle, sheep, pigs, horses, and greyhounds. Sales of live cattle, sheep, and pigs are liable to vat at the effective flat rate.

VAT Rates in Agriculture

By the time the Sixth Draft Directive was submitted to the Council, all the nine member states had determined their own provisions for dealing with agricultural activities (see Table 7-1). Only two of the EC member countries (Denmark and the United Kingdom) do not have a special regime for farmers. In both, farmers are treated the same as all other taxable persons, except that in Denmark they are allowed a longer time than other traders for paying the tax. In both countries this treatment of agriculture seems to work efficiently.

In the other member states, there are flat rate compensation systems which, in effect, mean that while the ordinary farmers may be technically within the vat scheme, they do not have to keep books, issue invoices, or normally furnish vat returns to the authorities. Of course, a flat rate farmer can, if he wishes, opt into the full vat system, but if he does, he must remain in it for a minimum number of years.

Exceptionally in France, the flat rate relief is not given to the farmer by the purchaser of his produce, but by the Government, a procedure that enables the tax authorities to check the accounts submitted by the purchasers of output from farmers. The French farmer submits an annual return; this means he may have the disadvantage that he does not receive any compensation until later than farmers in other EC member countries.

In all countries, specialist farmers, whose activities are primarily of an industrial or commercial nature (for example, growers of flowers in Belgium), are required to register and are treated in the usual way. Apart from Denmark and the United Kingdom, where registration is compulsory for all farmers if sales exceed a fixed limit, only a relatively small proportion of farmers eligible to use the flat rate opted to register in the early years of vat. Indeed, in some countries (for example, Belgium), all farmers must register regardless of turnover, but such registration does not oblige them to make tax returns unless they opt for the full vat system.

Treatment of Agriculture in Other Countries

In general, most vats in Latin America specifically exclude sales by farmers or exempt the first sale of unprocessed agricultural products. Chile is unique as it includes farmers as full registered traders and does not exempt any food from vat.

In addition to the administrative reasons just mentioned, there are other arguments for eliminating farmers from the tax net. In the first place, the products they sell, especially food, are likely to be exempted anyway because they tend to be a large part of the consumption expenditures of the lowest income groups. Equity considerations frequently dictate, therefore, that to mitigate the regressivity of a general sales tax these products should not be taxed (but see discussions in Chapters 3 and 11 showing that this argument is not necessarily correct). If, on the other hand, the products become taxable through processing, or upon resale by merchants, no additional revenue would be gained by bringing even large commercial farmers within the scope of the tax, since full collection through “catch up” will take place at later stages of production or distribution. However, vat collected earlier on farm inputs would not be credited. This is bound to create some cascade element and erode the neutrality of the system. In many countries, much of the farm output is exported and any vat collected at later stages would ultimately be refunded. However, the vat liability on inputs would remain and would put the export at some disadvantage.

So the problem remains, in Latin America as in the EC, of how to prevent multiple taxation of farm products when the farmers buy taxable items and, not being zero rated, are not allowed to claim a refund for the tax paid on purchases.

If the goods the farmer sells are processed further and become taxable, the subsequent processors and distributors receive no credit against their tax liability for the tax element contained in their purchase prices, and this causes cascading. The resulting cumulative effects, by comparison with the high value added by the primary sector, tend to be less significant. In simple peasant agriculture, the purchased inputs may be so small that the vat content can be ignored. Nonetheless, some countries have attempted to meet this problem by allowing subsequent handlers of farm products an arbitrary credit for tax presumed to have been borne by the farmer; this procedure has been followed, inter alia, by Argentina. Admittedly, unless this credit is shifted backward to the farmer through higher payments for his produce, the system does not compensate the farmer for vat paid on his taxable inputs.

Another approach, probably more suited to encourage increases in agricultural production, has been the outright zero rating of agricultural inputs that have no important alternative uses, such as animal feed, seeds, insecticides, and fertilizer. This still leaves an uncompensated vat paid by farmers on purchases of tractors, trucks, fuel, fork lifts, and, indeed, all capital inputs, including buildings. As an alternative, larger farmers could be allowed to register and be zero rated, thereby obtaining a refund of the tax paid on their purchases if the tax element is considered significant enough to warrant adjustments. This could be an important possibility where farming was on a large scale with significant capital inputs. Indeed, in some countries, “agriculture,” which has many of the characteristics of industry (for example, chicken farming, intensive pig farming, market gardening), can be required to be registered as a normal business.

Some countries such as Uruguay distinguish between farmers taxed on their actual income (and these are taxed under VAT) and others taxed on their presumptive income. Those paying income tax on a presumptive income are allowed to offset their vat liability on purchase invoices against their income tax liability. Such tax payments can be made annually or, if preferred, on account monthly.

Moreover, in some countries, agriculture is organized along state or cooperative lines that frequently involve the agricultural organization in extensive manufacturing activity (such as, slaughtering livestock, manufacturing meat and dairy products, plant maintenance, machinery repair and manufacturing, transport, and retailing). Such multiple activities can lead to some complicated demarcation decisions on goods and services liable to different rates of vat. It is clear that the nonagricultural activities have to be separated from the farming activities for the purposes of vat and this may involve many difficult decisions on internal transfer pricing.

Preferred Solutions

As farming becomes more complex and capital intensive, so the value of capital inputs and bought-in services rises. Modern farmers may purchase the services of specialists (sometimes other larger farmers) to plough, sow, spray, harvest, and transport their crops.7 These are basically business services and should be required to register as such.

In general, in more developed economies, as far as possible, the preferred solution is to treat farmers as a business. If their sales are small, they will be exempt under the small business exemption. If they are above the exemption limit, but below the limit that allows special treatment, then either (1) the flat rate compensation can be used or (2) agricultural inputs can be zero rated. Each system has its drawbacks but both relieve farmers of compliance costs. Farms with large turnovers or with the characteristics of commercial undertakings should have to register as full vat traders. Naturally, all farmers should be given the option of registering fully for the normal vat if they wish.

In developing countries, the government policy of encouraging farm production might be served best by a combination of exemption of farm inputs (or perhaps better, zero rating of farm inputs) and optional normal rating for large farmers.

Infrequent sales of agricultural products at the farm gate, or of fish at the house of a fisherman, through direct sales to the consumer at markets or through house-to-house sales, would not be considered to be taxable deliveries and would, therefore, not be subject to vat. Of course, even if a flat rate compensation scheme operated, the farmer would not be able to claim any compensation and neither would his purchaser (who is an unregistered final purchaser anyway). Prices charged at such direct retail sales are presumed to recompense the farmer fully for all costs including vat on inputs; otherwise, why would the farmer voluntarily make such a retail sale? However, if farmers are an integral part of the vat system, they should not be allowed to claim vat on all their inputs but suppress part of their sales; in this case, even their farm gate sales should be accounted for—as is the case in New Zealand. Again, in New Zealand, home consumption by the farmer of his own produce is supposed to be included as an output for VAT—clearly impractical in most countries.

Notwithstanding the zero rating of inputs specific to agriculture, the authorities may come under pressure to compensate smaller farmers for the vat on inputs that remains, such as vat on fuel, vehicles, and machinery. Some concessions may be needed. A scheme could be adopted under which a farmer, whose sales exceeded some very small figure, but who was still too small to be obliged to opt into the full scheme, could apply for repayment of the vat on his inputs. He would have to keep and submit his invoices and make a formal claim. The invoices submitted by claimants would serve as a useful basis for audit when the supplier is visited by an audit team. Provided the qualification levels were fixed sensibly, the administrative burden should not be too heavy as the number of claims would not be large. There could however be a psychological benefit in that small farmers would know that exceptional purchases for their farms would be freed from the input tax burden. It would have to be made clear that farmers must expect to bear the input tax up to some minimum amount as the price of escaping the burden of bookkeeping for vat.

A 1973 survey in the Netherlands estimated that under 3 percent of farmers kept accounting books in France, Italy, Ireland, and Austria, whereas over 80 percent kept books in the Netherlands and the United Kingdom.

See European Community, Sixth Council Directive, which defines a “Farmer” as being a taxable person who carries on an agricultural, forestry, or fishing undertaking considered to be such by the member state within the framework of a list (in Annex A to that Directive). The list of agricultural production activities is as follows:

  • I. Crop Production

    • General agriculture, including viticulture.

    • Growing of fruit (including olives) and of vegetables, flowers, and ornamental plants, both in the open and under glass.

    • Production of mushrooms, spices, seeds, and propagating materials, nurseries.

  • II. Stock Farming Together with Cultivation

    • General stock farming

    • Poultry farming

    • Rabbit farming

    • Beekeeping

    • Silkworm farming

    • Snail farming

  • III. Forestry

  • IV. Fisheries

    • Fresh water fishing

    • Fish farming

    • Breeding of mussels, oysters, and other mollusks and crustaceans

    • Frog farming

  • V. Where a farmer processes, using means normally employed in an agricultural, forestry, or fisheries undertaking, products deriving essentially from his agricultural production, such processing shall also be regarded as agricultural production.

García Azcárate (1986, pp. 139–40).

See European Community, Eighth Council Directive.

See European Community, Twentieth Council Directive.

In Luxembourg, Ireland, and in some states in Germany, the farmer himself issues the invoices.

A partial list of such services from the Sixth Directive is as follows:

—field work, reaping and mowing, threshing, baling, collecting, harvesting, sowing, and planting

—packing and preparation for market, for example, drying, cleaning, grinding, disinfecting, and ensilage of agricultural products

—storage of agricultural products.

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