Introduction

Several leading forms of VATs in OECD countries can be identified. This chapter describes the main VAT variants. The most influential is the harmonized VAT in the European Union (EU) member states. The EU model has the most extensive case law on VAT issues.

New Zealand departed from the EU model in a number of significant ways, including the expansion of the tax base for its Goods and Services Tax (GST) by limiting exemptions and zero-rating and by taxing many government services. South Africa modeled its VAT after the New Zealand GST but included some of its own unique features. For example, South Africa taxes all fee-based financial services. Australia’s GST is also inspired by the New Zealand model, but there are significant departures.

Japan departed from the EU model by requiring registered firms to calculate periodic tax liability in a different fashion. Under the Japanese Consumption Tax (CT), taxable i rms are not required to issue VAT invoices, which represent a central feature of other VAT regimes.

Canada has a national VAT (known as GST) and several provinces have harmonized VATs. The combined Quebec-national GSTs are administered by Quebec. The combined national and provincial HSTs (the Harmonized Sales Tax) are administered at the national level.

Allowance of Credit – General Rules

Under the credit or invoice VAT used almost universally, tax liability for each period is calculated as the difference between the tax chargeable on taxable sales (output tax) and tax charged both on taxable purchases and on taxable imports (input tax credit). Some credit-invoice VATs are worded so that the input tax is deducted from tax on taxable sales (output tax). In this book, input tax credit and input tax deduction are used interchangeably to mean the subtraction of input tax from output tax.

Unlike an income tax imposed on an income base that requires capital goods to be capitalized and depreciated and beginning and ending inventories to be taken into account in determining gross income from sales, VATs typically are consumption-based taxes that allow an immediate input credit for tax imposed on purchases of capital goods and inventory items. There are some exceptions discussed in this chapter.

The EU VAT Directive contains extensive rules on the availability of input tax credits (which the Directive refers to as deductions). An input credit is available for tax on purchases of goods or services, imports of goods, or certain taxable self-supplies if these items are used for purposes of taxable transactions. Taxpayers may engage in tax-motivated transactions in an attempt to convert assets used in making exempt supplies into assets used in making taxable supplies.

Introduction

For VAT purposes, most countries lump together insurance and financial services rendered by financial institutions. The typical pattern is to include insurance within the definition of exempt financial services. There are some exceptions.

Israel does not tax insurance under its VAT. Rather, it taxes insurance companies under a system administered by the income tax department. The Israeli tax is calculated under an addition method that includes wages and profits in the tax base and does not allow any deduction for VAT paid on business inputs. In effect, Israel imposes tax on the full value of insurance services.

New Zealand taxes insurance other than life insurance under its GST. South Africa and several other countries follow the New Zealand pattern of taxing the value added by property and casualty insurance companies, on the basis of the margin between premiums received and claims paid.

Timing (or tax accounting) rules are used to identify the tax period in which a taxpayer must pay tax on imports, report taxable sales, and claim deductions or credits for tax paid on allowable imports and domestic purchases. When a VAT is introduced or the rate is changed, effective date and transition rules are needed to identify which sales and purchases are subject to the old rules and which to the new or amended law.

VAT generally is imposed on the sum of the amount of money and the value of non-monetary consideration received for a taxable supply. Special valuation rules are provided for particular transactions. This chapter covers the timing, transition, and valuation rules.

The Timing Rules

Accrual, Hybrid, and Cash Methods – in General

This section discusses the rules governing the basic methods of accounting for VAT. It does not discuss the innumerable varieties of special schemes for retailers that are available in many countries.

Most taxpayers must use the accrual or a hybrid method of accounting to report sales and claim input credits under a credit-invoice VAT (like the European VATs). Under the accrual method, taxpayers generally report taxable sales when goods are sold or when services are rendered, subject to rules accelerating the reporting, and they claim input credits when the business acquires the goods or services eligible for the input credits.

Thanks to our students at Wayne State, Duke, Michigan, and Sydney law schools for their contributions to the revision of this book. Thanks to Deans Robert Ackerman and Jocelyn Benson and Wayne State University Law School and to Virginia Thomas, Director of the Wayne Law Library, and her staff, particularly Michael Samson, for the support that made this revision possible. Thanks to Richard Ainsworth and the two anonymous readers who made helpful suggestions on how we could improve this edition of the book. Thanks to Yimin Kou for discussions of the material in Chapter 14. Thanks to Zainab Sabbagh Hazimi for her helpful research assistance. Thanks to Olive Hyman for her assistance with various aspects of the manuscript. Thanks to John Berger, our editor at Cambridge University Press, and our project manager, Nishanthini Vetrivel, for their help in the process of converting our manuscript to final text.

The cutoff date for this book generally was December 31, 2013, although we have included some material published after that date. In particular, we included some European VAT Directives and Court of Justice cases. This book is not intended to be exhaustive. It therefore does not include all significant cases in all countries or even all English-speaking countries. It is designed to illustrate, analyze, and explain the principal theoretical and operating features of value added taxes, including their adoption and implementation.

Introduction

As with any tax, the VAT presents opportunities for tax avoidance and evasion. While some specific areas where avoidance and evasion occur have been discussed throughout this book, this chapter focuses on evasion and avoidance more generally. We use the standard terminology, with tax evasion meaning illegal behavior (usually involving fraud or concealment of facts from the tax administration) and tax avoidance meaning behavior that follows the letter but not necessarily the spirit of the law.

Avoidance

VAT avoidance transactions can take a number of forms. For example, a taxpayer may attempt to split a supply into several parts, some of which are exempt or zero-rated. A taxpayer carrying out both exempt and taxable supplies can carry out transactions aimed at manipulating the allocation of inputs to taxable supplies. If certain favorable treatment (e.g., the registration requirement or, as in the Ch’elle case discussed later, the requirement to use the accrual method) is based on a threshold amount of supplies, a taxpayer might fragment its business, so that each part of the business falls below the threshold.

To counter tax avoidance, the tax authority must of course first identify the tax avoidance transactions that it considers questionable. Although this takes some care, it is generally easier than uncovering tax evasion, because by dei nition tax avoidance does not involve the misstatement of facts or their willful concealment from the authorities. If that happens, then one enters the realm of tax evasion.

General Introduction

There are a group of services that pose particular problems under a credit-invoice VAT imposed on taxable transactions. They are gambling, transactions involving financial products that are priced to include implicit fees, and insurance (a particular kind of financial service). In all three cases, the value added by the service provider should be subject to a broad-based VAT, at least to the extent that it represents personal consumption expenditures. When early transaction-based, credit-invoice VATs were introduced in Europe and elsewhere, these kinds of services were difficult to include in the tax base because the credit-invoice VAT is based on charging tax on the consideration received by the supplier. For most financial services, the consideration is not explicitly stated. Moreover, financial services accounted for a much smaller percentage of personal consumption included in the VAT base than they do today.

Accordingly, it is not surprising that the default rule in early adopters of VAT was to exempt these services. Recently, some countries have been bringing gambling, more financial services, and casualty insurance into the VAT base. Many problems remain.

Gambling, Lotteries, and Other Games of Chance

In a typical transaction involving goods or services, a registered person remits to the government the difference between the tax on the price charged the customer and the tax on business inputs (such as inventory and supplies) used in making these sales. In a gambling transaction, whether a table game, a gaming machine, or a lottery, the gambler pays for the service (the chance to win) up front, and the value added cannot be calculated precisely until after winners are determined and winnings are paid out.

Scope of Book

The value added tax (VAT) has spread around the world more quickly than any other new tax in modern history. This book covers value added tax and, in some parts, other consumption taxes in use or proposed in developing and developed countries.

Tax on consumption generally refers to a tax on final consumption, consisting mainly of goods and services acquired by individuals for their personal use or satisfaction. It generally does not include business inputs (goods and services used by business in the production or distribution of goods or in the rendition of services).

It is difficult for a business to operate internationally without considering the implications of sales tax or value added tax, whether or not the company’s country of residence has a broad-based tax on consumption. For example, the United States does not have a sales tax or value added tax, except at the state and local levels of government. Nevertheless, a U.S. business operating in, shipping goods or transferring intellectual property or providing or receiving services to and from other countries must consider the VAT implications of exports to or imports from those countries.

This book explores value added and other consumption tax principles from a comparative perspective. We hope that this study may lead to suggestions for improving existing VAT systems and designing new ones. We discuss VAT in the Member States of the European Union (EU), and explain major departures from the EU model in non-European countries (especially in New Zealand, China, Japan, and South Africa).

Introduction

Almost all national-level (central-government) VATs rely on the destination principle to tax international transactions, with tax imposed on imports and removed from exports. The adoption at the subnational level of some form of VAT (see Table 2.7 for a review of the forms) is being debated or enacted in many countries. There has been renewed interest in the problems of cross-border trade in the EU and within federal systems, especially in Canada, India, Brazil, and the United States. In addition to the long-standing problems faced by the EU and federal countries with cross-border trade, some of the recent attention to these issues has been propelled by the explosion of trade over the Internet (electronic or e-commerce). Indeed, the US Congress enacted a moratorium on subnational (state level) taxes on Internet access and on multiple or discriminatory taxes on e-commerce.

Subnational units of government should control the revenue necessary to provide the services that they render. In any federal system, the fiscal authority and responsibility of subnational (referred to in this chapter also as regional) units of government must be established. To possess ultimate fiscal autonomy, subnational units of government should have the authority to choose the taxes to be levied, define their tax bases, set their tax rates, and administer the taxes they impose, but these elements can also be shared with national government.

Introduction

In 2013, the VAT in China yielded approximately the equivalent of USD 500 billion for the government, making it very likely the largest VAT in the world in terms of the dollar value of revenue generated. It is, however, not normally regarded as a paragon of VAT design and is perceived not only by international experts but also by Chinese tax policymakers and commentators themselves to be inferior to the VAT regimes adopted in advanced economies. The Chinese government has continuously attempted to “improve” its VAT in the last two decades, sometimes in part (but only in part) to make it conform more to common international practice. In this chapter, we present select aspects of the Chinese VAT, giving special emphasis to those features of it that contradict the normal recommendations for VAT design. We do this for three interrelated reasons.

The first is that many developing and middle-income countries and many transitional economies heavily rely on the VAT for revenue generation. Many of them have “imperfect” VAT systems relative to policies recommended by standard public finance theory and practices adopted in developed countries. However, from a comparative perspective, these systems (especially those found in large countries like China, India, and Brazil) are important in an obvious sense: they shape the understandings of large populations of taxpayers, tax professionals, and tax administrators about what the VAT is. For example, as discussed in this chapter, Chinese VAT taxpayers and tax administrators are accustomed to the fact that no refund for excess input credit will ever be given for domestic supplies. (The difficulty of issuing VAT refunds will resonate as a critical issue for those dealing with VATs in many, if not most, developing countries.) They also seem content with the absence of the concept of economic or business activity, supposedly central to the VAT laws of other countries. Relative to conventional portrayals of the VAT, these and other features of the Chinese VAT look quite unusual. However, it is useful for our comparative study to reflect some of this diversity of VAT law and design. Moreover, we may conclude, after careful analysis, that some of the supposedly “inferior” features of an impure VAT do not make enough of a difference in practice.

Introduction to International Trade

For most countries with VATs, international trade is a significant component of their economies. A country with a VAT must define the jurisdictional reach of the tax. Should the tax reach global supplies or should it be limited to supplies within the country’s territory? Whether global or territorial, should the tax be imposed on production within the country (an origin principle VAT), on domestic consumption (a destination principle VAT), or some combination of the two? Almost every country with a VAT imposes a territorial VAT that relies on the destination principle to define the jurisdictional limits of the tax. Under a pure destination principle, imports are taxed and exports are completely free of tax (zero-rated). With this system, it is important to identify the value of goods and services that are exported (and when they are exported) and identify the value of taxable imports and determine when they are taxable. This chapter discusses the rules that determine where a supply takes place, including the troublesome issues on cross-border transactions relating to the place where services are rendered and intangibles are supplied.

The location or place of the supply of cross-border services has become more significant with the advent of electronically supplied services. If the place of supply rules applicable to the sale of goods and those applicable to the sale of services differ, the supplier must determine whether the sale is of goods or services, and this may be more difficult in the case of electronic commerce. For example, if computer software, music, and videos are transmitted by electronic signals rather than in compact disks or other physical form, is the transaction a sale of goods or a sale of services? Sales of standard packaged software have been treated as sales of goods, but sales of customized software have been treated as sales of services.