rita de la feria ( centre for business taxation, university of oxford) and ben lockwood
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Opting for Opting In? An Evaluation of the Commission’s Proposals for Reforming VAT for Financial Services. Rita de la Feria ( Centre for Business Taxation, University of Oxford) and Ben Lockwood (University of Warwick and Centre for Business Taxation, University of Oxford) - PowerPoint PPT PresentationTRANSCRIPT
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Opting for Opting In? An Evaluation of the Commission’s
Proposals for Reforming VAT for Financial Services
Rita de la Feria (Centre for Business Taxation, University of Oxford)
and Ben Lockwood
(University of Warwick and Centre for Business Taxation, University of Oxford)
ETPF Conference, London, 27 April 2009
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April 27, 2009 VAT on Financial Services
Outline Why are Margin-based Financial Services Difficult
to Tax?
The Current Situation in the EU
The Commission’s Proposals: The “Three Pillars”
The Option to Tax: A Closer Look
The Incentives to Opt In
The Revenue Effects of Opting In
Alternatives to the Commission’s Proposals
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April 27, 2009 VAT on Financial Services
Why are Margin-based Services Difficult to Tax? Theory; consumption VAT should tax the value-added provided by
financial intermediation services (FIS), such as bank lending, insurance
But, in practice, difficult to distinguish value of FIS provided to lender and borrower
Example: bank pays 5% on a deposit of £1000, lends it out at 8%, so total value-added is 3% of £1000 i.e. £30
Not a problem if neither lender nor borrower are liable for VAT; just tax the total of £30
But if one or both are liable for VAT, need to determine VAT that can be reclaimed by each party (borrower, lender) on purchases of FIS, to avoid breaking the VAT chain
Theoretically, a cash-flow system of taxation with tax calculation accounts (TCAs) can solve this problem. But, has been assessed by the Commission and found unworkable in practice
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April 27, 2009 VAT on Financial Services
The Current Situation in the EU Most insurance and financial services are exempt under Article
135(1) of the VAT Directive An exception is where the financial service is exported outside the EU;
in this case, input VAT can be deducted (i.e. destination-based VAT)
Article 132(1)(f) of the VAT Directive allows cost-sharing groups 13 out of 25 current member states have national rules governing
these, with considerable variation in in scope and method National rules vary according to substantially
Article 137(a) of the VAT Directive currently allows (but does not compel) Member States to introduce an option to tax on all services except for insurance
Discretion on detail left to member states So far, only six member states (Austria, Belgium, Estonia, France,
Germany, Lithuania) have opted in, with considerable variation in scope and method
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April 27, 2009 VAT on Financial Services
The Current Situation in the EUDifficulties for Traders and Tax Administrations Arising
from Exemptions
Legal Economic
Definitional and interpretative problems
Irrecoverable VAT
Calculation of recoverable input VAT and apportionment of tax
Self-supplies vs. outsourcing: bias away from outsourcing
Planning and aggressive planning Foreign vs. EU suppliers: bias towards foreign suppliers
Violation of the consumption tax principle Tax cascading
Loss of tax revenue
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April 27, 2009 VAT on Financial Services
Ongoing Review:“The Three Pillars” Growing ECJ case-law: first cases from late 1990s
Previous review attempts (TCA 2000)
Current review process initiated in wake of Accenture ruling (2005)
Consultation paper in 2006
Current legislative proposals presented in November 2007, based on “three pillars”: Re-definition of exemption criteria based on explicit lists Extension / clarification of cost-sharing groups Major extension of option to tax
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April 27, 2009 VAT on Financial Services
Re-Definition of Exempt Services Clarification of exemptions applicable to insurance and
financial services through: Amendments to VAT Directive, with broad interpretative
guidelines provided Inclusion in separate Regulation of two detailed lists of
insurance and financial products, one of exempt products, and one other of taxable products
Rationale: to increase levels of legal certainty
Measures are helpful from legal perspective, but not a panacea: List will become naturally out of date in short to medium term
as new insurance / financial products arise Approval of amendments will not be straightforward Listings likely to give rise to interpretative / application
difficulties at the “edges” – with consequent planning / avoidance opportunities
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April 27, 2009 VAT on Financial Services
Scope of Current Cost-Sharing Groups
GROUP MEMBERS
PLACE OFESTABLISHMENT
RIGHT TODEDUCT
ESTABLISHEDIN SAME
MEMBER STATE
ESTABLISHEDIN ANY
MEMBER STATE
FULLY EXEMPT
PARTIALLYEXEMPT
ESTABLISHEDIN THIRD
COUNTRIES
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April 27, 2009 VAT on Financial Services
New Cost-Sharing Groups
New proposals extend / clarify current regime, using new terminology: Group members must be established within territory of
Community Eliminated reference to “distortion of competition” Exclusion of transfer-pricing adjustments
Problems/ limitations: Lack of further guidelines likely to give rise to different
national designs - only limitation being that members cannot be established in third countries
Some economic bias remains due to limited scope of measure e.g. outsourcing not covered
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April 27, 2009 VAT on Financial Services
Scope of Current Options to Tax
TRASANCTIONS COVERED
TYPECUSTOMERS’
NATUREQUANTITY
ALL EXEMPT TRANSACTIONS
SPECIFICTRANSACTIONS
B2B B2CSUPPLIER
BYSUPPLIER
TRANSACTIONBY
TRANSACTION
TIME SPAN
REVOCABLE IRREVOCABLE
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April 27, 2009 VAT on Financial Services
Extension of the Option to Tax New proposals extend current option to tax :
Compulsory introduction by all Member States of option to tax
Scope of option to be extended to all exempt services (including insurance services) BUT no guidelines on either design of option (scope), or method of taxation
Approval of details of option postponed to later stage
Rationale: eliminate all problems connected with exemptions and non-deductibility of input tax
Measure is problematic from legal perspective: Lack of further guidelines on design of proposal likely to
give rise to very different designs – only limitation being “type” of services to which option applies, and perhaps the “customer’s” status
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April 27, 2009 VAT on Financial Services
Extension of the Option to Tax
Conceptually, can technical difficulties be overcome?
“the option can only be exercised in specific transactions where the supplier invoices a ..taxable amount” (Commission, 2008)
So, two possibilities: either many margin-based products may continue to be untaxed; or problem of taxing financial services has finally been overcome!
If second, why not bring services within scope of full taxation?
Measure is not likely to eliminate current difficulties connected with exemptions
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April 27, 2009 VAT on Financial Services
Option to Tax: Incentives to Take up Option?Economic framework:
EU-based purchaser (B or C)
EU-based seller(s) of VAT-exempt financial services
Foreign e.g. US seller of VAT-exempt financial services
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April 27, 2009 VAT on Financial Services
Option to Tax: Incentives to Take up Option?Three scenarios studied:
many EU sellers (perfect competition)
single EU seller (monopoly)
EU and foreign seller (duopoly)
Robust conclusion: EU sellers have an incentive to “opt in” if and only if selling to a business purchaser
holds whatever the degree of competition in the market
holds even if facing “unfair” competition from foreign seller
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April 27, 2009 VAT on Financial Services
Option to Tax: Incentives to Take up Option? Example
opt out Opt in, B-to-C Opt in, B-to-B
Price of input ex VAT
100 100 100
VAT on input 10 10 10
Price of output inc. VAT
200 200 220
VAT on output 0 18.2 20
Profit 200-110 =90 200-110-(18.2-10) =81.8
220-110-(20-10)=100
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April 27, 2009 VAT on Financial Services
Option to Tax: Incentives to Take up Option? Conclusions:
Theoretically, strong incentives take-up of the option to tax on B to B transactions
But, this is subject to the constraint that “the supplier invoices a ..taxable amount”
And, may be little take-up of the option to tax on B to C transactions
B-to-C is significant proportion of the total: domestic demand for FI services by final consumers is between 45% and 75% of total for EU countries (Huizinga(2002))
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April 27, 2009 VAT on Financial Services
Option to Tax: Revenue Consequences Member countries are concerned about possible
negative impact on tax revenue i.e. loss of “irrecoverable VAT” on inputs to the FS sector
Lack of detailed data on this
“approximate figures for the United Kingdom indicate that unrecoverable VAT accounts for roughly 20% of the total UK taxes paid by the sector” (European Commission, 2008)
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April 27, 2009 VAT on Financial Services
Irrecoverable VAT: How Big is the Problem?
Table 1: Estimates of Irrecoverable VAT
Country Value of purchases of intermediate inputs, million Euro, 2006
Standard rate of VAT (%)
C-efficiency ratio
Estimated VAT paid on inputs, million Euro, 2006
Estimated irrecoverable VAT, million Euro, 2006
Estimated irrecoverable VAT, % of total tax revenue
1 2 3 4 5 6 France 66907.39 19.6 0.51 6688.06 1337.61 0.15 Germany 85414.57 19 0.54 8763.53 1752.71 0.17 Italy 38064.40 20 0.41 3121.28 624.26 0.05 Netherlands 15407.45 19 0.61 1785.72 357.14 0.14 Spain 22262.86 16 0.56 1994.75 398.95 0.10 UK 163622.63 17.5 0.49 14030.64 2806.13 0.35
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April 27, 2009 VAT on Financial Services
Option to Tax: Revenue Losses
Table 3: Estimated Revenue Losses from Allowing Opting In Estimated
irrecoverable VAT, million
2006 Euros
Intermediate demand as %
of total output*
Estimated maximum loss from allowing
opting in, million 2006 Euros
Estimated maximum loss from allowing
opting in, % of total tax revenue
France 1337.61 0.67 896.37 0.10 Germany 1752.71 0.70 1225.50 0.12 Italy 624.26 0.80 498.66 0.07 Netherlands 357.14 0.59 211.07 0.08 Spain 398.95 0.74 293.63 0.07 UK 2806.13 0.58 1624.02 0.20
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April 27, 2009 VAT on Financial Services
Option to Tax: Revenue Consequences
Loss of tax revenue need not be equal to irrecoverable VAT of the financial services sector, because of second round/general equilibrium effects;
opting in reduces costs of FS firms, and thus their output prices in competitive markets
In turn, this reduces input costs of purchasers of FS, possibly lowering final goods prices
If final demand is elastic, value of final sales will increase and there will be an offsetting revenue rise
But is the GE effect likely to be quantitatively significant?
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April 27, 2009 VAT on Financial Services
Option to Tax: Revenue Consequences
We investigate this using a simple general equilibrium model: competitive FS providers sell to another sector (manufacturing), which produces a good for final consumption
The model is (crudely) calibrated using UK input-output tables
The GE effect is small (<25%) relative to the first-round effect
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April 27, 2009 VAT on Financial Services
Conclusions: Evaluation of 2007 Proposals Pillar One: “re-definition of insurance and financial services”
Legal assessment: improvement on current status quo, but not a medium term solution
Economic assessment: distinctions between different products likely to create distortions
Pillar Two: “cost-sharing groups” Legal assessment: limited scope of application Economic assessment: limited scope likely to create distortions
Pillar Three: “option to tax” Legal assessment: likely to give rise to significant difficulties Economic assessment: may not be widely used, but even if it
is, the overall revenue losses are likely to be small