VAT introduction on financial services in Albania

The introduction of Value Added Tax (VAT) will have a profound impact on the financial services sector in Albania, if the lawmakers will think about as a new horizon for budget revenues and with a wide ranging economic impact.

Financial services are consumed by virtually all individuals and businesses in Albania. Given that VAT is a tax collected by business but imposed on the end consumer.

The financial services sector in Albania is undergoing significant regulatory change, with a series of steps towards interest rate liberalization progressing.

Furthermore, the percentage of gross revenue from non-interest income continues to grow, reflecting the greater diversity and increasing sophistication of the financial services sector. The VAT reform will need to cater for the longer-term impact of these regulatory and commercial changes.

More recently, countries such as Australia and South Africa have adopted ‘modern VAT systems. They differ from the EU system in that they seek to apply VAT to a broader base of services. Over time, these modern VAT systems have increasingly sought to tax many financial services under a VAT.

Implementation of VAT on financial services has been historically rejected from politics because of some arguments that they support against VAT on financial sector. The principle of exempting financial services from a VAT has been applied consistently throughout the European Union, which is where VAT emanated from for many years. However, over time, banks have increasingly lobbied internationally to have VAT apply to many of their financial services in preference for exemption.

As a matter of fact, most countries exempt financial services from a VAT based on two main principles:

1. The difficulty in measuring the value added to financial services on a transaction-by-transaction basis. For example, when an individual deposit an amount of ALL 100,000 into a bank and is paid 2 percent per annum interest rate, the bank does not subsequently lend that same fixed sum amount to a borrower at say 5 percent per annum of interest, for precisely the same period of time. In practice, the 3 percent value added by the bank in return for its services to each of the borrower and the deposit holder cannot be measured on a transaction-by-transaction basis.

2. Financial services facilitate the buying and selling of goods and services. The granting of an exemption from VAT recognizes that lending and deposit-taking are merely the means by which businesses and individuals fund consumption activities that is, lending to facilitate the early purchase of goods or services upon which VAT is then levied, and deposit-taking to facilitate the deferred purchase of goods and services upon which VAT is then levied.

While this may seem a contrary to the common-sense expectation outcome, there are important reasons for this:

Under a VAT exemption, the bank is effectively treated as the end consumer for VAT purposes, meaning they are unable to claim input VAT credits on their expenses. Consequently, VAT on their expenses is absorbed as part of their cost structure.
VAT is a tax which is collected by the service provider, but is intended to be passed on to the end consumer. Where a bank charges a fee or provides a service, which is subject to VAT, they are better able to pass on the VAT charge to the service recipient where it applies explicitly in a transparent way.
Where a bank provides a financial service to a business customer who is a general VAT taxpayer, the business customer is ordinarily able to claim an input VAT credit. However, in the situation where a VAT exemption applies, the VAT becomes embedded in the supply chain and acts as a deadweight cost for business.

But how can be prepared the model of transition of financial services into VAT scheme?

There are many tangible steps and questions that financial services businesses need to take into account when preparing for the reforms.

First, need to be identified those parts of the business either directly or indirectly impacted by the VAT reforms. This will involve a line-by-line characterization and location analysis of service flows and revenues from those services, followed by a line-by-line characterization analysis of expenses from purchases of services.

Second, the important is examining how the reform process will impact the business model.

As third step, should be an analyse of the impact that the proposed reforms have on the fees, charges and margins that the business derives. Would the business have the legal and commercial negotiating power to ensure that any price reductions are passed on by suppliers? How will fees and charges for services be affected? How will margins be affected? To what extent are there cross-border charges, and how will they be managed? Will the VAT impact on business customers in the same way as individual customers? Will there be cross-subsidization of the VAT impact between business and individual customers?

Forth, should be checked whether the business is entering into contracts now, which potentially span the introduction of the reforms. If so, are there contractual provisions within those contracts, which would allow the impact of a new tax to be passed on? If the business is entering into contracts for the purchase of goods and services, does the contract enable the supplier to pass on the impact of any changes in tax rates arising from the reforms? What about existing contracts?

Fifth, there’s a need for investigating whether IT and accounting systems adequately cater for a new tax. Do they enable recognition and claiming of input taxes on purchases that the business makes? Does the business use tax codes, which are suitable for a multi-rate VAT? Are there linkages between the business own systems and the IT Tax System?

Sixth, need to be taken in consideration the extent that the business should defer fixed asset purchases to potentially qualify for tax credits. Taxpayers currently subject to the exempted regime are unable to claim input credits for fixed assets used in their business.

Seventh step, is about identifying the invoicing and cash register system’s needs, as well as the internal controls. Will the business need to be able to obtain the equipment and information necessary to issue special VAT invoices for each branch, and if so, what controls need to put in place over the issue of special VAT invoices?

As an Eight step should to examine how the cash flow position will be affected by the reforms. How will the business ensure it receives payments from customers before it is required to remit VAT, and equally, minimize the time frame between paying VAT on purchases and claiming input VAT credits?

As ninth step, is important identifying how many suppliers, either current or potential, will be classified as small taxpayers and therefore, unable to claim input VAT. Would the banks cease doing business with them once the reforms are introduced in favour of businesses that are able to provide you with special invoices that you can claim input taxes?

While the objective of such a tale reform may be to tax as many financial services as is possible, the reality is that not all financial services will be subject to VAT. Inevitably, some financial services such as exported services, securities trading, and some other margin-based financial products are likely to be exempt from VAT.

In many VAT systems around the world, one of the most complex and time-consuming issues for financial institutions is in appropriately allocating their input VAT credits between those activities which are subject to VAT (or zero rated), and those which qualify for exemption from VAT. Part of the challenge is that many costs and expenses incurred by financial institutions serve multiple purposes, e.g., overhead costs such as office rental and IT systems.