Value Added Tax - Essay Example

Introduction The intimacy of economies, particular those to liberalization through multilateral regional agreements such as the European Union (EU), has brought home the impact of legislation and taxation on a new scale. Together with the development of electronic ales and distribution channels, many states and economic organizations have sought to respond to the challenge of governing these non-traditional markets more effectively. At the same time, there is a realization that though the provisions are limited to commerce in the EU, its implications extend beyond the borders of the union. One of the more controversial of these initiatives has been in the modernization of Value Added Tax (VAT) obligations for financial services and insurance markets. The concern for the measure is not limited to its monetary or financial impacts on trade and commerce but also in the overall all competitiveness of industries and markets. The objective of this paper is to be able to assess current opinion regarding the VAT measures and determine areas of concern. The opinion of various stakeholders on the issue, EU objectives and the state of global markets will also be taken into consideration. The paper will then conclude with a summation of the issues that dominate current discussion and weigh the legitimacy of projections on the issue. Background Lszl Kovcs' opening statement to the 2006 Joint Conference forum of the European Commission (EC) and the European Banking Federation (EBF) regarding the modernization of the VAT Rules for Financial Services and Insurances, acknowledged the interest of the issue to a number of sectors and industries. He reiterates to the assembly that the reviews of the VAT rules are motivated by the desire to simplify them to enhance and unify pan-European trade, particularly financial services (Tabellini 2003). However he also recognizes that there are revenue trade-offs that will result from the revision of VAT rules that has created significant reservations from the financial and service sectors. There have been several legislative reviews on the Sixth VAT Directive, rules primarily governing financial, insurance and service enterprises, since their initial enforcement in 1977. The Sixth Vat Directive was based on the assessment done by the 1973 Hutchinson Report: objections raised against the directive were concerned the lack of actual infrastructures to facilitate the application of the measures which impairs consumer credit levels. In response to the challenges of determining taxable amounts and VAT deductions in these industries, the industries were given exemptions due to the lack accounting and fiscal methods to implement measures. The lack of capacity was not based on the lack of fiscal or accounting skills but rather on the lack of justification of administrative charges and the complication of legal and accounting jurisprudence. It was only in the middles of the 1990's that efforts to implement full taxation were picked up. The Commission together with the Organisation for Economic Co-operation and Development (OECD) determined that it was possible to charge VAT using cash flow methods of financial services, known as the truncated cash flow method (TCA). Technical feasibility tests were conducted in financial institutions and yielded within acceptable parameters as well. Using the system, there would be no VAT or zero rating on business-to-business (B2B) transactions and will be considered as customer charges in business-to-consumer (B2C) transactions. However, there was still opinion that the systems was still to complex for actual implementation and migration to TCA was inhibitive because of the cost. In response to these continuing concerns, the Commission has identified three key issues for resolution (EC 2006, pp. 3-4): 1. Mitigation of administrative cost of implementation and fiscal supervision for economic operation and fiscal compliance 2. Establishment of related budget security and legal certainty for Member States and economic operators respectively 3. Resolution of inconsistence of current regulation and legislation such as enumerated in Financial Services Action Plan and Financial Services Policy (2005-2010) and the 1977 VAT provisions. McLure's (2000) review of the issue highlights the need to develop insights based on national and international contexts. He emphasizes that VAT directives have a significant impact on other taxes, importation of services as well as outsourcing (Tabellini 2003). Moreover, the opinion of non-EU member industries must also be taken into consideration since provisions since the burned to identify and locate their EU customers to apply the proper tax rates are borne by suppliers. The resistance to the directives has also come from changes and developing directions of the financial services industry. The development of the Financial Services Action Plan, Financial Services Policy (2005-2010) as well as the integration of the pan-European financial regulatory frameworks raised the question of relevance. The increase in competition in these markets because of liberalization could considered as restrictive and thus impair the growth and competitiveness of the EU in the market. Assessment Industry and Economy Industry analysts and experts have sufficiently highlighted the urgency of considering services and market performance and objectives internal processes to develop competencies to support flexibility and responsiveness of services provides. This is in response to the diversity emerging markets as well as the diversification of European financial, banking, service and related industries demands. The influx of service providers has decreased switching cost an issue already a concern for these mature markets. Therefore, any measure that is to be implemented should be motivated by operational improvement programmes and integrates all aspects of the service environment so that it becomes a strategic advantage. Assessment of the opinions presented in the 2006 EC-EBF Joint Conference that both those supporting and resisting the measures stems from their interest to develop efficiency in the industry and create competitive competencies in global markets. However, as pointed out by several of the participants to the forum, there are still significant concerns to be resolved if the VAT measures are to be considered beneficial rather than detrimental. A question that was repeatedly raised was that if there are no effective means for the VAT Directive to be implemented, then what is the value of legislating it Changes in corporate restructuring, in the of TCA and VAT application and remittance should not affect market performance, however, the cost and requirements of complying with the VAT Directives will necessitate some degree of sacrifice (Pinkernell 2006). Supporting VAT From a general perspective, the implementation of the VAT Directives or the cessation of the exemption given to financial services and its related industries has significant value. Considering the number of years that the measures have been waiting for full implementation, there seems to be limited effort directed to it resolution. The exemption given to the financial services industries was not designed to be permanent: there was an assumption that pending the development of technology and fiscal means to make effective its implementation. In view of the level of development in communications and technology today, previous concerns regarding the operability of the VAT Directives should not be as difficult as the original assessments that led to the exemptions in 1977. Furthermore, the adaptation of TCA has also been seen to be a step towards developing a universal accounting of cash flows. Another supporting argument presented by the EC (2006) points out that exemptions can still be provided particularly in the case on non-deductible VAT for economic sectors as well a provided for channels to address petitions for additional exemptions. There are also long-term benefits for business-to-business transactions: tax neutrality, power to deduct input VAT, fiscal control flexibility as well as support reform agendas such as Financial Services Policy (2005-2010). Reservations on VAT According to Needham (2005) one of the most glaring inadequacies of the current VAT Directive is it is not able to account for the nature of commerce today, in particular online consumer and business commerce. Another deficiency that he raised is that the directive contradicts itself in its objective of uniformity: under Article 9(1) of the VAT Directive, service procured from non-EU suppliers by EU consumers are not subject to VAT because the origin of the service supplied is not within the EU. This is in contrast when businesses are the ones procuring services from non-EU suppliers or in the case of consumers soliciting services from EU suppliers. Furthermore, Wassenaar & Gradus (2004) point that the solution provided for the current VAT distortions provides limited resolution for the concerns of tax-exempt service private or for public suppliers in other member-states. Burgin (2006) also noted that broadening definitions for exemptions is not an assurance that all application distortions can be addressed, suggesting that the objective is for an overall broadening of exemptions rather developing new qualification for it. Together with the current "tax disincentive", in particular, with regards to outsourcing, the effect is conditions that diminish productivity and competitiveness (p. 11). Similarly, Patterson & Philipowski (2006), Hahne (20006) and Sidders (2006) that economic and commercial realities in the EU today have highlighted that though the pan-European idea of a unified economy remains a priority, there is just as much need for the union to consider global competition. Furthermore, they reiterate that in industries such as finance, baking and service where there is a high demand for certainty and value, the implementation of the VAT directives diminished confidence in the efficiency of EU service providers versus non-EU competitors. And considering the accessibility of these competitors on line, traditionally geographical barriers to access do not provide any advantage to EU-base service providers. Moreover, the VAT distortion afforded non-EU service providers further deteriorated competitiveness or value of being a provider from a Member State. Analysis The issue of Sixth VAT Directive is both an industrial and macroeconomic issue that deserve the attention and concern it has receive. As per John Fay's, VAT partner of PricewaterhouseCoopers - Ireland, assessment, whether or not one supports, the legislation, there should be a realization of the significant backend requirements in implementing the directives. In the case of a U. S. based company for example, they will need to register in individual jurisdictions and remit regular periodic payments VAT returns the total amount of VAT that has been charged to their EU consumers all of the EU jurisdictions which will be then appropriated to the respective EU jurisdictions (Cox 2003). For EU companies, the only advantage would be proximity to the jurisdiction, however there is the distortion on the VAT application that continues to be a concern. The opinions expressed by Battiau (2006), Moss (2006), Fernndez (2006), as well as in the cases presented by Leijonhufvud (2006) and Besson (2006) indicate that the measures serve no actual value but only serve to convolute operations and processes. They do not just point out to the inoperability of the VAT measures but question its very rationale. However, as much as the measures are distinct to the EU, they could also be viewed as an indication of the integration of its financial markets. Moreover, without the institution of such legislation, there will be no incentive to develop the technology or operational means to increase efficiency in VAT computations (EC, 2002). The concern for the issue is even more critical if the perspective on individual business is to be taken. Consider Pinkernell's comment that, "Whether the EU can deliver on its promise of simplicity and fairness remains to be seen. US businesses already criticize the fact that they are required to identify and locate their EU customers in order to apply the proper tax rate, whereas EU suppliers are not required to do so". It is clear that the issue is becoming a constraint for the realization of liberalization not only on a macroeconomic level. It also can be source of distortion on public policies and market choices, distorting "decision-making of public authorities in their choice between public provision and contracting out" (Wassenaar & Gradus 2004, p. 393). Neither current safety nets nor refund schemes enough to quiet the reservations of industry leaders citing that neither tax-exempted supplies, Despite the degree of concern that has been raised on VAT, previous tax measures, private suppliers or public authorities will benefit from additional efficiency in terms of their profits Despite the degree of attention shown when they were being lobbied, have had marginal impacts to EU markets, the study of Gebauer, Nam & Parsche (2005) on the impact of approval of intra-EU duty-free shopping in the EU, there was negligible appreciation and there are some even evidence that the measures had a negative impact on purchases. An argument to this idea however is that the removal of the intra-EU duties rendered the measures limited to Member States and as such, the impact of non-EU competitors and the VAT advantage afforded them, were not an issue. Another perspective to be considered Considering the current size of the EU, compelling compliance for non-EU companies should be to the advantage of Member States (Brchner et al 2007). However, Needham (2005) has also points out that expecting compliance contravenes the EU's efforts for international integration of its markets. Conclusion The opinion against VAT is significant and detailed in its stand against any provision of exemption or contingency that the EC is offering. The prevailing opinions is the VAT measures are not sensitive to he the current situation and challenges of the financial banking or service markets nor serve and contradicts efforts to integrate industries and economies. Moreover, it deters competitive advantage, operational effectiveness and efficiency of EU businesses and Member States. However, the EC has also made significant effort to present not only alternatives but safety nets for the most concerns raised by the industry. Though the measures are viewed as divisive, there is equal weight in the EC's argument that the VAT measures can be cornerstone of unifying financial systems in the region and compelling international compliance as well. One of the challenges in the issue is the varying appraisal of the impact of the measures upon full implementation as well as the lack of existing infrastructures to gauge migration to TCA, computation of VAT or remittance systems at the scale that the measures are to be implemented. At the same time, there are significant variances in the response of EU markets to the application or removal of tax measures. In conclusion, before the VAT Directive can be accepted and appreciated by the public and industry, it has to be able to justify the cost of changes in accounting and fiscal costs, simplify application and remittance and does not impair the status or competitiveness of EU-based companies and Member States. References Battiau, P, 2006. Challenges for the European Finance Sector - Obstacles created by the current VAT regime. from the Modernizing the VAT Rules for Financial Services and Insurances Joint Conference, 11 May 2006, [Online]. Available at: [accessed 13 February 2008] Besson, P., 2006. The Allianz Case - VAT in a Financial Service Group with Europe as a home market. from the Modernizing the VAT Rules for Financial Services and Insurances Joint Conference, 11 May 2006, [Online]. Available at: [accessed 13 February 2008] Brchner, J., Jensen, J., Svensson, P. & Srensen, P. B., 2007. The Dilemmas of Tax Coordination in the Enlarged European Union. CESifo Economic Studies, Dec (53): 561 - 595. Burgin, N., The macro-economic impact of VAT on outsourcing. from the Modernizing the VAT Rules for Financial Services and Insurances Joint Conference, 11 May 2006, [Online]. Available at: [accessed 13 February 2008] Cox, B., 2003. EU VAT: a New Tax Headache for E-Commerce. Internet News, 21 April, [Online]. Available at: [accessed 13 February 2008] European Commission - European Banking Federation Lszl Kovcs http://ec.europa.eu/taxation_customs/resources/documents/common/about/speeches/modernising_VAT_11-05-06.pdf Modernizing the VAT Rules for Financial Services and Insurances Joint Conference European Commission, 2002. Consultation Paper on modernising Value Added Tax obligations for financial services and insurance. Europa, [Online]. Available at: [accessed 13 February 2008] Fernndez, G. N., 2006. VAT issues for an international banking group. from the Modernizing the VAT Rules for Financial Services and Insurances Joint Conference, 11 May 2006, [Online]. Available at: [accessed 13 February 2008] Gebauer, A., Nam, C. W. & Parsche, R., 2005. Lessons of the 1999 Abolition of Intra-EU Duty Free Sales for the New EU Member States. CESifo Economic Studies, (51): 133 - 157. Hahne, K., 2006. The perspective of public/regional banks. from the Modernizing the VAT Rules for Financial Services and Insurances Joint Conference, 11 May 2006, [Online]. Available at: [accessed 13 February 2008] Keen, M. & S. Smith .1996. The Future of Value-added Tax in the European Union. Economic Policy, 23: 375-411 Kovcs, L., 2006. Chairman's Introduction - Presentation from the Commission services. from the Modernizing the VAT Rules for Financial Services and Insurances Joint Conference, 11 May 2006, [Online]. Available at: [accessed 13 February 2008] Leijonhufvud, M., 2006. The Nordea Case -VAT issues in restructuring. from the Modernizing the VAT Rules for Financial Services and Insurances Joint Conference, 11 May 2006, [Online]. Available at: [accessed 13 February 2008] McLure, C. E., 2000. Implementing Subnational VATs on Internal Trade: The Compensating VAT (CVAT). International Tax and Public Finance, 7: 723-40. Moss, A., 2006. Views from the Insurance Industry. from the Modernizing the VAT Rules for Financial Services and Insurances Joint Conference, 11 May 2006, [Online]. Available at: [accessed 13 February 2008] Needham, A., 2005.VAT and the EU - VAT Voice. Taxation Web, [Online]. Available at: < http://www.taxationweb.co.uk/articles/article.phpid=156> [accessed 13 February 2008] Patterson, J. & Philipowski, R., 2006 The point of view of the asset managers. from the Modernizing the VAT Rules for Financial Services and Insurances Joint Conference, 11 May 2006, [Online]. Available at: [accessed 13 February 2008] Pinkernell, R, 2002. Application of the EU Value Added Tax to E-Commerce Transactions. [Online]. Availble at: [accessed 13 February 2008] Sidders, R., 2006. The solutions proposed by the finance sector. from the Modernizing the VAT Rules for Financial Services and Insurances Joint Conference, 11 May 2006, [Online]. Available at: [accessed 13 February 2008] Tabellini, G., 2003. Principles of Policymaking in the European Union: An Economic Perspective. CESifo Economic Studies, 49: 75 - 102. Taxation and Customs Union, 2007. Report on the review of Community Legislation on the VAT treatment of financial services. Europa, 8 August, [Online]. Available at: [accessed 13 February 2008] Wassenaar, M.C. & Gradus, R.H.J.M., 2004. Contracting out: The Importance of a Solution for the VAT Distortion. CESifo Economic Studies, Jan (50): 377 - 396. Read More