SOME UNRESOLVED ISSUES IN DESIGN AND IMPLEMENTATION OF VALUE ADDED ** JOHNF.DUE* ABSTRACT Criteriafor Decision Makingon the Issues A numberofvalue-addedtaxissueshave not beenresolved,ordiscussedextensively To indicateoptimal, or at least second in the literaturedespitewidespreadadop- best, solutionsto the issues, it is neces- tion of the .The purposeof this article sary to assume appropriate criteria for is to considersuch issues,including cov- evaluation.First, it is assumedthat in the erageof the tax by sector,the appropriate interests of economicefficiency,the tax thresholdforregistration,treatmentoffarm shouldcreate noincentivesto alter meth- inputs;zeroratingvs. exemption;the cov- odsofproductionand organizationofthe erageof services,realpropertyconstruc- productionand distribution systems.As tionand rental;multipleratesvs.separate an element in this criterion, the value levies;specialproblemswithinternational added tax must avoid cascading,that is transactions;and the refundissue. multipleapplicationoftax to the samefi- nal consumption items, which causes both economic distortions and loss of equity. Secondly, the final burden of the tax should alue added taxation (VAT) has be- be the same on imported and domestic Vcome the standard form of production; the tax should not provide throughout most of the world: Western protection, to be left to duties if Europe, Latin America, Canada (as of desired at all, nor discriminate against 1991), Korea, Japan, much of Africa in domestic products. Thirdly, for both eq- simplified form, and now the Caribbean. uity and economic efficiency reasons, it is The literature is substantial, the most assumed that the burden of the tax, in the significant being Alan Tait's Value Added sense of the pattern of reduction in real Tax (1988), OECD's Taxing Consumption income, should rest in relation to con (1988), Charles McLure's The Value Added sumer spending, either uniformly or in Tax (1987), and the World Bank volume conformity with a desired pattern of non- edited by Malcolm Gillis, Carl S. Shoup uniformity. Fourthly, the tax must meet and Gerardo P. Sicat, Value Added Tax- standards of equity accepted in the par- ation in Developing Countries (1990). There ticular country, which typically means are also numerous journal articles, gov- avoidance of significant tax burden on the eniment reports, and World Bank and Bff lowest income groups. Finally, the tax Working Papers.' But as anyone involved must be structured to permit adequate in the designing of a value added tax, compliance and administration at accept- particularly in a developing country, is able cost, a requirement that may conflict well aware, there are a number of issues with the others, necessitating a compro- that arise about which the literature has mise. little to say. This paper is designed to ad- dress some of these issues although sat- isfactory answers cannot be provided for The Scope of Coverage by Sector: many of them. Major ones widely dis- Manufacturing and Distribution cussed, such as the taxation of financial institutions and insurance, will not be The standard form of a value added tax covered. Emphasis is on the developing in the industrialized countries extends through the retail level, with some countries, but much of the analysis is rel- threshold, discussed below, for excluding evant to all countries. very small shops. But in developing coun- *University of Illinois at Urbana-Champaign, tries, retailing is primarily a small scale Champaign, IL 61820. endeavor, the proprietors often illiterate, 383

No. 41 UNRESOLVED ISSUES OF VALUE ADDED TAXES 385 taxable sales. Some provision to allow the nonfarm uses to escape tax-particularly administration to exclude such firms from seed, plants, and fertilizer for home gar- registering is desirable. The second issue dens, and nonfarm tractors. Attempt to is that of voluntary registration; should devise rules that will keep such items firms not required to register because of taxable when sold for nonfarm use, for ex- low sales volume be permitted to apply for ample, with seed, packaged for retail sale, vokntary registration? These are primar- have not proved-woXWle, aAd @ome es- ily firms exporting or selling to registered cape is inevitable. It is important to de- firms. While some countries will not per- fine the farm machinery category in such mit voluntary registration, it is almost a way that hand tools widely used for imperative to do so, provided the firms can nonfarm purposes are not placed in the demonstrate adequate record systems. zero rated category. But decisions must be For firms close to the threshold and made about such items as irrigation having substantial variation in sales from equipment, bee keeping equipment, and year to year, it obviously is desirable to many other borderline categories. An al- avoid the yoyo effect. Once a firm is reg- ternative to zero rating inputs is to au- istered, it should not be deregistered until thorize the European practice of allowing its sales have fallen below the threshold purchasers of farm products to assume that for several years in succession, perhaps a certain percentage of the purchase price three. consists of the tax element. But any such Related to the voluntary registration percentage is arbitrary, and the policy adds issue is that of registration of firms com- complications hardly suitable for devel- mencing operations, without experience oping countries. as yet about actual sales volume. Such firms often seek registration to obtain in- Zero Rating vs. Exemption put for purchases for establish- ing the business, and this is usually The issue of zero rating vs. exemption granted. has been considered at length by Alan Tait and others and only a few aspects will be mentioned here.' In principle, of course, Farmers zero rating is desirable when the objec- In a sense, farmers constitute simply one tive is to exclude the consumption of the class of small firms, and the same rules product completely from tax, whereas ex- with regard to registration may be ap- emption is warranted when it is not re- plied to them. Some countries, however, garded as feasible or desirable to tax the exclude all farmers from the registration activity but some tax on final consump- requirement if they sell only zero rated or tion is considered desirable, as for ex- exempt goods, as is not uncommon, es- ample with financial institutions. pecially in developing countries, where There are two major objections to ex- unprocessed farm products are usually zero emption. First, cascading results as the rated.' In any event, few farmers will be exempt firms and their business cus- registered in developing countries, or even tomers cannot receive input tax credit. in many industrialized ones (Denmark and Secondly, firms producing both exempt and New Zealand are exceptions). Thus there taxable (including zero rated) items must is no way they can receive credit for tax allocate inputs between the exempt and paid on their inputs, and cascading of tax non-exempt categories, and this is diffi- will result, of particular concern with ex- cult to accomplish in any non-arbitrary Port crops. way and to control. But on the other hand, A common but by no means universal zero rating gives rise to numerous re- rule is to zero rate major farm inputs- funds of tax, and policing of these refunds livestock, livestock feed, seed, fertilizer, is difficult. On the whole, however, zero and farm machinery and equipment. Un- rating is the preferred solution for sales fortunately this rule allows some sales of of commodities, exemption being confined these products for appropriately taxable to certain service transactions not feasi- 386 NATIONAL TAX JOURNAL [Vol. XLIII blieof to tax. The long support in the EEC have shifted from the latter approach to exemption in preference to zero rating the former before the law was enacted appears to be simply a mistake, and the (Trinidad and Tobago is an example). The policy has not been followed in most de- main reason for the specification ap- veloping countries. proach is simply that many services are not regarded as suitable for taxation, Designation of Commodities to be either for social policy reasons (medical, dental, hospital, educational, and even le- Zero Rated gal) or for administration reasons, be- The issue of the selection of those com- cause of the very small scale, non-com- modities to be zero rated, discussed widely mercial nature of the establishments. But in the literature on sales taxation gen- this in itself does not make the specifi- erally, will not be considered here, except cation approach essential; the danger of to stress the now generally accepted rule use of it is that the listing will let various that the broader the coverage of a value services for which there is no strong jus- added tax, like any sales tax, the more ef- tification for exclusion slip out from un- fective is its operation. But one issue has der the tax. The taxation of all services arisen in various developing countries: except those specified uses the same ap- should commodities excluded from the tax proach for services as for commodities but (or subjected to higher rates, as noted be- may bring some into the scope of the tax low) be designated by usual definition, or that are difficult to control. by number? Several countries pre- Regardless of the approach there re- fer the latter approach; in fact, the Tan- main a number of issues. First, should zania sales tax act lists all commodities services rendered primarily to business by BTN number and indicates the rate. 6 firms be included? Under a single stage When many taxable commodities are im- sales tax, clearly they should not be in- ported, there is limited merit in desig- cluded, because of the consequent cascad- nating those zero rated or subject to a rate ing and the incentive given to firms to other than the basic figure by tariff num- provide the services with employees rather ber. But doing so results in a much more than acquiring them from outside estab- detailed and complicated law, and is pro- lishments. But with a value added tax, no gressively less satisfactory as more and cascading or incentive distortions will arise more of the commodities are domestically with registered firms. Registration of these produced, with application of the tax made firms reduces cascading as tax they pay by persons not familiar with tariff des- on their inputs constitutes a tax credit. ignation numbers. There is merit in Only purchases for consumption purposes avoiding the practice initially or in mov- and by non-registered firms will actually ing away from it as development contin- be subjected to tax burden. There is a cer- ues. tain amount of wasted motion involved in There are numerous problems in defin- collecting the tax and then crediting much ing the excluded commodities, as for ex- of it to the using firms, but there should ample unprocessed food. The concept of be a substantial net revenue gain. A ma- processing is not easily defined. jor reason for including such services as accounting, managerial counseling, legal, and related activities is the political one: Coverage of Services the widespread belief, especially in many Most sales taxes worldwide apply to all developing countries, that these activities commodfties except-these epwh%*Ily ex- largely -escape income-tax *A#--thus there cluded, but only to specified services, and is merit in collecting VAT from them- this rule has been carried into many value even though the burden likely goes on to added taxes.' The issue of whether tax the users of the service. should apply to all services except those There is obviously general justification excluded or only those specified has been for the inclusion of consumer services debated in various countries, and some within the coverage of the tax. As the No. 41 UNRESOLVED ISSUES OF VALUE ADDED TAXES 387 value added tax is presumed to be de- ous problems of drawing the line between signed as a general consumption levy, the two. Commonly a 30-day rule is used; consumer expenditures on services con- charges for periods under 30 days are stitute a portion of total consumer expen- subject to tax, those over 30 days are free ditures just as those on commodities, and of tax. But does liability depend on the taxation of services may facilitate income nature of the lease, so that any contract tax administration. But it must be rec- for over 30- days is- free of tax, and, any ognized that in practice there are certain under that period taxable? Or, if persons differences between commodities and ser- stay more than 30 days in the same ac- vices. First, frequently individual house- commodation, are they then free of tax holds can more easily self-produce ser- from that date on? Do they receive a re- vices than commodities; the elasticity of fund for tax paid on the 30-day period? substitution is obviously much greater Does the liability depend on the type of between restaurant and home prepared establishment; if it is a hotel, as defined meals, home vs. commercial laundry, etc., by a law, is the charge taxable regardless than it is between home production vs. of the length of the period of stay, whereas purchase of furniture, to say nothing of a stay in an apartment (e.g., non-hotel) is gasoline and automobiles. Secondly, the not taxable even for short periods? Fur- audit trail for control of service establish- ther complications are created because ments is much less satisfactory for ser- some establishments provide hotel and vices than for commodities, since the pur- apartment type accommodations. In all of chases of taxed commodities by most these instances, for any establishment service establishments are much smaller supplying both types of accomodations, percentages of their sales than they are serious problems are created for alloca- for the usual sellers of commodities. By tion of tax on inputs. There is no simple the very nature of most service produc- answer to this issue; generally, if short- tion it is highly labor intensive (with the term accommodations are provided, these exception of various public utility ser- are subject to tax for the first 30 days un- vices, which in fact have more character- less a longer-time lease is entered into; if istics of commodities than of usual ser- the person stays more than 30 days, tax vices). no longer applies, but no refund is given There are several related issues with for the first 30 days. services. Universally, financial services are Some jurisdictions, particularly in re- excluded from the tax because of the sort areas, apply the tax for much longer problems of defining value added.' If such periods than 30 days-and some tax all services are excluded from the tax cov- rental accommodations regardless of the erage, should the charges for them be in- period, thus discriminating against ten- cluded in the figure of taxable price when ants compared to homeowners, especially they are rendered in conjunction with the if construction and other real estate in- sale of conunodities? Logically they should puts are not taxed. not be-but in fact they usually are, be- Another issue relates to service charges. cause of the problems in control of appro- Outside the United States and Canada, it Priate amounts of the charge. is conunon for hotels and restaurants to Some services, in addition to financial, add a "service" charge in lieu of (or some- give rise to special problems. Advertising times in addition to) tips. In a few coun- has always proven to be a particularly tries, Switzerland being the prime ex- difficult activity to bring under any form ample, these charges are built into a single of sales tax, because of varied procedures quoted rate. The general rule is that the among different parts of the advertising service charge is not a part of the taxable r-pectrum. Most would constitute an input charge, since it is considered to be in lieu tax credit anyway. of a voluntary tip, which is never taxable. If hotel services are to be taxed, as is But this rule does discourage the use of almost universal, but permanent rental the Swiss approach, one that many trav- accommodations are not, there are seri- ellers prefer. If mandatory service charges 388 NATIONAL TAX JOURNAL [Vol. XLIII are to be included in the taxable price, de- the purchases by contractors rather than lineation between a mandatory and vol- the entire contract price-but this is not untary addition to the bill is not always suitable for construction for business pur- obvious. For example, in the United poses. An alternative to concessions on the Kingdom, the VAT Tribunal held that if tax on construction is to allow refunds of the menu and the bills contain the state- a portion of the tax paid on new housing ment that a service charge (10 percent in construction to owners of the property. But this case) is added to all bills (Potters Lodge on rental housing there is a problem of Restaurant Ltd. v. Commissioners of Cus- ensuring that the tenants benefit from the toms and )' the service charge is a refund, and any refund system adds to ad- portion of the taxable charge, but when ministrative complications and is subject there is no such statement (the menus to fraud. read: "Service Not Included") and a 15 A serious problem relates to the rela- percent charge added by the waiters to the tionship of existing vs. new construction. bills did not have to be paid by the cus- If new housing is taxed but old houses are tomers if they objected, the service charge not, as is usual, the sale values of the lat- was not taxable (NDP Co. Ltd. v. the ter rise, creating a windfall gain. But to Commissioners).'o tax the initial sale of existing houses af- ter imposition of the tax is difficult to im- Real Property Construction and plement and a source of much ill will. In general, there seems to be little option but Rental to tax new construction, repair and ex- A debated issue with any sales tax is tensions, and to exclude from tax (ex- the treatment of building contractors and empt) the sale of existing housing facili- sale and rental of real property, a field ties, whether built before or after the date complicated by the importance of subcon- the tax became effective. tractors in the construction industry and A related issue is speculative building; by the long life of buildings." There are a contractor builds the structure on his two approaches with contractors. One is own account and then sells it. In such in- to register contractors, apply tax to the stances the tax would appropriately apply amounts of the contracts, and allow the to the selling price, the contractor receiv- firms credit for tax paid on their inputs- ing input tax credit. thus treating them as manufacturers. On construction of buildings for busi- Subcontractors are taxed in the same ness use, the tax would apply in the same fashion, the general contractor of course fashion as for housing construction. Some receiving credit for tax paid to the sub- complication is caused when the firm for contractor. One problem is that in some which the building is erected self-con- countries many contractors are small es- tracts. The purchase of inputs would of tablishments difficult to control. The al- course be taxable, but the total tax would ternative is to regard the contractors as be less as there is no contractor's margin. final consumers; they are not registered, Given the input tax credit feature, the only thus pay tax on their inputs with no in- tax saving is the liquidity gain, but this put tax credit, and they do not apply tax may be substantial. Rental of business on their sales. This second approach re- property would be taxable, except hous- duces the revenue from this sector and is ing, which most jurisdictions exclude from not satisfactory when the building is used tax for social policy reasons. for business purposes since no input tax There are timing problems with respect cra&t is-po"ible. to 4he input tax or-edk. If, for example, an The problem of taxing this sector is office building is erected, and tax applies complicated further by the fact that much to the contract price, the owner of the construction is for housing, owner-occu- building would receive an immediate in- pied or rental, and governments often seek put tax credit for the entire amount of the to hold down the tax element in housing. tax, thus likely being entitled to a large One method of accomplishing this is to , unless special rules are applied. No. 41 UNRESOLVED ISSUES OF VALUE ADDED TAXES 389 Immediate refund, of course, avoids dis- taxation of these sales when made by a couraging building. There are also com- registered firm encourages still more pri- plications relating to dual use for housing vate sales-in some instances the dealer and business purposes, as allocation of in- becoming merely a broker for a private put tax credit is necessary. sale. There is no general solution to this The sale of existing business buildings, problem. The most important category of just as houses, would presumably be ex- used goods sold among individuals is that empt from tax, especially in the view of of aut6hiobiles. There is merit in levying the very long life of many buildings and a separate tax on all sales of motor ve- the fact that no net consumption is in- hicles between non-registered persons, to volved in the shifting of ownership of a be collected in conjunction with the reg- building. For the same reasoning, sale of istration of the vehicle in the name of the land often is not subject to value added new owner. tax (Canada is an exception). 12 But a Related to the issue of the sale of used problem arises with the sale of a new goods is the tax treatment of -in al- building by a speculative contractor, since lowances. Does the tax apply to the gross the sale price would include an element price including the value of the trade-in, of land value. It is possible to allow an or to the price less trade-in, the sum ac- exclusion of the estimated sale value of tually paid? The actual consumption ex- the land, but this complicates compliance penditure is the net price paid; the item and administration. traded in represents a partially consumed good. This is most obvious with consumer durables, particularly when they are Secondhand Goods traded in after a relatively short period, The sale of secondhand goods creates no long before the end of their useful life. Yet particular problems with a single stage allowing the deduction of the trade-in al- retail sales tax, being treated as a usual lowance encourages overstatement of this sale and taxable. Failure to tax the sale amount and understatement of the mon- under a value added tax would materially etary payment. But this is the only fea- complicate record keeping for firms sell- sible solution consistent with the philos- ing both new and used goods and invite ophy of a . evasion, through labelling new goods as used ones. But application of tax to the The Approach to Multiple Rates selling price raises the question of input tax credit, particularly if the goods have Most value added taxes have at least two been purchased from non-registered in- rates: the basic positive rate and a zero dividuals or taken as a trade-in. There is rate. In many countries there has been no optimal solution to this problem. When extensive discussion over the use of mul- a VAT first goes into effect and the goods tiple positive rates as a means of making had not been taxed when originally sold, the tax more progressive and dampening there is no significant problem; tax will luxury consumer spending." While zero apply to the entire selling price without rating of basic foods and a few other items input tax credit. After the tax has been is without question effective in lessening in operation for a time, a common rule is the burden on the poor and regressivity, to allow the vendor to assume that a cer- there is substantial evidence that multi- tain percentage of the selling price rep- ple rates contribute little toward progres- resents tax originally paid on the item and sivity. There are numerous objections to treat this as an input tax for credit, but the use of multiple rates, as explained ef- this involves a deviation from standard fectively by Tait, though there may be VAT operation and should be avoided in justification for high rates on a few com- the interests of simplicity. modities. Apart from the latter, political The problem is aggrevated by the fact pressures and popular attitudes may re- that many sales of used goods are made quire some differentiation. The issue then between individuals not registered, and becomes: Should this be accomplished by 390 NATIONAL TAX JOURNAL [Vol. XLIII using more than one rate in VAT, or by offsetting gain. If the combined burden is supplementary or special con- regarded as excessive, the special levy can sumption levies? Particularly in devel- be reduced. oping countries, simplicity in the opera- tion of a VAT is essential for its effectiveness, and thus the case for a sin- Some Aspects of International gle rate is very strong. Transactions Under VAT Thus if differentiation is to be accom- plished, there is merit for doing this via As the value added tax has developed, special levies, imposed at a single stage it is essentially a levy on domestic con- (import and manufacturing), without VAT sumption: are zero rated, imports features. Such levies are certain to be used are subject to tax in the same fashion as on the traditional excise goods-tobacco, domestically produced goods, under the alcoholic beverages, and motor fuel-and destination principle. While the EEC has they can be extended to a few other major plans for harmonization and shift to the categories, such as automobiles. But the origin principle for trade within the Com- use of a number of special levies compli- munity for administration and collection, cates the overall tax structure in the revenue would be divided among member realms of compliance and control. Even countries in proportion to consumption, limited to a few commodities, this ap- that is, in accord with the destination proach is not ideal, since it encounters principle. For other countries the basic some of the objectionable features of a nature is unlikely to change. But various manufacturers sales tax-discrimination problems arise, which have often been ne- against integrated firms and encourage- glected. ment to shift functions beyond the point Many countries, especially smaller ones of impact of the tax. But despite these that have been seeking to develop problems, this approach is superior to us- markets, import substantial amounts of ing multiple rates under VAT. In coun- materials, machinery, etc., for export pro- tries in which the products subject to spe- duction. Under the basic rule, tax would cial levies have standard retail prices be collected at- importation, and the firms established by the importer, manufac- would receive credit for this tax and a re- turer, or the government, the tax can be fund at the time of export of the products. applied to the final retail price, avoiding But there is often strong pressure for ex- the distortions on allocation of functions empting the inputs, to reduce working by type of business activity, though col- capital requirements for these export-ori- lected from the manufacturer. ented firms, particularly if there is a de- Whether these special levies take the lay in paying refunds. If compliance is legal form of excises or special consump- complete there is no net revenue loss to tion levies is largely dictated by the tra- the government from exemption, except ditions of the country. In many British for the interest on the sums that would be Commonwealth countries, the concept of paid ahead of the time the input tax credit an excise as a levy only on domestic pro- would be given. But there are dangers from duction is so ingrained that it is difficult exemption. This practice will make more to apply such levies to both imports and difficult the development of domestic pro- domestic goods-which is imperative ff the duction of inputs now being imported- objectives of the levies are to be obtained, unless these purchases are zero rated-and and thus levies called consumption taxes add one more complication to the tax. Ex- are-pr-oferable. emption removes the tax from imported When a country is using excises or con- inputs, but not off domestic inputs; to do sumption taxes, or both, in conjunction so requires zero rating. Furthermore, there with a VAT, it is imperative that the items is always danger that some of the goods subject to the special levies are also sub- imported tax free will leak into the do- ject to VAT. To do otherwise seriously mestic market, other than through reg- complicates the operation of VAT, with no istered firms. On the whole there is merit No. 4] UNRESOLVED ISSUES OF VALUE ADDED TAXES 391 in not exempting these inputs-but the transaction, and should be subject to zero pressure is strong. rating. But questions arise as to what Related is the practice encountered in '@performed in another country" means. some countries of exempting various in- Does it mean, as may occur, that persons puts in manufacturing, imported or do- go from the home country to the other mestic, rather than allowing the firms to country to perform the services and the claim input tax credit. The reason for doing customer is billed in the latter? But often so is the same as that relating to im- much of the work, and perhaps all of it ports-to lessen the need for working (preparing plans for a new factory, for ex- capital, and with industrial machinery, the ample) win be performed in the home amount of money capital necessary for country. The basic rule that appears most development or expansion of a business. satisfactory is one based on where the But this practice is contrary to the basic benefits of the service are realized, not on nature of a VAT and creates serious com- where the work is done. As an export plications. There is great merit in avoid- transaction, credit would be allowed for ance of any exemptions of commodities in input tax paid, a value added tax, and to rely on the in- The treatment of import of services is put tax credit feature to avoid cascading. much more difficult operationally. Ob- A number of questions arise with re- viously a foreign firm carrying on service spect to international transport. One is activity within another country, with vol- application of VAT to tickets for inter- ume of receipts in excess of the threshold, national travel, particularly air travel. must register under VAT and collect and When a country does so, there is grave remit tax. But frequently, much of the danger that travellers will simply buy work may be done outside the country, and tickets to a neighboring country and then in many instances the foreign firm would acquire the remainder of the ticket. Rigid not be above the threshold on the basis of exchange controls may prevent this, but work in the country and not liable to reg- the wealthier travellers will often have ister. There is therefore likely to be sub- foreign exchange from outside sources. stantial leakage, much of it legal. One op- If domestic tickets are taxable and in- tion is to require the user of the service temational ones are not, a problem arises to account for tax on the service when the with respect to trips that are partly do- tax has not been collected by the service mestic, partly international. There are also firm. But enforcing this rule is possible questions relating to various sales and only with an adequate audit program and services to international carriers, both air only against registered firms. Further- and sea. Some countries, for example, do more, much of the effort to enforce it is extensive servicing and repair for foreign wasted because the tax would constitute airlines and cruise ships, as well as pro- an input tax credit for the firm benefit- viding supplemental fuel. Are these to be ting from the service. Only when the ser- defined as export transactions? There is vice is rendered to a non-registered per- merit in doing so, in part because much son is there any net tax involved. of the business may be lost to neighboring There are other problems with certain countries if this policy is not followed. types of international transactions. For There is always some danger that the example, if tours are taxable, which coun- goods may leak back into domestic use try has the appropriate claim, the country without payment of tax. where the tour is booked and paid for, or Some of the most diiticult problems arise the country in which the tour occurs? The with regard to other types of services latter choice is more logical, but difficult which take on an international character: to enforce. Magazine subscriptions also a public accounting, law, or managerial create operational problems. Typically consulting firm in one country provides magazine subscriptions within the coun- services in another country. How is this try are taxable, as are individual pur- to be treated? Rendering of services in an- chases of magazines. But customers may other country is basically an export order magazine subscriptions from pub- 392 NATIONAL TAX JOURNAL [Vol. XLIII lishers or distributors outside the coun- A related issue is that of the require- try. These should be subject to tax. But it ment of tax invoices." Many countries is not feasible to collect the tax when the specify exactly what a tax invoice, eligi- individual magazines enter the country ble as a basis for input tax credit, must (bulk shipments for distribution within the contain. These are fairly complicated, and country can be taxed), and there is no way not suitable for the typical retail trans- to ensure that tax is paid on the subscrip- action. It is imperative that simplified tion-in the absence of rigidly enforced forms of invoices be acceptable, including exchange controls. mere cash register receipts, but they must show the tax separately from the price. To prevent business firms from accumulat- Quotation of Tax and Invoicing ing these receipts for personal purchases The VAT may be quoted separately from to gain input tax credit, they can serve as the price of the product, or it may be in- a basis for such credit only when accom- corporated into the price. Separate quo- panied by adequate documentation. Some tation on sales to other registered firms count-ties have encountered problems with is connnonly required and has obvious firms advertising that purchases from merit, since it serves as the basis for de- them are free of value added tax. This is termining the amount of input tax credit, deliberately misleading, and legislation without the need for factoring out the is necessary to prevent it. amount. It also facilitates the audit trail for control of the various firms. On final sales, there is less necessity of separate The Refund Issue quotation, and some countries, as a mat- A necessary key element in a value ter of general policy, not only do not re- added tax is the credit for input tax and quire it but prohibit it. Commonly a choice the ability to obtain a refund if the input is given the firm. But tax-inclusive pric- tax credit exceeds the tax due on sales. ing of VAT on final sales requires that This situation will occur with firms with vendors distinguish between sales to reg- substantial export business, with almost istered firms and other customers, which all new firms starting up, and with firms they do not otherwise need to do. With any expanding the business or acquiring ex- form of sales tax it can be argued that pensive new equipment. there is merit in having final consumers The inherent problem with a value aware of the amount of tax they are pay- added tax is the danger that fraudulent ing-although in some countries there is claims for refunds will be made, without long-standing preference that consumers any invoices to justify them or fictitious not be aware of the tax. But a main rea- invoices. This is not a major problem in son for allowing separate quotation of tax Europe, but it is in many developing on the final sale is to avoid the necessity countries. Accordingly, the governments for the firms to distinguish between the have been reluctant to pay out the re- two types of purchasers-as they must do funds, at least prior to a time-conftliming with the usual retail sales tax. Another audit. Guatemala and the Dominican Re- reason is that this sale lessens the danger public are examples. If revenue is to be that firms may add tax to all goods, zero protected, the government may find itself rated as well as taxable. in a position of being unable to make the A related issue is whether the VAT rate refund payments on schedule. This in turn should apply to tax inclusive rates. Only destroys the confidence of the business Sweden and Finland do so. This of course cormpunity in the gqverninent and the permits a lower* to raise the 'sa--me su'r@v-4i-v@a'r6fthe in@ut ii@Kcre(fli system, key money. But application to the price net of to the operation of a value added tax. The VAT not only is simpler to understand, but problem is not so much one of structure stresses the separation of the VAT charge of the tax as it is of effective audit and from the price of the good throughout pro- enforcement but it does-endanger the type duction and distribution levels. of sales tax that is essentially the most No. 41 UNRESOLVED ISSUES OF VALUE ADDED TAXES 393 desirable by usual standards. restrict the coverage of the VAT to in,- Drain of revenue has been encountered portation and manufacture, the use of in some countries when refund of the pre- thresholds for registration unsuited to ef- vious sales tax on stocks of goods on hand fective operation of the tax, the use of ex- or credit for this tax against current VAT emption instead of zero rating, the prob- liability was authorized. By logic this rule lemr, of treatment of services and building seem&4'rable,w but t4e effoct on reven _ue construction and sale, and excessive use is so drastic in the first few months of a of multiple rates in the tax. Many of these new VAT that it may be intolerable from issues have no ideal solutions and only the govenunenvs standpoint. Based on this second best ones are feasible. experience, other countries have not been providing such a credit. It can be argued that the previous tax was providing rev- ENDNOTES enue in the period in which it was in ef- **The author is greatly indebted to Professors Oliver fect and thus no refund is warranted; the Oldman and Charles McLure for their comments on the original version of the manuscript and to them fact that some goods which were sub- and Professors Carl Shoup, Richard Bird, Sbbren jected to the previous tax will be hit by C,.,,,,, and Malcolm Gillis, and Drs. Alan Tait and the VAT is not relevant in terms of eq- S. N.Poddar,togetherwithtax policyand tax admin- uity, since the new tax is providing gov- istration personnel in a number of developing coun- tries for discussion of the various issues. ernment revenues in the subsequent pe- loii-.r major references include Bird (1985, 1987), riod. American Bar Association (1989), U S Treasury (1984), Aaron (1981), Canada Department of Finance (1989), Shoup (1988), Cnossen (1982,1985) Conclusion 2A good statement of this issue is provided in Cnos- ,,en (1985). There is general agreement that an ideal 3The issue is reviewed by Tait (1988), Organization value added tax would apply to all pro- for Economic Cooperation and Development (1988), duction activity, by the private sector and and Due (June 1990). 4A detailed discussion is provided by Tait (1988, government, at a uniform rate, without chap. 7), Organization for Economic Cooperation and exemptions or zero rating except of eX- Development (1988, 160-162), and Due (June 1990). ports. The New Zealand levy comes close 5See Tait (1988, chap. 3). In Europe, widespread use to this ideal. But typically deviation from of zero rating is largely a British-Irish phenomenon. 'rhe Tanzanian structure is explained in Due (May the ideal is imperative, especially in de- 1990). veloping countries. Some of the devia- 'For further discussion, see Cnossen (1985, pp. 48- tions arise from purely compliance and 58), Gandhi (1977), and Kay (1990). administrative considerations, particu- 'This issue has received extensive consideration in the literature. See for example Gillis (1990, chap. 7), larly the need for excluding small firms Bakker (1985), Barham (1987), Henderson (1988), and farmers from the coverage of the tax, Hoffmn (1987), Weidenbaum (1989). except in a few most highly commercial- @LON/79/286. ized countries. Some arise from the prob- 'OVATTribunals Report (1988), 40-43. "The question is considered by Conrad (1990) and lerns with financial institutions, defining Tait (1988,80-89). value added and delineating lending ac- "Tait (1988,102-105). tivities from financial intermediation. 13The rate structure issue is considered by Cnossen Some arise from equity and social policy (1982) and Tait (1988, 42-43). considerations, especially the desire to "Tait (1988, 279-281). minimize the absolute burden on the low- est income groups. But all of these devia- REFERENCES tions create serious borderline delinea- A,, Henry J. (1981). The Value-Added Tax:Les- tion and operational problems, and sonsfi-omEurope. Washington,D.C.:BrookingsIn- frequently decisions have been made that stitution. are contrary to the basic philosophy and AmericanBar Association(1989).ValueAdded Tax: operational capacity of the tax. Almost all A ModelStatute and Commentary. Bakker, Carl, and Phil Chronican (1985). Financial Of the deviations result in loss of eco- Services and the GST. 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