EU in deadlock over move to retain lower VAT rates

A deal to retain lower VAT rates across Europe for business was in the balance last night after the new German coalition government threatened to veto the move.

Finance ministers yesterday failed to break a two-year deadlock on extending the reduced rates for services such as hairdressing and window-cleaning in nine EU states after current arrangements expire on December 31.

Amid claims that imposing the minimum rate of 15% would cost 200,000 small business jobs the issue was handed over to next week's EU summit, already beset by the impasse over the budget and Britain's rebate.

The issue has assumed emotional resonance in France where President Chirac offered to cut VAT on restaurant bills from 19.6% to 5.5% during his 2002 election campaign to boost tourism. Angry chefs staged demonstrations at his failure to deliver on his pledge.

But Peer Steinbrück, German finance minister, said he had no plans to change the government's stance that there should be no exceptions to the general taxation rules. He won backing from Austria and Denmark. The german government, headed by Chancellor Angela Merkel, plans to raise normal VAT from 16% to 19% to stave off a budget crisis and avoid fresh EU proceedings for breaching the 3% deficit limit. It has broken the limit for the past four years.

Thierry Breton, the French finance minister, said most governments wanted a deal and a decision could be put off until January. Sources said Mr Chirac is counting on Franco-German solidarity to persuade Ms Merkel to give way. Gordon Brown, who chaired the meeting, said: "We are very close to an agreement and we think there is a good chance of reaching one in the council next week." Ministers have agreed that countries extending reduced VAT rates beyond the January 1 cut-off date will not face legal action.