Introduction

A direct tax on individuals that is measured by their level of consumption rather than their income is commonly referred to as a cash-flow or consumption-based income tax. Most taxes on consumption are indirect taxes. These taxes are collected by sellers of taxable goods and services and are expected to be borne by final consumers of those goods and services. The indirect tax on consumption may take the form of a single-stage tax such as the retail sales tax or a multistage tax such as a value added tax.

A value added tax is a generic name associated with a multistage tax that is levied on the value added by each business firm at every stage of production and distribution of goods and services. In part, the description of a VAT depends on the method used in calculating tax liability. In this chapter, there is a discussion of the addition, sales-subtraction, and credit-subtraction methods of calculating VAT liability.

The legislature may alter a VAT base by removing some sellers or somegoods and services. This alteration of tax base is accomplished by providing an exemption for designated businesses (such as small businesses) or entities, such as units of government or nonproi t organizations. The legislature also can alter the tax base by granting exemption or altering the rate for particular goods and services, regardless of the nature of the seller. This chapter also discusses these various methods of providing special treatment under a value added tax.

Introduction

Most VAT regimes impose VAT on a supply only if it is for consideration, and there is a clear connection between the supply and that consideration. This chapter first examines the question, what is a supply for VAT purposes? It explores notions of supply, consideration, and the required link between a supply and the consideration received by the seller.

A sale for a single price may incorporate elements of multiple supplies that are taxed differently. For example, a portion of the supply, if independent, is taxable at a positive rate, and another portion, if independent, is exempt from tax. It is significant for VAT purposes if the transaction is respected as a single supply of these two components or is treated as two separate supplies. A major part of this chapter therefore focuses on resolving the perplexing question, what is “the supply”? In some cases, the VAT legislation and case law may draw a distinction between mixed supplies (with main and incidental elements) that are classified as a single supply of the main element and composite supplies that can be disaggregated and classified as multiple independent supplies.

Finally, a VAT invoice containing required information and issuable only by registered persons is considered central to a European-style invoice VAT. Some aspects of the VAT invoice are discussed in this chapter.

Introduction

One of the most complicated problems in designing a VAT base involves the taxation of real (immovable) property. Although in a sense real property is no different from many goods, in practical terms its extremely long life presents a number of difficulties.

If an economically idealized VAT base were envisaged, it would consist of personal consumption. Most goods and services are consumed shortly after purchase. For these, there is not much difference between this ideal “economic” tax base and the “legal” tax base as defined in VAT laws, namely, the value of goods and services supplied to final consumers. For real property, however, personal consumption takes place over many years (the same is true for other consumer durables). One way of reconciling the legal tax base with the economic ideal is to reason that taxation at the time of first sale of residential real estate is a form of up-front taxation of the consumption value – that is, the legal tax base corresponds to the economic tax base in present value terms. However, the equivalence ceases to hold if the price of the property changes after its initial acquisition. One of the questions that has concerned VAT policy analysts is whether this suggests that there is something wrong with how residential real property is taxed, if tax is imposed only at the time of acquisition. As will be discussed further, it turns out that the answer is not as obvious as some might think.

Introduction

Most VAT regimes require registered (or taxable) persons to file returns and remit tax. In most cases, a firm is required to register if it makes or expects to make at least the statutory minimum level of annual taxable sales in connection with its business or economic activity.

Not all sales by a person come within the scope of a VAT. For example, in most countries, an individual’s casual sales do not constitute taxable business activity and are not taxed. Hobbies and similar activities that do not rise to the level of a “business” generally are not taxed. An employee could be treated as a person rendering taxable services to her employer and therefore a VAT taxpayer, but no country has done this. This chapter discusses registration (including some required registration by nonresidents), who is liable for tax, and what economic activity subjects a seller to tax under various VAT regimes.

Registration

In General

Registration is part of a self-assessment VAT system that typically is reinforced with harsh civil and criminal penalties for noncompliance. Many VAT systems dei ne a taxable person subject to the VAT rules as a person who is registered (a registrant) or is required to register. Nonresidents without a fixed location in the country may be subject to a different set of rules. The registration requirement generally is imposed on a person or firm that makes at least a threshold amount of taxable sales.

Introduction

This chapter covers exemptions and zero-rating. As discussed in more detail in Chapter 2, an exemption may be an “item” exemption limited to particular supplies of goods or services or an “entity” exemption applicable to all or most supplies by a particular kind of entity. Zero-rating generally is provided for exports of goods (regardless of the nature of the goods exported) and exports of some services. In the case of supplies by a unit of government or nonprofit organization, an exemption may be provided for all supplies, restricted to certain supplies on the basis of the nature of the goods or services supplied, or provided for all supplies except those that compete with the private sector.

The next two parts of this chapter cover zero-rating and exemptions, with attention focused on the complexity resulting from borderline cases involving “item” exemptions or “item” zero-rating. Sections IV and V discuss cases in which two or more items with different VAT consequences are bundled to obtain the desired tax treatment and A-B-C transactions in which an upstream supplier wants to integrate its supply with a downstream supply to obtain the VAT treatment of the downstream supply. Section VI of this chapter discusses some of the special VAT problems associated with the nonprofit and governmental sectors and proposals to include more services by these sectors in the VAT base.