VAT, GST And Sales Tax Developments worldwide

From India’s proposed goods and services tax reaching a significant milestone, to the European Union’s VAT Plan and the vexed question of sales tax jurisdiction on internet purchases in the United States, this feature looks at some of the major recent consumption tax developments.

India – GST At Last?

Perhaps the most significant development to have taken place recently was the Indian Parliament’s approval on August 4, 2016, of legislation for the long-awaited goods and services tax.

The replacement of India’s spaghetti bowl of state and national level indirect taxes with a GST was the key recommendation of the Kelkar Committee on indirect taxation back in 2003. It was a proposal taken up by then Finance Minister P. Chidambaram in his 2006 Union Budget speech. The intention was then that the legislative framework for the GST would be drawn up and approved by parliament in time for introduction on April 1, 2010. Evidently, it was a deadline which was missed.

The GST is one of India’s most ambitious economic reforms of recent times. At central level, the tax will replace Central Excise Duty, Additional Excise Duty, Service Tax, Additional Customs Duty, and Special Additional Customs Duty. Several state level taxes will also be subsumed by GST, including value-added taxes, Entertainment Tax, Central Sales Tax, Octroi and Entry Tax, Purchase Tax, Luxury Tax, and gambling taxes.

It is predicted that the replacement of these complex and cascading taxes on trade with a single tax on the supply of goods and services would remove a major obstacle to inter-state commerce, raise tax revenue for state and central governments more efficiently, reduce the tax burden on consumers and ultimately lead to stronger economic growth.

GST is India’s most significant tax reform in decades. GST, when implemented, is expected to usher in a harmonized national market of goods and services and shall lead to a simplified, [taxpayer]-friendly tax administration system. Once implemented, it will subsume all of the country’s central and state level duties and taxes, thus making the country a national market and contribute significantly to the growth of the economy.

However, the legislation has proved problematic because state governments, half of which must back the new law for it to become effective, feared that they would see their tax revenues fall under GST, and have been able to block progress. While the central government eventually came to an agreement with the states over a compensation package, the present Government missed its April 1, 2016 deadline after opposition parties, which outnumbered the ruling BJP party in the upper house of parliament, the Rajya Sabha, consistently voted against the constitutional amendment bill needed to introduce GST.

But, while parliamentary approval of the GST legislation represents a significant milestone, and has been hailed by business groups and Prime Minister Narendra Modi, it is not the end of the saga. A number of key aspects of the tax still need to be agreed by the central government and the states, not least of them the actual rates of GST. So, while it is plausible that GST could be introduced by the government’s new deadline of April 1, 2017, further delays are not out of the question.

Japan – Kicking The Sales Tax Can

Another country where sales tax changes have been stuck in a loop is Japan. There, the government recently postponed again a proposed increase in the country’s sales tax from eight percent to 10 percent because of the fragility of the Japanese economy. Prime Minister Shinzo Abe announced in June 2016 that consequently, the consumption tax rise planned for next year will now be delayed for a further two and a half years.

Japan’s present eight percent consumption tax rate was scheduled to increase to 10 percent in April 2017. The tax rate rise was originally programmed for October 2015 but it will now not take place until October 2019 at the earliest. The Government has been aware that any rate hike could have had a deleterious effect on the currently weak Japanese economy. The previous consumption tax hike from five percent in April 2014 caused a deeper economic contraction than anticipated.

Although the Government has therefore been cautious about triggering another substantial fall in consumer consumption, it has also been pointed out, particularly by the credit agencies, that the Government still requires additional revenue to maintain the country’s social security programs and to fulfill the promise of eliminating its primary fiscal deficit by 2020.

Moody’s said shortly after Abe’s announcement that the postponement would be “credit negative” for Japan and “raises further questions over the Government’s ability and willingness to meet its stated fiscal consolidation goals.”

“By delaying the tax hike, we estimate the administration will forego additional revenues worth around one percent of gross domestic product per year. The stimulus will constitute a further unknown cost,” Moody’s said.

Fitch Ratings confirmed Japan’s long-term “A” credit rating on June 13, but revised its outlook to negative, largely due to the recent decision to postpone the consumption tax increase.

“The consumption tax increase was an important element in the government’s fiscal consolidation strategy, which aims to bring the primary deficit of the general account of the central and local governments into balance by the fiscal year from April 2020 to March 2021 (FY20), against a 3.3 percent deficit in FY15,” Fitch said.

In order to mitigate the impact of the consumption tax increase, which most analysts seem to think is necessary to stave off a fiscal crisis – the International Monetary Fund has said that the Government should raise the tax in bite-sized chunks.

The IMF said in its annual review of the Japanese economy that “the stop-go nature of yearly supplementary budgets [and] discretionary changes in consumption tax hikes … has left fiscal policy without a credible medium-term anchor and are contributing to policy uncertainty.”

It recommended that “a credible fiscal consolidation course needs to be charted now, including a pre-announced path of gradual consumption tax hikes … towards at least 15 percent, e.g. by 0.5 or one percent per year over regular intervals.” This, it added, “would strike the right balance between supporting growth and achieving fiscal sustainability in the long run.”

Given that the consumption tax continues to be the third rail of Japanese politics, it wouldn’t be surprising if this particular can is kicked down the road well into the future.

Canada – To Improve GST/HST

Recently, the Federal Government announced that it will revise and clarify goods and services tax and harmonized sales tax rules in a number of ways, in an attempt to improve the existing regime. To this end, draft legislation and regulations released for comment in July 2016 would:

• Revise the GST/HST rules applicable to pension plans, to ensure that they apply fairly and effectively to pension plans that use master trusts or master corporations;
• Improve the clarity and effectiveness of the GST/HST rules applicable to certain pension plans and financial institutions, by introducing clarifications and technical improvements to those rules;
• Extend the application of the GST/HST rules applicable to selected listed financial institutions, to include group trusts for registered education savings plans;
• Revise and modernize the GST/HST drop shipment rules, to enhance their effectiveness and introduce technical improvements;
• Clarify the application of the GST/HST to supplies of municipal transit services, to accommodate the ways in which those services are provided and paid for today; and
• Introduce housekeeping amendments to improve the accuracy and consistency of the GST/HST legislation and regulations.

Nevertheless, as the budgets of provincial governments come under pressure once again, several have opted to increase the provincial element of HST in recent provincial budget statements. New Brunswick, and Newfoundland and Labrador both increased HST by one percent to 15 percent on July 1, 2016, while Prince Edward Island will also increase HST to 15 percent on October 1, 2016.

European Union

Perhaps the most significant development this year with regards to VAT in the EU was the publication by the European Commission of its Action Plan on VAT, setting out plans for the next two years to modernize EU VAT rules.

By the end of 2016, the Commission is to propose legislation that would extend the current One Stop Shop concept to all cross-border e-commerce, including distance sales. It will also introduce common EU-wide simplification measures to help small start-up e-commerce businesses, and streamline audits for companies engaged in the sector. In line with the OECD’s recommendations in its Action 1 report on the tax challenges of the digital economy, it will also remove the VAT exemption for the importation of small consignments from suppliers in third countries.

Further, the Commission will seek to improve cooperation between tax administrations including from non-EU countries and with customs and law enforcement bodies, to strengthen tax administrations’ capacity for a more efficient fight against fraud. A report evaluating the Directive on the mutual assistance for the recovery of tax debts will also be released. This work will be taken forward in 2017 also, alongside a proposal to enhance VAT administration cooperation and bolster Eurofisc, the anti-fraud agency.

The Commission will also ensure that member states have greater freedom on setting VAT, including providing for technology-neutral VAT treatment for digital economy supplies, by allowing the same VAT treatment for the digital equivalents of traditional supplies (for example, for e-books and tangible books).

The Commission has already begun tackling one of the more controversial elements of the EU VAT regime – the disparity in VAT treatment of e-books and online journals compared with their “physical” counterparts.

Currently member states may tax printed books, newspapers, and publications at a reduced rate of no less than five percent. In addition, some member states are permitted to levy VAT rates lower than five percent or are permitted to zero rate supplies of certain printed publications. However, digital publications that are electronically supplied must currently be taxed at the standard VAT rate.

However, in July 2016, the Commission launched a consultation on changing the VAT rules that apply to electronically supplied publications such as e-books to enable them to benefit from the same, reduced VAT rates as for printed publications.

While unfair tax competition concerning electronically supplied services was negated from January 1, 2015, when place of supply rules were changed to tax such supplies in the location of the consumer (thereby removing any advantage for companies to set up in low tax member states), this latest change concerning tax rates will ensure parity between different forms of publications. The change is consistent with the Commission’s pledge to make value-added tax rates technology neutral as part of its Digital Single Market initiative.

Africa – South Africa Considers VAT Hike, Egypt Prepares For VAT

There was some confusion over whether the Davis Tax Committee, established by the Government to examine options for tax reform, recommended a VAT hike or not. For its part, the committee itself clarified in August 2015 that it did not explicitly recommend an increase in VAT, but issued a range of recommendations on the tax gap, zero rating, dual (multiple rates), exemptions, place of supply rules, and rules on e-commerce.

As far as an increase to the current South African 14 percent VAT rate is concerned, the report stated that it would be “somewhat inflationary in the short-run,” while an increase in personal or corporate income tax rates would be “much less inflationary.” On the other hand, a VAT rate rise would have a lesser effect on economic growth than income tax rate rises.

Nevertheless, many continue to speculate that at some point, the Government will increase the main rate of VAT as it grapples with a deepening budget deficit. One of them is the IMF, which said in July 2016 that, given the recent slowdown in South African growth, and the consequent risk that the Government’s fiscal deficit reduction target will not be met VAT rate may have to be raised.

Meanwhile, Egypt expects to finalize legislation to introduce VAT from September 2016, according to recent reports. Egypt’s Finance Minister, Amr EL-Garhy, told reporters in July 2016 that lawmakers were making progress on the adoption of a draft VAT law, which was tabled before Parliament in June, after having earlier been approved by the Cabinet.

In May, the minister disclosed that 52 goods and services will be exempt from VAT. This list reportedly includes basic foodstuffs. Businesses targeting tourists, including restaurants and hotels, will not be subject to VAT also. Certain companies operating in the natural resources sector will be exempt, as will banks, although further clarification on the taxation of these sectors is expected. Education, scientific research, and religious organizations will also receive exemptions.

The long-awaited introduction of VAT is a key part of plans to significantly reduce the nation’s budget deficit, which is expected to reach about 11.5 percent of gross domestic product this year. EL-Garhy said that VAT would generate between EGP20bn (USD2.25bn) to EGP25bn in 2016-17.

United States – Main Street Versus E-Street; VAT USA?

The most pressing sales tax issue in the United States remains whether or not state and local sales taxes should apply to goods and services bought from suppliers located out-of-state transactions which have generally not been subject to such taxes.

As things currently stand “brick-and-mortar” retailers in states that impose sales and/or use taxes are legally obliged to collect sales taxes from customers who make purchases in their stores at the point of sale and remit them to the state tax authority. However, if a resident of the same state chooses to purchase the same item from an online retailer or catalog seller based out-of-state, sales tax usually goes uncollected by the vendor because they don’t have a physical presence there.

Main Street retailers argue that this uneven sales tax playing field puts them at an unfair competitive disadvantage, especially as internet retailers generally already have lower overheads. The good news for them is that state governments are on their side according to the National Conference of State Legislatures at the last count this existing state of affairs costs USD23bn in uncollected taxes each year.

While the US Supreme Court established a “physical presence” test for applying existing sales taxes to out-of-state merchants in 1992, it has said that only Congress has the authority to regulate interstate commerce under the Commerce Clause of the US Constitution, therefore leaving it to federal lawmakers to resolve the matter.

The Marketplace Fairness Act is one such attempt at a federal solution to this issue. Reintroduced in March 2015 after expiring at the end of the previous congressional session, this would require online retailers to collect sales tax for state and local governments, even though they lack a physical presence in a state. The MFA would certify the Streamlined Sales and Use Tax Agreement, an interstate system involving 24 states which is attempting to harmonize state and local government sales and use taxes and associated administrative requirements.

However, while the MFA has bipartisan support in Congress, many Republicans aren’t keen on the proposals. Some see the MFA as just another tax that will impose additional burdens on business, and while the legislation was approved by the then Democrat-led Senate in 2013, it failed to come up for a vote in the Republican-led House of Representatives. Unsurprisingly, given the overall Republican majority in Congress, the 2015 version of the MFA continues to languish in committee at the time of writing.

Indeed, there are those in the GOP ranks that are hostile enough towards the MFA that they support legislation preventing states from taxing online purchases from out-of-state vendors. One such bill is the No Regulation Without Representation Act of 2016, introduced in the House on July 14, 2016, which would prohibit US states from imposing sales tax collection requirements on individuals with no physical presence in the taxing state.

As if the US tax code wasn’t presently complicated enough, there are some in Congress arguing for the introduction of a national VAT system, although it is intended that such a tax would enable swathes of the US tax regime to be abolished and simplified as a result.

One of them is Jim Renacci, an Ohio-based Republican member of the House of Representatives Ways and Means Committee and Budget Committee. In July 2016 he issued a US tax reform plan – Simplifying America’s Tax System (SATS) that would eliminate corporate income tax and replace it with a new seven percent credit-invoice based consumption tax.

The new so-called business activity, which has been likened to a VAT, would be a complete break from the official policy proposed by the House Republican Party that would cut the federal headline corporate tax rate from the current 35 percent to 20 percent. The VAT would apply to all private businesses and the federal government, but would exempt nonprofit organizations and state and local governments.

The Tax Foundation (TF) has indicated that, on a traditional static basis, Renacci’s plan would reduce tax revenues by USD845bn over the next ten years. However, on a dynamic basis (allowing for the increased economic growth the plan should generate), it would end up raising additional revenue of USD695bn, with most of the dynamic revenue coming from the new “VAT.” According to TF, the plan would lead to 5.6 percent higher gross domestic product over the decade, with 1.9m additional jobs.

Such proposals are, however, hugely controversial, and unlikely to make the agenda in Washington any time soon.

Senator Marco Rubio, also a former Republican candidate for the presidency, said in a January speech that VAT would be “a huge new tax, [which] would grow the federal government while concealing the costs to the American people.”

VAT proposals have also been criticized from the left of center in US politics because such taxes tend to be regressive, and tax poor people more as a percentage of their income than the wealthy. Therefore, given the recent inability of Congress to approve the most basic of tax measures, don’t expect a deeply partisan legislature to suddenly rally around VAT legislation any time soon. Then again, perhaps the political stalemate will be unblocked by this year’s presidential election, and in this increasingly unpredictable and stable world, perhaps nothing should be entirely ruled out!