By Jan Schwartz and Andreas Cremer
HAMBURG/BERLIN (Reuters) - Volkswagen can bounce back from the scandal over its rigging of diesel emissions tests in two to three years, its new CEO predicted on Thursday, as the carmaker outlined plans to recall 8.5 million affected vehicles in the European Union.
Matthias Mueller, who took the helm last month after Europe's biggest automaker admitted to cheating U.S. diesel emissions tests, said the German company needed to give more power to its brands and regional operations while working to get to the bottom of the biggest business scandal in its history.
"We have a good chance of shining again in two to three years," he said in a speech to Volkswagen managers in Leipzig.
Volkswagen has said up to 11 million vehicles worldwide could contain banned software that allows them to know when they are being tested and temporarily reduce toxic emissions.
The German company said on Thursday it would recall around 8.5 million vehicles affected in the European Union following an order from Germany's KBA automotive watchdog, which is taking the lead for other national EU regulators.
Volkswagen had said previously there were around 8 million vehicles affected in the EU. A spokesman said it was recalling a further 500,000 "voluntarily," but did not know whether they might also contain the cheat software.
The KBA said the recall, involving 2.4 million vehicles in Germany, should start at the beginning of next year and would be mandatory, meaning drivers do not get to chose whether or not to bring in their cars and vans for servicing.
A recall of all 11 million vehicles would be among the biggest in history by a single automaker, similar in scale to Toyota's 2009-2010 recall of more than 10 million vehicles over acceleration problems, though dwarfed by the number recalled by multiple carmakers due to faulty Takata air bags.
Some analysts have said the scandal could cost Volkswagen as much as 35 billion euros ($40 billion) to cover vehicle refits, regulatory fines and lawsuits.
Prosecutors in Italy said on Thursday they were investigating local managers at Volkswagen and its Lamborghini sports car business for alleged fraud. [ID:nL8N12F2LA]
Nearly four weeks after it publicly admitted to rigging U.S. emissions tests, Volkswagen is under pressure to identify those responsible. It has been criticised by politicians, investors and consumers for the time it is taking to produce answers.
Two people familiar with the matter said on Thursday the company had suspended Falko Rudolph, who oversaw the development of diesel engines between 2006 and 2010, as part of its investigation into the wrongdoing, which has already seen three top engineers suspended.
FUTURE OF DIESEL
The scandal has wiped around a quarter off Volkswagen's stock market value, forced out its long-time CEO and rocked the global auto industry and German establishment.
"We will significantly streamline structures, processes and (decision-making) bodies. We must become leaner and take decisions more rapidly," Mueller said of his recovery plan.
"Our competitors are only waiting for us to fall behind on technology matters because we are so preoccupied with ourselves. But we won't let that happen," he added.
German Environment Minister Barbara Hendricks said on Thursday the government should think about ending tax breaks for diesel cars and promoting electric ones, though she later said higher taxes for diesel vehicles were not on the agenda.
Tax breaks have given a big boost to diesel vehicles in Europe, where they account for about a half of sales compared with just a small fraction in the United States. Abolishing them could have business implications for European carmakers including Renault, Peugeot and Fiat, as well as Volkswagen.
France said on Wednesday it planned to reduce a tax break on diesel fuel.
German Transport Minister Alexander Dobrindt said the KBA had given Volkswagen until the end of the month to come up with a plan for a software fix needed for 2.0 litre vehicles affected by the recall.
The carmaker has until the end of November to come up with a technical solution for 1.6 and 1.2 litre vehicles, he added.
Volkswagen has said it aims to complete a refit of all affected vehicles by the end of 2016, with some requiring more complex and expensive changes to hardware.
Germany had previously said 2.8 million Volkswagen vehicles were affected by the scandal in the country. Dobrindt said only 2.4 million needed to be recalled because the other 400,000 were no longer on the roads. He reiterated the affected vehicles were safe and could be driven as normal.
($1 = 0.8738 euros)
(Additional reporting by Caroline Copley, Michael Nienaber and Sara Rossi; Writing by Maria Sheahan and Mark Potter; Editing by Giles Elgood and Anna Willard)
