Applicability of reduced VAT rates

In our previous newsletter – in which we analysed the relevant report of the European Commission – we presented in detail the VAT rate differences that continue to exist among Member States within the European Union’s harmonised VAT system. Recently, however, there has once again been growing interest in the possibility of deviating from Hungary’s standard 27% VAT rate for certain types of transactions. In this newsletter, we therefore examine the cases in which Council Directive 2006/112/EC on the common system of value added tax (hereinafter: the “VAT Directive” or the “Directive”) allows the application of reduced VAT rates, which of these options have already been used by the Hungarian legislator, and in what directions the scope of reduced VAT rates may be modified within the framework of the Directive.

EU Rules on VAT Rates and Hungarian Reduced VAT Rate Categories

As a general rule, the VAT Directive distinguishes between the following VAT rate categories:

• Standard VAT rate: Member States are required to apply a standard VAT rate of at least 15%.

• Reduced VAT rates (minimum 5%): Member States may set up to two reduced VAT rates of at least 5%, which may be applied to the supplies of goods and services listed in Annex III of the Directive.

• Super-reduced VAT rate (below 5%) and exemption with the right to deduct: Member States may also set a reduced rate below the 5% minimum, or an exemption with the right to deduct, but only for the categories of goods and services expressly specified by the Directive (for example, medical products).

In line with these framework rules of the Directive, the Hungarian legislator has introduced not only the standard 27% VAT rate but also the reduced VAT rate categories available under the general rule: Hungarian legislation therefore distinguishes three main preferential VAT rate groups – the 18% and 5% reduced VAT rates, as well as exemption with the right to deduct.

Under the currently effective Hungarian legislation, the following goods and services fall into these categories:

18% VAT rate

• Goods: milk and dairy products (yoghurt, kefir, cheese, butter, etc.); certain bakery products and cereal-based foods; dessert-type cheese products.

• Services: admission to occasional outdoor events (music and dance events).

5% VAT rate

• Goods: medical products and medical aids; certain animal products (meat, fish, eggs, fresh milk) and live animals; books, publications and their electronic versions; newly built residential property (up to specified floor area limits), and in specific cases passenger transport services by bus.

• Services: district heating services; restaurant catering services; internet access services; commercial accommodation services; live instrumental music services (within a specified scope).

In addition, the 0% VAT rate with the right to deduct currently applies only to daily newspapers.

At the same time, legislation introducing a 0% VAT rate with the right to deduct for prescription medicines is currently in progress, which was covered in more detail in our previous newsletter. In addition, a legislative amendment is also being prepared that would allow the application of the 5% VAT rate to the sale of firewood.

Taking into account the reforms introduced by Council Directive (EU) 2022/542 and applicable from 1 January 2025, Annex III of the Directive lists a total of 32 categories of goods and services for which Member States may apply a reduced VAT rate. For 24 of these categories, the application of a reduced VAT rate of at least 5% is permitted, while for a further 7 special categories Member States may even introduce a VAT rate below 5% or a 0% VAT rate with the right to deduct.

European Trends and Possible Directions for Expansion

When considering a potential expansion of the categories subject to a reduced VAT rate, it is worth examining in which areas and in what directions EU Member States currently use the flexibility provided by the Directive. Below, we review the two most prominent trends – green economy incentives and expansions aimed at social and welfare objectives.

1. Sustainability

Renewable energy and energy investments

One of the most significant innovations of the 2022 reform of the Directive is that Member States were given the possibility to apply preferential VAT treatment to products and services related to the installation of solar panels and energy-efficient systems. Accordingly, certain Member States use VAT incentives built into their VAT systems as targeted green incentives, in line with EU climate and energy policy objectives.

Public transport

There are also examples in the European Union of a reduced VAT rate for scheduled passenger transport. The logic behind this incentive is twofold: on the one hand, it reduces the related burden on consumers and thereby shifts demand from private car use towards public transport; on the other hand, it also generally supports lower-emission modes of transport.

 2. Social and Welfare-Oriented Categories

Food products

Annex III of the Directive provides broad flexibility for the differentiated application of reduced VAT rates to food products, ranging from basic products to food categories that are particularly important from a social policy perspective. Member States typically use this option to reduce consumer prices and ensure access to basic food products that should be supported for public health policy reasons.

Cultural and leisure events

The Directive identifies a wide range of cultural events and venues – including museums, cinemas, exhibitions and zoos – as possible subjects for the application of a reduced VAT rate. Many Member States have made use of this possibility; however, Hungarian legislation applies this preferential treatment within a narrower scope: in the cultural category, currently only live instrumental music services are subject to the 5% reduced rate, while admission to occasional outdoor music and dance events is taxed at the 18% reduced rate.

Residential property

The Directive specifically refers to housing transactions “defined by a Member State as being part of a social policy” as eligible for a reduced VAT rate; however, Member States may interpret this concept flexibly. This interpretative flexibility makes it possible to extend the preferential scope beyond new construction to residential property renovation, energy-efficiency upgrades and certain rental transactions.

Hungarian legislation currently makes use of this possibility within a narrower scope: a 5% VAT rate applies to the sale of newly built residential properties – up to a total usable floor area of 150 m² in the case of multi-apartment buildings and 300 m² in the case of single-family residential properties – but this preferential treatment generally expires on 31 December 2026. An exception applies to newly built residential properties of up to 150 m² located in designated brownfield action areas, for which the reduced rate is applicable for an indefinite period.

Catering and food services

The Directive’s wording “restaurant and catering services” also covers a broader interpretative scope than the concept of “restaurant catering services” currently used in Hungarian legislation and linked to TESZOR codes. This preferential category could even include workplace catering, such as the concession-based operation of canteens.

Energy products

Furthermore, until 1 January 2030, a reduced VAT rate may also be applied to the supply of natural gas in line with the Directive, providing an opportunity to reduce consumer prices.

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Based on the above, it can be concluded that the application of reduced VAT rates is not merely an economic policy instrument based on the free discretion of Member States, but a possibility that can be exercised within strict EU frameworks. The VAT Directive sets out in detail the categories of goods and services for which a reduced VAT rate may be applied, as well as the extent to which and the number of cases in which deviations from the standard VAT rate are permitted.