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How VAT took over the tax world

Value-added taxes and goods and services taxes should be broad-based and integrate a long-term perspective to be effective.

By Gerri Chanel

Value-added tax is continuing to evolve and expand as new systems roll out and existing ones adapt to digital disruption and other forces.

In the six decades since the value-added tax (VAT) first made its debut in France, this broad-based consumption tax has spread rapidly across the globe. 

Governments are fond of VAT and its cousin, the goods and services tax (GST), for many reasons. The levies are considered one of the least harmful taxes for economic growth and can raise large amounts of revenue because they apply to a significant proportion of economic activity.

"One of the biggest issues we had was businesses that did not prepare early enough in terms of systems testing and training."

Dato’ Sri Subromaniam Tholasy, Director General, Royal Malaysian Customs Department


According to the Organisation for Economic Co-operation and Development (OECD), some 166 countries operated VAT or GST in 2016 – twice as many as only 25 years ago. Many countries have had a VAT or GST system for decades. Other jurisdictions are recent adopters, such as Malaysia and Tanzania (2015), Egypt (2016), India (2017) and Member States of the Middle East’s Gulf Cooperation Council (2018).

Today, VAT and GST continue to expand and evolve as new systems roll out and existing ones adapt to the implications of digital disruption and other forces. This transformation has consequences for businesses, which must adequately prepare for new VAT and GST rules and procedures, and update their technology to comply with new e-filing requirements. 

Early bird

Countries planning to introduce a new VAT or GST system should keep in mind that a well-planned transition is important. The introduction of such a tax requires adequate administrative capacity, training and technology on the part of both businesses and the government. 

“There’s typically a broad public education program, as well as a lot of publicity about the resources that will be attached to enforcing the tax,” says Alan Schenk, Distinguished Professor at Wayne State University Law School in Detroit, who drafted VAT legislations for numerous Caribbean and African countries.

"In the EU, making changes is particularly difficult because all the countries need to agree unanimously on the change."

Christopher Heady, Professor of Economics, University of Kent


Royal Malaysian Customs Department Director General Dato’ Sri Subromaniam Tholasy says that it’s critical for businesses to start preparing for new VAT and GST systems far in advance. 

“One of the biggest issues we had was businesses that did not prepare early enough in terms of systems testing and training,” Subromaniam Tholasy says.

“Some companies left the implementation to the finance and accounting staff, but it requires much broader involvement. People from the sales and marketing sides also need to be involved since, for example, agreements may need to be renegotiated. It was also our experience that many small- and medium-sized businesses waited until the last minute, then had issues when it came to filing.” 

Lessons learned

VAT and GST systems should be broad-based and take a long-term rather than short-term view to be effective. Many jurisdictions have learned the hard way that if their initial VAT and GST system exempted too many items or entire economic sectors, it is hard to eliminate those exemptions later. 

The task is made even more difficult when multiple jurisdictions require consensus to alter what is subject to tax, as is the case with the European Union (EU).

“In the EU, making changes is particularly difficult because all the countries need to agree unanimously on the change,” says Christopher Heady, Professor of Economics at the University of Kent in the UK and former head of the OECD’s Tax Policy and Statistics division.

“Many people think there are things wrong with it, but there’s not a great deal of optimism that much can be done about them.”

Nevertheless, the EU’s VAT system is moving forward in other ways. “There are multiple ongoing EU discussions regarding VAT issues, including certain VAT obligations for supplies of services and distance sales of goods, administrative cooperation, and a system for intra-community supplies of goods between taxpayers,” says Jenny Netterström, Business Developer at the Swedish Tax Agency (Skatteverket).

"The Immediate Submission of Information (ISI) program … will undoubtedly allow us to provide better service to businesses as well as reinforce control actions."

Rufino de la Rosa, Director, The Department of Tax Management, Spain


Since eliminating exemptions often proves difficult or impossible, jurisdictions often turn instead to raising rates. Since the start of the financial crisis in 2008, worldwide VAT and GST rates have risen rapidly, with the standard rate hitting a high of 27% in Hungary. The trend has now slowed down, however, and as economic conditions improve, some jurisdictions are lowering their standard rates. 

Heady says that the lesson for countries launching a new VAT and GST system is to start with as few exceptions and reduced rates as they can possibly manage.

Some countries have managed to implement this type of broad-based tax, generally referred to as a modern VAT, says Schenk. “This approach started in New Zealand (1986), then was picked up by Canada (1991) and in a number of the new VATs around the world,” Schenk says. 

Another lesson a number of countries have learned is to avoid lists of specific items to be taxed, according to Heady. Similarly, single rates are preferable. Otherwise, tax administrations may be forced to debate how new products or services should be taxed. 

“In the UK, most food and many beverages are zero-rated but soft drinks are subject to the standard VAT rate,” says Heady. “In one dispute, smoothies were an issue. Are they a food or a soft drink? How much fruit does there have to be in a smoothie for it to be a food and not a soft drink?”

Immediate information

VAT and GST compliance and administration is rapidly becoming digital — from the collection of taxpayer data to the process of audits and inspections. Most tax authorities now require electronic filing of periodic VAT and GST returns and increasing numbers of tax authorities allow or require the use of e-invoicing for VAT and GST accounting.

This is a useful tool for businesses, as e-invoices generally cost significantly less to produce and process than printed documents. E-invoices can also provide a useful source of data for tax administrations and a more transparent audit trail.

In 2015, Sweden and other EU Member States introduced a new program for the reporting and payment of VAT, called the VAT Mini One Stop Shop (VAT MOSS). The VAT MOSS regime is a program that has provided administrative relief from the compliance burden.

It allows suppliers to register online, file VAT returns and pay the VAT to a single Member State. This is one of the first tax systems in Sweden in which officers are working in a fully digital environment using email as the only method of communication, says Netterström. 

In increasing numbers of countries, such as Brazil and China, taxpayers now submit detailed transactional information directly to the tax administration. Tax authorities are also beginning to demand the transmission of information on a real-time or near-real-time basis.

Spain’s pioneering near-real-time reporting regime came into effect in July 2017. Rufino de la Rosa, Director of Spain’s Department of Tax Management, reports that the process is going well.

Rufino de la Rosa, Director, The Department of Tax Management, Spain

Image: James Rajotte

“The Immediate Submission of Information [ISI] program gives us immediate information on the companies’ invoicing, providing a control system for the actual development of the transactions performed, which in turn will undoubtedly allow us to provide better service to businesses as well as reinforce control actions,” de la Rosa explains. 

De la Rosa says that despite initial concerns, all business sectors have shown a commitment to comply with the new rules, although some entities had some difficulty, such as non-established operators or international groups, in which decision-making takes place at the group level. 

Even in these cases, however, “companies have been able to meet the requirements and count on the support provided by the tax agency, both to clear any implementing doubts and facilitate the supply of information,” de la Rosa says.

Going forward, de la Rosa says that the next milestone is allowing businesses to know what their customers and suppliers have reported about their operations. “And in 2018, as a preliminary step to the eventual preparation of a draft VAT return, we are designing a taxpayer-friendly environment that will allow companies to see, in an aggregated manner, the information in the VAT register book that was submitted to the ISI.”

Digital threats

While digitalization is giving tax authorities faster and better information, it is also creating new challenges in the area of VAT and GST.

For example, the gross turnover that a large business generates using its employees is subject to VAT. But in the so-called gig economy, many of the newly self-employed may have such low turnover that they will not meet the VAT threshold in most countries. This, in turn, causes revenue loss to governments, according to Heady. 

Cross-border trade is another challenge, especially when it comes to services. The rapid increase in digital services provided directly to consumers — from telecommunications to cloud services
to online subscriptions — is challenging the fundamentals of how and where VAT and GST applies.

Since nonresidents generally fall outside a jurisdiction’s VAT and GST tax system and it is difficult to collect the tax from final consumers, many countries now view these new services as a significant threat to indirect tax revenues and domestic service providers.

Dato’ Sri Subromaniam Tholasy, Director General, Royal Malaysian Customs Department

Image: Royal Malaysian Customs Department

The OECD’s Task Force on the Digital Economy has been examining this issue of VAT and GST neutrality in the digital era. Moreover, the OECD’s Committee on Fiscal Affairs and its Working Party No. 9 on Consumption Taxes are working on the implementation of the guidelines for VAT and GST neutrality.

“It is extremely important to ensure tax neutrality,” says Subromaniam Tholasy. “Otherwise, you are going to penalize local services.”

Malaysia and other governments are already taking or considering action to clarify and change their VAT and GST legislation for digital services. In October 2017, the Royal Malaysian Customs Department proposed amendments to the GST regulations that would address digital economy and e-commerce transactions. And, Subromaniam Tholasy says that the tax administration is having discussions with foreign suppliers about the best way to tax cross-border services.

There are more dramatic shifts in store for the VAT landscape in the coming years and businesses should prepare accordingly, predicts Gijsbert Bulk, EY Global Director of Indirect Tax. 

“We believe that by embedding indirect tax issues early on in the planning process for a digital strategy, organizations can avoid unwanted surprises that could end up hurting their business and the bottom line,” Bulk says.

Key action points

  • Make certain that people, processes and systems are ready for digitalized and comprehensive near real-time VAT-related reporting
  • Monitor the development of anticipated changes to VAT treatment of cross-border transactions, especially in the area of digital services
  • Develop active communication and engagement between policymakers and taxpayers about the potential impact of VAT policy changes so that new policies are clear and consistent, and that policymakers understand the business implications of any changes

How we can help: Indirect Tax Services

CONTACT

Gijsbert Bulk

EY Global Director of Indirect Tax

gijsbert.bulk@nl.ey.com

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EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients.

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