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All content in this area was uploaded by Richard Krever on Jun 09, 2016
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CHAPTER 1
Ending VAT Exemptions: Towards a
Post-Modern VAT
Rita de la Feria and Richard Krever
*
§1.01 INTRODUCTION
Struggling to rebuild its economy three years after the end of the Second World War,
the French government decided to try a unique gamble, rebating the turnover tax borne
by a selected range of enterprises exporting their goods. The hope was that the increase
in exports from a more competitive and efficient export sector would more than offset
the initial revenue cost of the refunds. The gamble paid off and the experiment was
extended a few years later to more turnover tax transactions.
1
By the 1960s, plans were
put in place to transform the entire turnover tax system to one that would rebate the
turnover tax all the way along the production chain to the final consumer, shifting the
turnover tax from an inefficient compounding tax on production or sales to an efficient
and fair tax on final consumption. Europe was on the path to a value added tax.
2
* We are grateful to our discussant Stephen Smith, and to participants at the conference for
comments received therein. All remaining errors are our own. This paper forms part of the
work undertaken under ESRC Grant RES-060-25-0033.
1. At the time, the introduction of the value added tax was characterized as ‘an invention of the
first order’, and France as an ‘innovator in taxation’: see C.S. Shoup, Taxation in France, 8(4)
Natl. Tax J. 325−344 (1955).
2. An earlier VAT had been enacted in 1953 at state level in Michigan in the United States, but
without the VAT’s invoice-credit format that now prevails around the world. For an analysis of
this earlier VAT see C.W. Lock, D. Rau & H. Hamilton, The Michigan Value-Added Tax, 8(4)
Natl. Tax J. 357−371 (1955); and J.A. Papke, Michigan’s Value-Added Tax After Seven Years,
13(4) Natl. Tax J. 350−364 (1960). A VAT had also been enacted in 1950 in Japan but was
repealed a few years later, prior to commencement; see M. Bronfenbrenner, The Japanese
Value-Added Sales Tax, 3(4) Natl. Tax J. 298−314 (1950); and A. Schenk, Japanese Consump-
tion Tax: The Japanese Brand, 42 Tax Notes 1625 (1989).
3
From Europe to the rest of the world, the new value added tax (VAT) quickly
spread, becoming what has been described as an unparalleled tax phenomenon,
3
and
the most important event in the evolution of tax structure in the last half of the
twentieth century.
4
Yet, despite its overwhelming popularity and its undeniable appeal
in its pure form, in practice VATs applied around the world are – to different degrees
– imperfect with exemptions, an anathema to the logic of the VAT,
5
being a common
and significant design imperfection in many of those tax systems.
6
Not only do they
constitute exceptions to the core principle of VAT as a tax on consumption, but they are
also equally perceived as being particularly damaging to the efficiency and neutrality of
the tax.
7
In European countries, where VAT was first introduced, exemptions consti-
tute a very sizable – and growing – portion of the potential tax base. In most other
countries around the world, where a VAT was enacted later, the number of exemptions
is typically significantly smaller and alternative legal designs for taxing specific sectors
of the economy that are exempt under the European VAT have been adopted.
However, whether considering a traditional VAT – like that applied in European
countries – or a modern VAT – such as that applied in New Zealand, Australia or
Canada – questions remain over the suitability of exemptions.
8
Are VAT exemptions, in
the words of one contributor to this volume, a necessary evil, an unnecessary evil, or
no evil at all?
9
Thirty years since the first appearance of modern VATs on the world
stage the debate on (or battle against) exemptions continues, and if anything has
actually intensified.
10
Is it time to consider a shift in tax design and progress towards a
post-modern VAT?
11
The various chapters in this volume attempt to answer these questions through
in-depth analysis of existing exemptions and consideration of alternative legal designs
– both of those designs that have already been attempted in different countries around
the world, and of others that are as yet untested. It would be impossible to do justice
in this introductory chapter to the wealth of knowledge and insight displayed in all
these contributions. Our aim, therefore, is merely to bring together in a systematic
3. A.A. Tait, Value Added Tax – International Practice and Problems 3 (International Monetary
Fund 1988).
4. S. Cnossen, Global Trends and Issues in Value Added Taxation, 5(3) Intl. Tax & Pub. Fin.
399−428 (1998).
5. I. Crawford, M. Keen & S. Smith, Value-Added Tax and Excises,inDimensions of Tax Design –
the Mirrlees Review 275−422 (S. Adam, T. Besley, R. Blundell, S. Bond, R. Chote, M. Gammie,
P. Johnson, G. Myles & J. Poterba eds., Oxford University Press 2010).
6. V. Lenoir, April 1954–April 2004 – VAT Exemptions: The Original Misunderstanding,10
European Taxn. 456−459 at 459 (2004). The multiple rates found in some jurisdictions,
particularly in European countries, constitute another serious deviation from the theoretically
ideal VAT.
7. See OECD, Consumption Tax Trends 2010, at 15 (OECD Publishing 2011).
8. The expression ‘modern VAT’ to classify this new, improved VAT model, as opposed to the
‘traditional VAT’ used in Europe, appears to have been coined by L. Ebrill, M. Keen, J-P. Bodin
& V. Summers, The Modern VAT (International Monetary Fund 2001).
9. See J. Englisch, The EU Perspective on VAT Exemptions, Ch. 2 in this volume.
10. As predicted by L. Ebrill (n. 8 above), at 198.
11. As referred to in the Preface to this volume, the use of the expression ‘post-modern’ is not
meant in the cultural sense of ‘postmodernism’, but rather to express the shift from a modern
VAT to a new, improved, VAT.
Rita de la Feria and Richard Krever§1.01
4
fashion all the various topics discussed therein, as well as to offer our own thoughts on
the future of VAT exemptions.
In section §1.02, we start with general considerations on VAT exemptions,
discussing their origins, namely through consideration of their historical roots in the
European model and the attempt to limit their scope in modern VATs; and then
consider the concept of exempt supplies, particularly when compared to that other
similar concept of out-of-scope supplies. In section §1.03, we delve deeper into the
concept of out-of-scope activities and analyse the two main types of activities which fall
within this concept: those that are deemed to be out-of-scope for reason of the type of
supply in question (out-of-scope supplies), and those that are regarded as out-of-scope
because of the nature of the supplier (out-of-scope suppliers). In section §1.04, typical
exemptions are analysed in detail. We consider first the so-called merit or concessional
exemptions, such as those typically applied to healthcare, cultural activities and
education services; and we then move on to technical exemptions, applied to what is
known as difficult-to-tax supplies, namely gambling, immovable property and finan-
cial and insurance services. We conclude in section §1.05 with considerations on the
current state-of-play as regards VAT exemptions and potential alternative designs, and
on a possible move to a post-modern VAT.
§1.02 GENERAL CONSIDERATIONS ON VAT EXEMPTIONS
[A] On the Origin of Exemptions
The theoretical roots for the VAT were sown shortly after the First World War when an
American scholar and a German industrialist separately, but almost at the same time,
wrote papers setting out proposals for the tax. The timing of the first proposals remains
unclear, with one later scholar attributing the first articulation to T.S. Adams, a leading
public finance scholar in the US.
12
However, it is more likely that industrialist Carl
Friedrich von Siemens’pamphlet slightly preceded Adams’work by a year.
13
Ironi-
cally, neither advocate for the VAT viewed their proposals as reforms for turnover
taxes; rather, both saw it as a possible substitute for corporate income tax, which they
thought to be inferior to a tax that ultimately fell only on final consumption. It is almost
certain that neither was aware of the other’s contributions to the subject.
As is so often the case, the ultimate adoption of the VAT had little to do with the
grand theoretical concerns of academics or industrialists, but rather was a response to,
on the ground, pragmatic considerations. At the time VAT was adopted in France, there
were two models for final consumption taxes that eliminated cascading taxes on
12. See R.W. Lindholm, The Origin of the Value-Added Tax, 6(1) J. Corp. L. 12 (1980). Lindholm
suggests Adams had supported the concept from 1911, although his earliest papers on the topic
appear to date from 1921: see T.S. Adams, Fundamental Problems of Federal Income Taxation,
XXV Q. J. Econ. 553 (1921).
13. Cf. von Siemens, Veredelte Umsatzsteuer (Siemensstadt 1919), who cites his brother, Wilhelm
von Siemens, as originator of the proposal: see R.A. Musgrave, Schumpeter’s Crisis of the Tax
State: An Essay in Fiscal Sociology, 2 Evolutionary Econ. 89−113, at fn.9 (1992).
Chapter 1: Ending VAT Exemptions: Towards a Post-Modern VAT §1.02[A]
5
business, which distorted business decision-making and encouraged possibly ineffi-
cient practices such as vertical integration. The first was the retail sales tax (RST),
adopted in most sub-national jurisdictions in North America, which avoids tax on
business through a suspension system: the tax is, in theory, suspended on any supplies
made to registered enterprises making acquisitions for business purposes. The VAT in
contrast, imposes tax on every supply, be it to a registered business or final consumer,
but then rebates, through a refundable input tax credit, any tax borne on business
acquisitions. Each business will collect tax on the full value of its supplies but only
remit a net amount after recovering all tax on inputs used for business purposes. It will
pay tax on the entire price to the supplier but then recover it from the customer and
only remit the portion of the VAT collected equal to the value added at that stage. Thus,
while VAT is paid by the purchaser on the full value of supply, the seller only passes on
to the government a slice of the tax received equal to the tax on the excess of the sale
price over the value that has previously been taxed. Only if no part of the value has
been subject to tax previously (all the inputs were entirely tax free) would the tax
remitted be the same as the tax collected. The title ‘value added tax’ refers therefore to
the mechanics of the remittance system, not the intended tax base, which is the full
value of the supply.
14
For that reason, a number of modern VAT systems have adopted
the name ‘Goods and Services Tax’ (GST) to reflect the tax base as opposed to the
remittance method.
Although an ideal RST and an ideal VAT should be economically equivalent,
15
in
practice their differences, in particular as regards the remittance method, may affect
their economic impact
16
and administrative efficiency. Since the time of adoption of the
RST and VAT, there has been, therefore, an ongoing debate on the relative merits of the
two bases.
17
Proponents of VAT argue – amongst other aspects – that it is more
14. Ebrill et al. illustrate the difference with a restaurant meal in a tax regime in which raw food
products are entirely free of tax from the farmer through wholesaler through retailer, see n. 8
above. The value added by the restaurant may represent only a small amount of the final selling
price but if the sale of raw food is tax free while restaurant meals are taxable supplies, the entire
value of the meal will be taxed at the restaurant level.
15. See W. Hellerstein, Comparing the Treatment of Charities under Value Added Taxes and Retail
Sales Taxes, Ch. 5 in this volume. See also S. Cnossen, VAT and RST: A Comparison,35
Canadian Tax J. 3 (1987); M. Gillis, P. Mieszkowski & G. Zodrow, Indirect Consumption Taxes:
Common Issues and Differences Among Alternative Approaches, 51(4) Tax L. Rev. 725−774
(1996); C.H.E McLure & W. Hellerstein, Congressional Intervention in State Taxation: A
Normative Analysis of Three Proposals, 31 State Tax Notes 721−735 (2004); and M. Keen & S.
Smith, VAT Fraud and Evasion: What Do We Know and What Can Be Done?, LIX(4) Natl. Tax
J.L861−887(2006).
16. See S. Fedeli, The effects of the interaction between direct and indirect taxation: the cases of VAT
and RST, 53(3-4) Pub. Fin. 385−418 (2003). On the economic impact of who remits tax, see also
J. Slemrod, Does It Matter Who Writes the Check to the Government? The Economics of Tax
Remittance, LXI(2) Natl. Tax J.L 251−275 (2008).
17. The key issues in the debate are surveyed in R. Bird & P-P. Gendron, The VAT in Developing
and Transitional Countries Ch. 3 (Cambridge U. Press 2007), ‘Is VAT Always the Answer?’. The
relative merits of the two versions of a ‘final consumption’ VAT were considered in S. Cnossen,
The Technical Superiority of VAT or RST,inAustralian Tax Reform in Retrospect and Prospect
325−359 (J.G. Head ed., Australian Tax Research Foundation 1989), and later debated at some
length in N. Leccisotti & M. Maré, On the Presumed Technical Superiority of VAT, 9(3)
Rita de la Feria and Richard Krever§1.02[A]
6
resistant to losses through fraud because of the incremental collection on the way,
18
while proponents of the RST argue a VAT system which offers refundable tax credits all
the way up an economic chain may actually be more susceptible to fraud. They also
argue the churning – collection of VAT and subsequent upfront refund in cases where
the buyer would use acquisitions to make supplies over a long period – is inefficient
and costly to businesses that have to fund finance for the period between remittance
and refund. In response to this particular concern, the VAT in many jurisdictions has
moved to adopt the RST model and suspend any tax – via a zero-rating mechanism –
on supplies in a range of circumstances such as sales of going concerns
19
or intra-group
supplies.
20
This debate did not feature in the initial decision to adopt the VAT in Europe.
The first moves towards a VAT in France consisted of a slight tinkering of an existing
tax to provide refundable input tax credits in limited circumstances.
21
The very
gradual expansion of the program in France pointed the way to a method by which
existing European turnover taxes could be transformed into final consumption taxes,
without replacement with a radically new tax such as a RST. The Neumark
Committee, appointed by the European Commission to assess tax impediments to and
options for a common market, suggested in 1962 that Europe’s existing turnover tax
systems could follow the French example and be easily shifted to a final consumption
tax through the use of input tax credits,
22
a proposal which has been characterized as
Australian Tax Forum 259−269 (1992) and S. Cnossen, Misunderstanding VAT: A Comment on
‘On the Presumed Technical Superiority of VAT’, 9(3) Australian Tax Forum 271−276 (1992).
18. For a recent view on why VAT is a preferred form of taxation, see S. Cnossen, A VAT Primer for
Lawyers, Economists and Accountants, 55(4) Tax Notes Intl. 319−332 (2009).
19. In the EU, Articles 19 and 29 of the Council Directive 2006/112/EC of 28 November 2006 on the
common system of value added tax, OJ L347 of 11 December 2006, 1–118, hereafter ‘EU VAT
Directive’ allows Member States to consider that no supply of goods or services has taken place
on sales of ongoing concerns. On the EU Court of Justice interpretation of these rules, see recent
commentary by G. Richards, Finanzamt Ludenscheid v. Christel Schriever:shedding more light
on transfers as a going concern, 2 British Tax Rev. 151−153 (2012).
20. In the EU, Article 11 of the EU VAT Directive gives Member States the option to introduce a VAT
grouping scheme, although it does not provide any guidelines on its design. Consequently just
over half of the EU Member States have introduced a VAT grouping scheme, but with legal
designs that vary greatly. On this topic see European Commission, Communication from the
Commission to the Council and the European Parliament on the VAT Group option provided in
Article 11 of Council Directive 2006/112/EC on the common system of value added tax,
COM(2009) 325 final, 2 July 2009; A. van Doesum & G.J. van Norden, T(w)o become one: the
communication from the Commission on VAT grouping, 6 British Tax Rev. 657−667 (2009); and
J. Swinkels, The phenomenon of VAT groups under EU law and their VAT-saving aspects, 21(1)
Intl. VAT Monitor 36−42 (2010). Australia, New Zealand, Canada and Singapore are just some
of the other countries which also allow VAT/GST groups; for a general overview of the
applicable rules in these countries, see P. Stacey, A rational basis for setting GST and VAT
grouping thresholds, 17(3) Intl. VAT Monitor 186−190 (2006); R. Millar, Time is of the Essence:
Supplies, Grouping Schemes and Cancelled Transactions, 7(2) J. Australian Taxn. 132−195
(2004); and R. Thomas, Leaving a GST group – Is a Clean Exit Possible?, 9(6) Australian GST J.
73−76 (2009).
21. The work of M. Lauré was particularly influential in the French process of adopting a VAT: see
M. Lauré, La Tax à la Valeur Ajoutée (2d ed., Librarie du Receuil Sirey 1953) and M. Lauré, Au
Secours de la TVA (Presses Universitaires de France 1957).
22. Also known as the Fiscal and Financial Committee, the Neumark Committee was set up by the
European Commission to assess the manner by which the disparities of public finance within
Chapter 1: Ending VAT Exemptions: Towards a Post-Modern VAT §1.02[A]
7
‘audacious’.
23
In light of the recommendations of the Neumark Report, the European
Commission submitted legislative proposals which envisaged the adoption by Member
States of a common system of VAT that followed the fundamental principles of the
French VAT system.
The final proposal by the European Commission deviated from the majority
recommendation of the Neumark Committee that the VAT operate up to but not
including the final retail stage, instead calling for the adoption of a full VAT through all
stages of production and sales. The mandatory rollout throughout the Community
commenced with promulgation in 1967 of the Commission’s First and Second VAT
Directives
24
and by 1973 all original members of the EEC had transformed their
turnover taxes into VATs. Ten years later, motivated by the introduction of VAT as a
Community own resource, and in an attempt to address the existing divergence of VAT
national systems, a blueprint for common rules, the Sixth VAT Directive, was approved
amidst high expectations,
25
and effectively regarded at the time as a new ‘European
VAT Code’.
26
As this new VAT legislation became part of the acquis communautaire,
the introduction of a VAT system, subject to the rules set out therein, became a
pre-condition for accession of any countries subsequently joining the European
Economic Community, its successor the European Community and today’s European
Union.
This redesign of the turnover tax into a VAT enjoyed significant advantages over
the adoption of a new tax base, particularly in terms of the administration, compliance
and acceptance by the business community. The VAT could be presented to this group
as a continuation of the existing turnover tax with a benefit in the form of full recovery
by businesses of all taxes incurred on acquisitions. To this day, in Europe the VAT is
often referred to both unofficially and officially as a ‘turnover tax’.
27
Winning over the business community, however, was not the only political
challenge faced by proponents of the VAT. An equal, and perhaps greater, challenge
was achieving acceptance by those who would ultimately be most affected by the move
to a comprehensive tax on final consumption, the consumers. To gain the acceptance
needed for the change, the first VAT contained a wide range of implicit subsidies by
Member States could prejudice the establishment of a common market; included within this
mandate was the potential harmonization of turnover taxes: see The EEC Reports on Tax
Harmonisation – The Report of the Fiscal and Financial Committee and the Report of the
Sub-Groups A, B and C (Amsterdam: IBFD Publications, 1963).
23. See B. Terra and P. Wattel, European Tax Law 200–201 (4th ed., Kluwer Law International
2005).
24. OJ 71 of 14 April 1967, 1301−1312.
25. Sixth Council Directive 77/388/EEC of 12 May 1977 on the harmonization of the laws of the
Member States relating to turnover taxes, OJ L145 of 13 June 1977, 1. For a detailed analysis of
the process which preceded the approval of these Directives and ultimately led to the
introduction of VATs in European countries, see R. de la Feria, The EU VAT System and the
Internal Market 47−56 (IBFD 2009). See also J. Englisch (n. 9 above).
26. P. Miconi, Razões Justificativas da Introdução de um Sistema de Imposto sobre o Valor
Acrescentado, 244/246 Ciência e Técnica Fiscal at 429 April/June (1979); and A.E. Genot, Fiscal
Harmonisation and European Integration: A 1978 Appraisal, 3 European L. Rev. 355–369, at
360 (1978).
27. See Article 113 of the Treaty on the Functioning of the European Union.
Rita de la Feria and Richard Krever§1.02[A]
8
way of reduced rates for some types of supplies and ‘exemptions’for selected other
types of supplies, which often replicated those that had been in place under the
previous turnover taxes.
28
Alongside these concessional quasi-subsidy exemptions
were a number of exemptions adopted for ‘technical’ reasons, namely the perceived
difficulties of fitting these supplies into the ordinary VAT regime. The most significant
examples of such supplies are financial and insurance services, some types of
transactions on immovable property and gambling services. The implication is that
these activities would ideally have been subject to VAT, but pragmatic considerations
determined that they be exempt. Preparatory work to the Sixth VAT Directive confirms
this reasoning.
29
Crucially, all the exemptions included in European VAT legislation,
both concessional and technical, have been from the outset mandatory in nature.
While the EU legislator allowed Member States to depart from the rules set out therein
in many other areas of the tax, such as the application (or not) of reduced rates, insofar
as exemptions are concerned Member States are in principle obliged to apply them, and
cannot to this day deviate from what is set out at European level. The fact that there are
a few exceptions – where Member States have retained some level of discretion as
regards the application of exemptions – does not take away from this general rule.
30
The theoretical economic neutrality advantages of the VAT, its potential for
enhanced compliance as a consequence of multi-stage collection and invoicing, and its
proven ability to raise significant revenues, led advisors from Europe and international
organizations such as the International Monetary Fund (IMF) to recommend adoption
of a VAT in their development models,
31
and over the next decades approximately 150
nations adopted taxes they called VATs.
32
In practice, few of these were VATs in the
European sense of applying in a relatively comprehensive fashion to goods and services
28. See S. Cnossen, What Rate Structure for a Value-Added Tax?, 35(2) Natl. Tax J. 205−214, at 209
(1982); and V. Lenoir (n. 6 above), at 456−457.
29. European Commission, Proposal for a Sixth VAT Directive on the harmonisation of legislation
of Member States concerning turnover taxes – Common system of value added tax: uniform basis
of assessment, COM(73) 95, 20 June 1975, Bulletin of the European Economic Communities,
Supplement 11. See also the Hutchings Report, which was a broad consultation on VAT and
financial services undertaken by the tax authorities in the then six Member States in close
liaison with the industry, European Commission, Les Operations Financières et Bancaire et la
Taxe sur la Valeur Ajoutée, Working Document XIV/241/71, June 1971.
30. Article 137 of the EU VAT Directive allows Member States to grant taxable persons the option
to tax in respect of financial services and immovable property; and under Article 133 of the
Directive Member States may make the granting of some concessional exemptions conditional
on specific requirements. On this point see J. Englisch (n. 9 above).
31. For an assessment of the comparative advantages of VAT, as well as other historical and
practical reasons for its spread, see L. Ebrill et al. (n. 8 above), at 4−13; M. Keen & B. Lockwood,
The Value-Added Tax: its Causes and Consequences, 92(2) J. Dev. Econ. 138−151 (2010); and
R.M. Bird & P-P. Gendron (n. 17 above), at 16 et seq. For a critical view of the IMF approach
to tax reform, including its role on the spread of VAT, see M. Stewart & S. Jogarajan, The
International Monetary Fund and Tax Reform, 2 British Tax Rev. 146−175 (2004).
32. A complete list as of 2007 can be found in A. Schenk & O. Oldman, Value Added Tax – A
Comparative Approach app. A. (Cambridge University Press 2007).
Chapter 1: Ending VAT Exemptions: Towards a Post-Modern VAT §1.02[A]
9
while providing a robust input tax credit system to avoid cascading taxes on business-
to-business transactions. Some only applied to goods and others provided at best
limited input tax credits.
33
Attempts to enact VAT systems outside of Europe revealed some of the short-
comings of the European model. While European tax administrations had long
turnover tax experience that could be applied to develop administration systems
capable of handling the complexities of multiple VAT rates and concessional exemp-
tions, the complexity of the European model was beyond the capabilities of adminis-
trations in developing countries. More significantly, the resulting narrow base required
exceptionally high – and, outside of Europe, politically unsustainable – standard rates to
raise sufficient revenue, and there was considerable concern with respect to the eco-
nomic costs of biases and embedded tax in a multi-rate, multiple exemption VAT system.
An alternative model appeared in 1984 with the enactment in New Zealand of
what has become known as the modern VAT – in contrast to the traditional European
VAT. Like its European counterpart, the New Zealand GST uses invoices to track
acquisitions and determine entitlement to refundable input tax credits (invoice-credit
method). Unlike the European VAT, however, the New Zealand VAT has a single, and
consequently much lower, standard rate with no reduced rate(s), no merit conces-
sional exemptions and limited exemptions for technical reasons.
34
From the mid-1980s
onwards, most non-European VAT laws have followed the modern VAT model and
while most have adopted one of the foundation principles of the New Zealand law, a
single rate, few have adhered as closely as New Zealand to the second principle of no
concessional exemptions or exclusions. In addition to rejecting the use of exemptions
to subsidize particular activities or types of consumption, the modern VAT showed it
was possible to apply the VAT to many types of supplies that had been classified as too
difficult to tax under the traditional VAT, and therefore, appropriate for exemption. It
illustrated how gambling services, certain types of immovable property transactions,
some types of insurance services, and entities such as government departments, public
bodies and charities, could all be included in the VAT system.
Not all modern VATs have opted for the same design alternatives as New
Zealand, with different countries opting for different solutions as regards traditionally
exempted sectors. Moreover, even the modern VAT had its limits at the time it first
appeared, the most significant of which was the maintenance of the traditional VAT’s
exemption for financial services. A quarter century after its introduction, the model for
the modern VAT, the New Zealand’s GST law, finally addressed in part this remaining
33. China being one of the most well-known examples of both these phenomena: see W. Cui & A.
Wu, China,inThe Future of Indirect Taxation – Recent Trends in VAT and GST Systems Around
the World, EUCOTAX Series on European Taxation 159−190 (T. Ecker, M. Lang & I. Lejeune
eds., Wolters Kluwer 2012); and X. Yang, Merger of Business Tax into VAT in China, 2 Intl. VAT
Monitor 120−123 (2009).
34. On the introduction of the GST in New Zealand, see in particular R. Douglas, The New Zealand
GST Policy Choice and its Political Implications,inGST in Retrospect and Prospect 3−11 (R. Krever
& D. White eds., Thomson Brookers 2007); R. Green, Consulting the Public in Developing a GST,
in GST in Retrospect and Prospect. 13−25 (R. Krever & D. White eds.); and J. Todd, Implementing
GST – Information, Education, Co-ordination,inGST in Retrospect and Prospect. 27−43 (R.
Krever & D. White eds.).
Rita de la Feria and Richard Krever§1.02[A]
10
exemption, perhaps in the process paving the way to the consideration of a post-
modern VAT.
[B] What Are Exemptions?
The term ‘exempt supplies’is used in most VAT systems to describe supplies that do
not bear output tax – the supplier need not collect or remit any tax in respect of the
supply – and do not entitle the recipient to any input tax credits in respect of tax borne
on acquisitions related to the making of the supply.
35
The irony of the term is not lost
on VAT experts, even if other economic players, particularly final consumers, are
misled by the terminology. From the perspective of registered businesses an ‘exempt’
supply in the VAT system is actually a taxable supply, while a ‘taxable’ supply is
actually an exempt supply. As there is no recovery of input tax embedded in the price
of exempt supplies, the cost of the tax included in the price must be borne by the
business that acquires the exempt supply and can only be recovered if the tax is passed
on to customers. A taxable supply, on the other hand, is tax-free to a registered
business customer as the tax can be recovered through the input tax credit system.
Ultimately, both taxable and exempt supplies are taxed supplies from the perspective
of the final consumers – albeit at different levels – with an explicit tax levied on the first
type of supply, and a (smaller) embedded tax included in the cost of the second.
36
Unlike the case with an explicit tax levied on taxable supplies, measurement of
the tax embedded in the cost of an exempt supply may be problematic, as it is
dependent on various factors. The level of VAT embedded in the price of an exempt
supply will depend on the value of services provided by the supplier making the
exempt supply and the character of supplies up the supply chain. Where there is little
labour input in the supply and relatively little mark up by the supplier for his or her
work in making the supply available, the embedded VAT may not be far below the VAT
that would have been charged had the supply been taxable.
37
If most of the value of the
supply is attributable to the labour input of the person making the supply and that
person draws upon few inputs to provide the labour, the rate of embedded tax relative
to the value of the supply may be small.
The Organisation for Economic Co-operation and Development (OECD) has
identified a range of standard exemptions which vary greatly across member nations,
35. Some label these supplies as ‘exempt without credit’ - both outside Europe, e.g., Brazil, and
within Europe, e.g., Portugal - while Australia uses the term ‘input taxed supplies’, both
alternatives being more accurate in terms of the effect of the rules applicable to supplies of this
type.
36. As Keen puts it, when referring to the financial services exemption, ‘business users pay too
much tax (in the sense that the normal crediting mechanism of the VAT would wipe out such
input VAT …), while final consumers pay too little (because the value added by the financial
institutions is not taxed)’; see M. Keen, The Taxation and Regulation of Financial Institutions,
IIPF Musgrave Lecture (2010).
37. Of course the level of the mark up may itself be influenced by the amount of embedded VAT.
Depending on the price elasticity of the products offered or/and the competitiveness of the
market, the supplier might not be able to set prices that reflect the full extent of the embedded
VAT, having instead to decrease its profit margin.
Chapter 1: Ending VAT Exemptions: Towards a Post-Modern VAT §1.02[B]
11
with significant differences between European nations and other members. Generally,
jurisdictions outside the EU have a very limited number of exempt supplies. In
contrast, exemptions proliferate in Europe. Standard exemptions in European coun-
tries include postal services, transport of sick/injured persons, hospital and medical
care, human blood, tissues and organs, dental care; education, sporting activities,
cultural services (excluding radio and television broadcasting), charitable work,
non-commercial activities by non-profit organizations, certain fund-raising events, the
supply of land and buildings (including letting of immovable property), betting,
lotteries and gambling, insurance and reinsurance, and a range of financial services
including loan intermediary services and capital raising operations. Beyond these core
items are exemptions covering a wide diversity of sectors such as legal aid, passenger
transport, public cemeteries, waste and recyclable material, water supply, precious
metals and certain agricultural inputs.
38
Two other types of supply may replicate the effect of an exempt supply in the
VAT: out-of-scope supplies made by VAT registered suppliers and supplies made by
out-of-scope suppliers. The first of these is a supply that falls outside the scope of the
VAT legislation, either for technical reasons related to its design or as a result of narrow
judicial interpretations of provisions in the VAT law. Whether an out-of-scope supply
will bear embedded input tax in the same manner as an explicitly exempt supply will
depend on the technical design of the input tax credit measures in the VAT law. In cases
where the entitlement to input tax credits for acquisitions is not directly tied to the use
of those acquisitions in making taxable supplies, the supplier will be able to recover the
input VAT and the supply will be tax-free. If, however, the law only allows input tax
credits where the acquisition is directly connected with a taxable supply, the out-of-
scope supply will bear embedded VAT in the same manner as explicitly exempt
supplies.
The second type of supply that can replicate the effect of an exempt supply is a
supply made by an out-of-scope supplier. Suppliers may fall outside the scope of a VAT
law for three reasons. First, they are taxable enterprises with turnovers less than the
threshold for compulsory registration under the VAT law. Second, they may be
excluded from the definition of taxable enterprises as a result of a narrow definition in
the VAT law or narrow judicial interpretation of the concept of taxable enterprise.
Third, they may be explicitly excluded from the operation of the VAT system by the
relevant legislation.
§1.03 ACTIVITIES OUTSIDE THE SCOPE OF VAT
[A] Out-of-Scope Supplies
The use of restrictive terminology in VAT legislation or the effect of restrictive judicial
interpretation of terms used in the law can leave supplies made by registered persons
38. See OECD (n. 7 above), at 76−81. See also R. Bird & P-P. Gendron, who offer a sample of
exemptions applicable in some countries outside the OECD; see n. 17 above, at 121−123.
Rita de la Feria and Richard Krever§1.03[A]
12
(or persons who are required to be registered) as out-of-scope supplies, often also
referred to as non-taxable supplies. The result is an under-taxation of supplies to final
consumers and over-taxation of business customers.
Occurrences of out-of-scope supplies by registered businesses are found in both
the EU traditional VAT and the modern VAT. Many instances in the former are
attributable to the ‘direct and immediate link’ doctrine developed in the European
Court of Justice in the 1980s. The doctrine established as a condition of a taxable supply
that there be a direct (and formal) link between a supply and payment (consideration)
received in respect of that supply.
39
Thus, for example, a voluntary payment to a
person making supplies at large would not be treated as consideration for a taxable
supply in the traditional VAT.
40
Another source of out-of-scope supplies found in both the traditional and modern
VAT is a narrow understanding of ‘supply’ to exclude, for example, supplies of
inaction, supplies made at large and involuntary supplies. An example of the first is the
fulfilment of a non-competition covenant or agreement to cease activities upon receipt
of consideration for non-performance.
41
An example of the second is the assumption by
an entity of social or economic responsibilities or undertakings in return for payment.
42
An example of the third is an expropriation of property where the supply is the result
of compulsory acquisition by the acquirer, not voluntary disposal by the vendor.
43
A third cause of out-of-scope supplies is the characterization of some dealings in
financial securities such as shares and bonds by an otherwise fully taxable enterprise
as investment activities undertaken by the firm rather than part of its business
activities. If the impugned transactions constitute a significant enough portion of the
enterprise’s activities, the entire enterprise may be tainted as an out-of-scope person,
not engaged in requisite economic activities.
44
39. The doctrine was first introduced in Cases 154/80, Staatssecretaris van Financien v. Cooper-
atieve Verenigning Cooperatieve Aardappelenbewaarplaats GA (Dutch Potato) [1981] ECR 445;
and 102/86, Apple and Pear Development Council (APDC) v. Commissioners of Customs and
Excise [1988] ECR 1443.
40. See Case C-16/93, R. J. Tolsma v. Inspecteur der Omzetbelasting Leeuwarden [1994] ECR I-743,
a case involving a street musician receiving ‘donations’from passers-by. The approach used by
the Court to exclude the transaction in that case from VAT is analysed in A. Schenk & O.
Oldman (n. 32 above), at 120. The nexus required by courts to establish the link between
consideration and a supply has been more relaxed in some cases. See for example Case
C-498/99, Town & County Factors Ltd v. Commissioners of Customs & Excise [2002] ECR I-7173.
41. See, for example, Case C-215/94, Mohr v. Finanzamt Bad Segerberg [1996] ECR I-959, where a
farmer was paid to withdraw from milk production.
42. See, for example, Chatham Islands Enterprise Trust v. CIR (1999) 19 NZTC 15,075 (Ct of A)
(NZ) where a trust received funds from the government after agreeing to assume responsibility
for what were previously government responsibilities; and CIR v NZ Refining Co Ltd [1997] 18
NZTC 13,187 (Ct of A) (NZ) where a company received a payment from the government in
return for an agreement to stay in business following deregulation.
43. Hornsby Shire Council and Federal Commissioner of Taxation (2008) AATA 1060 (AAT)
(Australia) where a local government expropriated property owned by a registered enterprise.
44. See, for example, Cases C-333/91, Sofitam SA (formerly Satam SA) v. Ministre chargé du
Budget, [1993] ECR I-3513; C-4/94, BLP Group plc v. Commissioners of Customs & Excise [1995]
ECR I-983; C-80/95, Harnas & Helm CV v. Staatssecretaris van Financiën [1997] ECR I-745;
C-98/98, Commissioners of Customs and Excise v. Midland Bank plc [2000] ECR I-4177;
C-16/00, Cibo Participations SA v. Directeur régional des impôts du Nord-Pas-de-Calais [2001]
Chapter 1: Ending VAT Exemptions: Towards a Post-Modern VAT §1.03[A]
13
[B] Out-of-Scope Suppliers
As noted earlier, there are three groups of suppliers that may fall outside the scope of
VAT law. The first are businesses that would otherwise be subject to VAT but with
turnovers below the compulsory VAT threshold; the second are entities that fall outside
the scope of the tax as a result of judicial interpretations of legislative charging
provisions; the third are entities explicitly prevented from registering by legislative
exclusions. The first category of out-of-scope supplier is common to the traditional VAT
and the modern VAT. The second and third types of out-of-scope supplier are found
most often – albeit not exclusively – in the traditional European VAT systems.
[1] Unregistered Businesses
Most VAT laws, both traditional and modern, contain registration ‘thresholds’that
exempt small businesses from compulsory registration and inclusion in the VAT
system, although the thresholds vary widely across countries.
45
These registration
thresholds were not always well perceived. When VAT initially appeared on the world
stage, the general view was that the ideal VAT threshold should be zero, and therefore
the usual expert advice was to set the threshold as low as possible.
46
This view was in
line with optimal taxation theory which stated at the time that differentiation of tax
liability based on firm size violates production efficiency.
47
A number of disadvantages
to establishing a registration threshold were cited to buttress the case for no or very low
thresholds.
The first disadvantage – or advantage, if the rationale is to enhance the competi-
tive position of small firms – of thresholds is that they may distort competition between
those above and below the trigger point, particularly in the case of firms selling directly
ECR I-6663; C-465/03, Kretztechnik AG v. Finanzamt Linz [2005] ECR I-4357; C-437/06,
Securenta Göttinger Immobilienanlagen und Vermögensmanagement AG v. Finanzamt Göttin-
gen [2008] ECR I-597; and C-29/08, Skatteverket v. AB SKF [2009] ECR I-10413. For compre-
hensive discussion on this jurisprudence see A. van Doesum & G.J. van Norden, The Right to
Deduct under EU VAT, 5 Intl. VAT Monitor 323−329 (2011); and P. Melz, Activities Outside the
Scope of VAT and Exempt Activities, 5 Intl. VAT Monitor 330−331 (2011). See also R. de la Feria,
When Do Dealings in Shares Fall Within the Scope of VAT?, 1 EC Tax Rev. 24−40 (2008); J.
Englisch, The Future of Indirect Taxation – Recent Trends in VAT and GST Systems Around the
World, EUCOTAX Series on European Taxation 159−190 (T. Ecker, M. Lang & I. Lejeune eds.,
Wolters Kluwer 2012), at 549−585;D.R. Jensen & H. Stensgaard, The distinction between direct
and general costs with regard to the deduction of input VAT – the case of acquisition, holding
and sale of shares, 4(1) World Tax J. 3-32 (2012); A. van Doesum, H. van Kesteren & G.-J. van
Norden, Share disposals and the right of deduction of input VAT, 19(2) EC Tax Rev. 62−73
(2010); G. Richards, Skatteverket v AB SKF: exploring the impact on input tax recovery on the
boundary between exempt transactions and non-business activities, 3 British Tax Rev. 273−275
(2009); and C. Amand, VAT: deductibility of the costs of issuing new shares – the direct and
immediate link test, 5(3) EC Tax J. 203−230 (2001).
45. Several developed countries with good tax administrations, such as Spain, have thresholds of
zero, so that every business regardless of how small, must register for VAT, see OECD (n. 7
above), at Table 3.9.
46. See R. Bird & P-P. Gendron (n. 17 above), at 115.
47. See P. Diamond & J.A. Mirrlees, Optimal Taxation and Public Production I: Production
Efficiency, 61(1) Am. Econ. Rev. 8−27 (1971).
Rita de la Feria and Richard Krever§1.03[B]
14
to final consumers. In the case of business customers, the apparent lower VAT included
in the cost of supplies from unregistered suppliers is negated by the fact that these
suppliers cannot issue tax invoices and no input tax credits are available to recover the
embedded VAT included in the supplies. In contrast, the fully taxable supply made by
the registered supplier is free of tax after input tax credits are claimed. The registered
business customer will thus almost always prefer to limit acquisitions to those supplied
by registered persons. To ensure smaller businesses are not at a competitive disadvan-
tage relative to larger firms with turnovers greater than the registration threshold, most
VAT systems provide for voluntary registration by smaller firms that may wish to
supply registered businesses. On the other hand, small businesses supplying to final
consumers may find it advantageous to remain as unregistered suppliers. Their
customers will bear the entire cost of embedded VAT included in the price of goods and
services acquired by the suppliers, but incur no tax liability in respect of the value
added by the suppliers. As final consumers are indifferent between tax that is
embedded in the price and tax that appears on a tax invoice as a separate line before the
total amount payable, unregistered suppliers will be able to attract non-business
customers so long as the embedded tax is less than the explicit tax charged by
registered businesses.
The ability of unregistered businesses to make de facto exempt supplies provides
small businesses with a slight competitive advantage in some cases, or with a better
ability to compete in the face of the economies of scale and volume purchase pricing
available to larger registered competitors. It might be argued that this competitive
advantage given to unregistered firms is desirable as it tends to be the smaller and
hence presumably poorer traders that are relatively advantaged and the implicit
subsidy of reduced taxation meets vertical equity concerns.
48
On the other hand, an
indirect subsidy delivered by way of reduced consumption tax liability is a very crude
redistribution instrument that is impossible to target effectively. To the extent the
implicit subsidy keeps less efficient smaller firms afloat,
49
the economic consequences
may be counter productive and it might actually further growth by firms approaching
the threshold, creating a bunching of firms just below the threshold and an absence of
firms for some distance above it.
50
A recent study seems to confirm this possibility, not
solely by finding a clustering of companies just below the threshold, but also
suggesting that masquerading behaviour – either in the form of avoidance or evasion
– in order to fall outside the scope of VAT may be commonplace.
51
The second disadvantage of establishing a registration threshold is the loss of
potential revenue. This aspect must, however, be seen in the context of administrative
and compliance costs. The initial view dismissing the benefits of registration thresholds
above zero implicitly assumed that there were little or no additional administrative and
48. M. Keen & J. Mintz, The Optimal Threshold for Value-Added Tax, 88 J. Pub. Econ. 559−576, at
564 (2004).
49. Smaller firms tend to be less efficient than their larger competitors; see A. Schenk & O. Oldman
(n. 32 above), at 77−79.
50. M. Keen & J. Mintz (n. 48 above), at 568.
51. See K. Onji, The Response of Firms to Eligibility Thresholds: Evidence from the Japanese
Value-Added Tax, 93(5-6) J. Pub. Econ. 766−775 (2009).
Chapter 1: Ending VAT Exemptions: Towards a Post-Modern VAT §1.03[B]
15
compliance costs from the low threshold. The evidence now suggests that firm-size
differentiation can indeed be part of an optimal tax system when there are fixed-per-
firm cost elements in the administrative costs of running a tax system.
52
In fact,
bringing every small business into the VAT system increases administrative costs
exponentially, and the additional VAT collected may be largely absorbed as costs in
collecting the tax. Therefore, even if some revenue is forgone by dropping small
taxpayers, in most countries any revenue loss could be likely recouped by removing the
high administration costs of assessing numerous low-return taxpayers who universally
account for relatively little VAT revenue.
53
Additional rationales for low thresholds concern the interest of tax authorities in
gathering information and assessing participants in the shadow economy. Since good
tax administration rests on information, it has been argued that including the largest
possible share of the economic activity in the tax base has the advantage of capturing
as much information as possible; it may also be that dipping as deeply as possible into
the pool of potential taxpayers will lead to catching some ‘hidden whales’.
54
Neither of
these reasons is particularly convincing, however. There has been no evidence of
concealed VAT profit windfalls waiting to be uncovered through broader assessment of
small businesses.
Optimal tax administration analysis now suggests the VAT registration threshold
should be determined by balancing collection costs against the marginal value of
additional tax revenues.
55
Interestingly, the older and more current views are not
reflected in distinctions between traditional VAT and modern VAT jurisdictions’
practices. Some traditional VAT systems such as those in place in the Czech Republic,
France, Ireland, Slovak Republic and the United Kingdom apply a high threshold
compared to those applied in modern VAT systems such as Australia, Canada or New
Zealand.
56
To the extent to which these thresholds reflect conclusions on the relative
cost of administration relative to revenue collection, there may be room for improve-
ment of administration processes in some jurisdictions.
[2] Deemed ‘Non-business’Enterprises
The definition of taxable person for VAT purposes varies from jurisdiction to jurisdic-
tion, but a common feature to all definitions is the requirement that the person be
carrying on economic activities – a stipulation intended to exclude private household
activities. A significant point of departure between the traditional and modern VAT
systems, however, is the approach taken by courts when interpreting phrases such as
‘business’, ‘enterprise’ or ‘economic activities’used within those definitions. In
52. See D. Dharmapala, J. Slemrod & J.D. Wilson, Tax Policy and the ‘Missing Middle’: Optimal Tax
Remittance with Firm-Level Administrative Costs, J. Pub. Econ. 95, 1036−1047 (2011).
53. M. Keen & J. Mintz (n. 48 above). In this regard, it is also worth noting that in most countries
reportedly ‘a surprisingly small number of VAT registrations, sometimes less than a few dozen,
account for 80% to 90% of VAT collections’, see R. Bird & P-P. Gendron (n. 17 above), at 115.
54. See R. Bird & P-P. Gendron (n. 17 above), at 120.
55. See M. Keen & J. Mintz (n. 48 above).
56. See OECD (n. 7 above), at tbl. 3.9.
Rita de la Feria and Richard Krever§1.03[B]
16
modern VAT jurisdictions, these terms tend to be given wide interpretations – prima
facie, an entity with a significant number of employees, making substantial acquisi-
tions, owning or renting commercial property, and so forth is carrying on economic
activities and would be treated as a taxable person under the modern VAT.
57
They
would thus be able to register and claim input tax credits, even if they make no taxable
supplies – the test for eligibility for input tax credits in the modern VAT is whether the
acquisitions are related to carrying on the person’s enterprise and do not give rise to
personal consumption, rather than whether they are directly used to make taxable
supplies.
In contrast, courts in traditional VAT jurisdictions – in particular the EU Court of
Justice – have read down the notion of an ‘economy activity’
58
through a phenomenon
of what has been designated elsewhere as creeping case law,
59
so it rarely extends
beyond activities involving supplies for consideration in the course of an ongoing
business. Three key groups left out of the scope of economic activity by the narrow
concept, and thus of the ability to make taxable supplies or creditable acquisitions, are
mutual business organizations, holding companies and investment companies. All
these enterprises play intermediary roles in the economy, reflecting no final consump-
tion, but nevertheless incur unrecoverable input tax on acquisitions as a result of their
exclusion from the VAT system by the judicial interpretations.
The exclusion from the business concept of mutual organizations applies where
an organization carrying on substantial activities absorbs all its income into making
supplies to its members.
60
If the body’s members are not final consumers, the
designation of the organization as a non-business entity results in over-taxation with
members unable to claim input tax credits on their membership fees that are in turn
used in part or in whole to acquire taxable services through the mutual organization.
57. On the definition of ‘enterprise’ under Australian GST law, see R. Millar & D. McCarthy,
Australia,inThe Future of Indirect Taxation – Recent Trends in VAT and GST Systems Around
the World, EUCOTAX Series on European Taxation 159−190 (T. Ecker, M. Lang & I. Lejeune
eds., Wolters Kluwer 2012), 21−96, at 32−33; on the definition of ‘commercial activity’ under
Canadian GST law, see M. Abbas & A.J. Cockfield, Canada,inThe Future of Indirect Taxation
– Recent Trends in VAT and GST Systems Around the World, EUCOTAX Series on European
Taxation 159−190 (T. Ecker, M. Lang & I. Lejeune eds., Wolters Kluwer 2012), 109−141, at
114−116; and on the concept of ‘taxable activity’ under New Zealand GST law, as interpreted
by the courts in that country, see P. Blanchard, Some Basic Concepts of New Zealand GST, in (R.
Krever & D. White eds.) (n. 34 above), 91−101.
58. In the language used in Article 9 of the EU VAT Directive.
59. The term is used to describe the phenomenon whereby the introduction of a general principle
in a given judgment has demanded extra qualifications, and explanations by the Court in
subsequent decisions, resulting in the accumulation of a complex body of case law, riddled
with factual minutiae: see R. de la Feria (n. 44 above), at 24−25.
60. For example, the UK House of Lords has held that the activities of the Institute of Chartered
Accountants (UK) in ensuring accountants adhere to certain standards are undertaken without
a view to profit and thus do not constitute a business, a threshold test for a taxable person in
the UK: see Institute of Chartered Accountants in England and Wales v. Commissioners of
Customs and Excise [1999] STC 398.
Chapter 1: Ending VAT Exemptions: Towards a Post-Modern VAT §1.03[B]
17
The designation by European courts of holding companies as non-taxable
persons that are unable to claim input tax credits
61
results in unrecoverable tax
becoming embedded in business to business transactions that involve no final con-
sumption, generating the biases that the VAT was intended to eliminate.
62
Despite calls
for reform,
63
and indeed the European Commission’s recognition of the problem, there
seem to be no immediate plans to address the problem in the traditional VAT.
64
The third group sometimes left out of the scope of economic activity amounting
to a business are investment and financial companies, often situated within a corporate
group. By using the services of a financial member to source debt and capital and invest
excess capital, a corporate group may realize significant economies of scale benefits,
reducing costs and increasing returns. As noted previously in the context of out-of-
scope supplies, an enterprise that carries on some financial transactions might find the
transactions are characterized as passive investment activities rather than business
activities and if the scale of these transactions relative to the entire operations of the
enterprise is significant, the entire enterprise may be characterized as an out-of-scope
enterprise not engaged in business-like economic activities. Lending operations by a
factoring company
65
or making annual financing loans to subsidiaries
66
will be
considered business activities, as would a fund manager’s ongoing investing for the
purpose of generating gains,
67
but the managed sale of an investment portfolio will not
61. This interpretation of the EU VAT Directive was initially introduced by the EU Court of Justice
in the Polysar case in the early 1990s: see Case C-60/90 [1991] ECR I-3111, a judgment that at
the time ‘seemed innocuous enough in itself’. See P. Farmer, Taxable persons and the ‘Private
Life’ of Companies, 2 EC Tax J. 41−48, at 42 (1997). The doctrine has been reinstated and
developed in later decisions, which indicate that a holding company may qualify as an eligible
enterprise where different exceptions apply. For an analysis of this case law from both a
European perspective and that of national courts, see R. de la Feria (n. 44 above); and J.
Englisch, Input VAT Deduction by Holding Companies – German Practice and Community Law,
2 Intl. VAT 172−179 (2007).
62. For a principle-based analysis of the EU Court of Justice jurisprudence on holding companies
see R. de la Feria, A Natureza das Actividades e Direito à Dedução das Holdings em Sede de IVA,
4(3) Revista de Finanças Públicas e Direito Fiscal (2011).
63. See recently M. Aujean, Harmonization of VAT in the EU: Back to the Future, 3 EC Tax Rev.
134−143 (2012).
64. In 2010, the European Commission seemed to be considering a review of the VAT treatment of
holding companies: see Green Paper on the Future of VAT – Towards a simpler, more robust and
efficient VAT system, Communication from the Commission to the European Parliament, the
Council and the European Economic and Social Committee, COM(2010) 695 final, 1 December
2010; for a comment see A. van Doesum & G.J. van Norden, EU2011, EUtopia and EU2020: the
European Commission’s Green Paper on the Future of VAT, 3 British Tax Rev. 253−272, at
263−267 (2011). However, by the following year the issue seemed to have been dropped from
the Commission’s immediate plans; see Communication on the Future of VAT – Towards a
simpler, more robust and efficient VAT system tailored to the single market, Communication
from the Commission to the European Parliament, the Council and the Economic and Social
Committee, COM(2011) 851 final, 6 December 2011.
65. Cases C-305/01, Finanzamt Gross-Gerauv v. MKG-Kraftfahrzeuge Factoring GmBH [2003] ECR
I-6729; and C-93/10, Finanzamt Essen-NordOst v. GFKL Financial Services AG [2011] ECR I-000.
66. Case C-77/01, Empresa de Desenvolvimento Mineiro SGPS SA (EDM) v. Fazenda Publica [2004]
ECR I-4295.
67. Case C-8/03, Banque Bruxelles Lambert v. Etat Belge [2004] ECR I-10157.
Rita de la Feria and Richard Krever§1.03[B]
18
cross this threshold.
68
The borderline is murky at best and the narrowing of the
economic activity concept can result in a compounding VAT liability on enterprises
seeking a more efficient allocation of resources and skills within a company group.
[3] Government Departments, Other Public Sector Bodies, and Charities
While the treatment of supplies by governments and government bodies attracts much
comment and generates many tax disputes and consequent case law, in many cases the
question is of little importance in practical terms. The clearest case where the tax status
of a government body is irrelevant is where the government that levies the VAT
provides monopoly services such as issuing passports or issuing spectrum licences.
69
All customers for the former will be individuals and the acquisition will be private
consumption. It makes no difference to the customers if the government charges a
lower price and imposes VAT or charges a higher price and has no VAT. A supply such
as a telecommunications spectrum licence, on the other hand, will only be acquired by
a registered enterprise in the course of a business. When calculating how much to bid
for the supply, this customer should be indifferent between a higher price that includes
a recoverable VAT component or a lower price that is exempt from VAT, provided it
knows beforehand whether the supply will be taxable or not.
Difficulties may arise if the character of a monopoly supply is not made clear prior
to the supply being made. If, for example, the government has assumed a supply did
not include VAT and the customer assumed it did, the customer may overpay for an
acquisition from the government. Alternatively, it may be the customer that assumes
the supply is exempt and bids a lower price, later seeking a windfall by claiming the
lower amount was VAT-inclusive. Leaving the cases of poor prior communication
aside, however, the character of monopoly supplies is relatively unimportant so long as
both the government and customers agree beforehand on that character and the
government or customer, as need be, adjust their prices or bids respectively.
In terms of the government that levies the VAT, the treatment of government
bodies under the VAT will only affect the budget allocation between departments. For
example, if the police and army can register and claim input tax credits, their
acquisition costs will fall and a smaller funding allocation from the central budget will
be needed. If they cannot register, their acquisition costs will rise and the government
will fund them with higher direct budget allocations rather than lower allocations
combined with input tax refunds.
The treatment of lower tier governments and government bodies is much more
problematic in the VAT. Two distinct sets of issues arise – should taxes paid to lower
tier governments be treated as consideration for taxable supplies and should lower tier
68. Case C-155/94, Wellcome Trust Ltd v. Commissioners of Customs and Excise [1996] ECR 1-3013.
69. Examples of litigation seeking to determine whether VAT is included in the price of these
supplies include Cases C-284/04, T-Mobile Austria GmbH and Others v. Republic of Austria
[2007] ECR I-5189; and C-369/04, Hutchison 3G UK Ltd and Others v. Commissioners of
Customs & Excise [2007] ECR I-5247.
Chapter 1: Ending VAT Exemptions: Towards a Post-Modern VAT §1.03[B]
19
governments be allowed to register for VAT purposes or should they be kept out of the
VAT system and thus treated in effect as persons making out-of-scope supplies?
Agreeing to pay a particular level of taxes (by way of the democratic process)
results in forgoing consumption that could otherwise be acquired with the funds used
to pay taxes. It can be argued consequently that taxes paid to a democratically elected
government are simply another form of consideration for taxable supplies, the supplies
being the public goods and services provided by the government and desired by the
taxpayers who agree to pay higher taxes and reduce other consumption. On this basis,
modern VAT systems may treat taxes paid to lower tier governments as consideration
for taxable supplies.
70
The practice is relatively rare, however.
The second issue, whether lower tier governments should be allowed to register
for VAT purposes and claim input tax on all acquisitions, not just those used to make
taxable supplies that compete with supplies offered by private sector businesses, is a
matter of great concern in all jurisdictions and one that leads to considerable political
tension and litigation. If lower tier governments are not able to register and claim input
tax credits on all their acquisitions, there will be a transfer of tax revenues from the
lower tier governments to the higher level government that levies the VAT. The lower
tier governments will be forced to raise local taxes to pay non-recoverable VAT on all
their acquisitions.
This problem does not arise in modern VAT systems that allow all enterprises to
register without regard to whether they are public or private, or for profit or not for
profit. In these jurisdictions, lower tier governments simply register within the ordinary
VAT system.
71
In other jurisdictions, particularly those modelled after the traditional
European VAT with its narrower definition of enterprise that excludes governments,
lower tier governments commonly bear a non-recoverable VAT burden on acquisition,
resulting in a transfer of funds to the central government. There have been ongoing
discussions about the need for a European-wide solution but to date there have been no
effective steps taken to resolve the problem.
72
In the meantime, alternative solutions
70. New Zealand, for example, treats most taxes paid to lower tier governments as consideration
for taxable supplies. The Australian legislation provides for similar treatment but delegates to
the Treasurer the power to specify that some taxes should in effect be treated as consideration
for exempt supplies. In practice, therefore, and for political reasons Australian Treasurers have
excluded almost all lower tier government taxes from the VAT system.
71. To overcome constitutional issues, lower tier governments in Canada are registered under a
separate system that parallels the national GST system.
72. In 2000, the Commission published a VAT strategy aimed at improving the operation of the
Internal Market. Under the heading ‘other potential future priorities’, the Commission set out
the areas which it considered warranted a thorough review. The first item on this list was the
treatment of subsidies, public authorities and services in the public interest: see A Strategy to
Improve the Operation of the VAT System within the Context of the Internal Market, Commu-
nication from the Commission to the Council and the European Parliament, COM(2000) 348
final, 7 June 2000. The Commission’s intention to reform the VAT treatment of public bodies
was reiterated in 2003 in their review and update of the VAT strategy. It stated then that
preparatory work for reform of this area was already under way, and despite its complexity, a
final proposal would be presented in the fourth quarter of 2004: see Review and Update of VAT
Strategy Priorities, Communication from the Commission to the Council and the European
Parliament, COM(2003) 614 final, 20 October 2003. Yet, six years on, the Commission has not
only failed to do so, but equally there are no obvious signs of an intention to initiate the
Rita de la Feria and Richard Krever§1.03[B]
20
have been developed at the national level to address the problem of tax transfer from
lower tier governments to the government levying the VAT. The most common
solution is to establish a parallel regime that allows lower tier governments to file
returns in the parallel regimes and claim refunds of all or part of their input tax. While
these refund schemes have the advantage of eliminating the bias towards self-supply
and away from outsourcing, they, too, give rise to difficulties.
73
The VAT treatment of government departments and other public sector bodies
and charities marks another point of departure between the modern and traditional
VAT, with these entities treated as out-of-scope suppliers in the European VAT.
Public bodies are a concept set out (and defined) in EU law,
74
and the special VAT
status of these entities is largely an issue only in the traditional VAT. In broad terms, a
public body is an entity established by, and largely funded by, a government but which
operates outside any government department. An example is a national sports institute
or arts organization.
The special rules for public bodies in the traditional VAT are in essence an
anachronism derived from the roots of the European VAT in turnover taxes.
75
Today’s
European VAT law makes a distinction between ‘commercial’ supplies made by a
public body that competes in the market with private profit-making entities and other
supplies that are not seen to be offered in competition to supplies from private sector
enterprises.
76
EU legislation treats public bodies as out-of-scope suppliers to the extent
their supplies are non-commercial supplies, presumably on the assumption that there
is some merit to their outputs that deserves a subsidy. The economic distortions and
compliance consequences of dissecting and characterizing an organization’s outputs
may be significant,
77
with a bias towards self-supply and opportunities for aggressive
planning and avoidance.
78
At the same time, the treatment of these bodies as out of
consultation process, which would usually precede such a move. See M. Aujean, Application
of VAT to Public Bodies: The EU VAT System, Current Issues and Proposals,inVAT in Africa
71−79, at 79 (R. Krever ed., Pretoria University Press 2008).
73. See R. de la Feria, The EU VAT Treatment of Public Sector Bodies: Slowly Moving in the Wrong
Direction, 37(3) Intertax 148−165, at 161−162 (2009).
74. For example, Article 1(9) of the Procurement Directive defines public body or, in the terms of
the definition, a ‘body governed by public law’ as any body ‘(a) established for the specific
purpose of meeting needs in the general interest, not having an industrial or commercial
character; (b) having legal personality; and (c) financed, for the most part, by the State,
regional or local authorities, or other bodies governed by public law; or subject to management
supervision by those bodies; or having an administrative, managerial or supervisory board,
more than half of whose members are appointed by the State, regional or local authorities, or
by other bodies governed by public law’.
75. As Advocate-General Jacobs of the Court of Justice so clearly stated in the Waterschap Zeeuws
Vlaanderen case: ‘It is inherent in the existence of exceptions to the VAT system that they will
interfere to some extent with the application of the principles of neutrality and of equality
treatment. Whatever the merits of the decision to treat public sector bodies as final consumers,
it forms an integral part of the Directive. In that and in comparable situations, the treatment of
taxable persons and persons excluded from the VAT system will inevitably be different’: see
Case C-378/02, Waterschap Zeeuws Vlaanderen v. Staatssecretaris van Financien [2005] ECR
I-4685, at para. 38.
76. See Article 13 of the EU VAT Directive.
77. See R. de la Feria (n. 73 above).
78. Cases C-223/03, University of Huddersfield [2006] ECR I-1751 and C-63/04, Centralan [2005]
ECR I-11087.
Chapter 1: Ending VAT Exemptions: Towards a Post-Modern VAT §1.03[B]
21
scope suppliers to the extent they make non-commercial supplies at best amounts to an
inefficient and ill-targeted subsidy.
Unlike public bodies, the concept of charitable organizations is common to both
traditional and modern VAT jurisdictions. Their VAT treatment is not consistent,
however. In the European traditional VAT systems, charities are treated as out-of-scope
suppliers, unable to register and claim input tax credits. The result is input taxation of
their charitable supplies, an uneven and perhaps illogical government levy on their
activities. In some modern VAT jurisdictions, the activities of charities are viewed as
economic activities in the broader sense, even if they are not for profit, and the bodies
will be considered taxable persons, able to recover input tax on acquisitions and thus
eliminate any embedded tax on their supplies of charitable goods or services. This is
not the case in all modern VAT jurisdictions, however. In fact, while there appears to
be a consensus that the VAT system should not be modified to deal with the perceived
problem of charities,
79
in practice the exclusion of charities from the scope of VAT is
not limited to traditional VAT jurisdictions,
80
with some countries, such as Canada,
adopting a ‘middle-ground’ approach.
81
§1.04 PARTICULAR CATEGORIES OF EXEMPTIONS
[A] Merit / Concessional Exemptions
The original designation of many types of exempt supplies as exempt was based not so
much on clearly articulated policy objectives but rather on pragmatic political goals, as
designers of the VAT sought to replicate the impact of the predecessor turnover taxes
and deflect concerns about the tax on beneficiaries of previous concessions. Over time,
two ex post facto rationales have been offered for the concessions. The first is based on
vertical equity concerns, with the exemption of essential products said to diminish the
natural regressivity of a VAT. The second is based on the alleged benefits of subsidizing
particular types of consumption that yield positive externalities, with exemptions seen
as a way of increasing consumption of so-called merit goods.
Once it is accepted that exemptions for merit goods amount to tax expenditures,
the concessions should be subject to the same cost-benefit analysis as direct expendi-
ture programs: what are the objectives of the exemptions and are there alternative
spending or subsidy programs that might achieve the intended social and distributional
goals more efficiently and fairly.
The equity / countering regressivity rationalization for exemptions derives from
the fact that the proportion of income that is saved reduces as income reduces, with the
79. See W. Hellerstein (n. 15 above); and W. Hellerstein & H. Duncan, VAT Exemptions: Principles
and Practice, 128 Tax Notes 989−999 (2010).
80. In fact, the OECD lists New Zealand and Turkey as the sole exceptions, see n. 7 above.
81. For an analysis and defence of this middle-ground approach see P.P. Gendron, VAT Treatment
of Public Sector Bodies: The Canadian Model, Ch. 3 in this volume; for a critique to this
approach in defence of the full-taxation model, see R. Millar, Smoke and Mirrors: Applying the
Full Taxation Model to Government under the Australian and New Zealand GST Laws,Ch.4in
this volume.
Rita de la Feria and Richard Krever§1.04[A]
22
lowest income earners using all their income for consumption and diverting none to
savings. As a consumption tax falls only on income used for consumption and exempts
income that is applied to savings, consumption taxes fall more heavily on lower income
persons than on higher income persons in terms of the proportion of income derived by
those persons. The vertical equity principle guiding the design of the income tax
suggests that tax should rise as a proportion of income if income is a valid measure-
ment of ability to contribute to public goods and services. A consumption tax that
yields the opposite outcome is troublesome for those adhering to this notion of vertical
equity and the use of taxation as a tool for redistribution. Exemptions for commodities
that form a higher percentage of the spending budget of lower income persons are seen
as a way of reducing the tax burden on these persons and thus increasing their
consumption capability.
Exemptions as a social welfare measure fare quite badly compared to the
alternative of full taxation and targeted income support, and constitute a blunt
instrument for redistribution.
82
They come at a significant revenue cost to the govern-
ment, a cost that far exceeds the benefit derived by lower income persons. Even though
consumption of any particular commodity will represent a lower percentage of the total
income of a wealthy person compared to the consumption of a poorer person, in
absolute terms the high income person is likely to spend more on the commodity.
83
If
the item were fully taxed and low income persons compensated for the tax by direct
payments, the government could return the tax to lower income persons and have
additional revenue left over to apply to other redistributive programs.
84
In this sense,
lower income persons may be much worse off with a tax system that contains
exemptions designed to assist them than they would be in a tax system with no
exemptions and redistribution of the excess revenue raised under a more neutral tax
base.
85
The ‘positive externalities’rationale for exemptions derives from a belief that the
market price for some types of supplies does not fully reflect the overall benefits from
consumption of those supplies and government intervention to subsidize consumption
of those goods is desirable. The assumption is that exempt supplies would be less costly
to final consumers than fully taxable supplies, as they would bear VAT on inputs up to
82. J. Creedy, Indirect Tax Reform and the Role of Exemptions, 22(4) Fiscal Stud. 457 (2001).
83. Cnossen has argued that VAT is regressive with respect to income but not necessarily with
respect to consumption: see S. Cnossen, The Value-added Tax: Key to a Better Tax Mix, 6(3)
Australian Tax Forum 265−281 (1989). Davis and Kay provide amusing examples with
reference to the United Kingdom to illustrate the shortcomings of using the VAT structure as
mean to diminish its regressivity: see E.H. Davis & J.A. Kay, Extending the VAT base: problems
and possibilities, 6(1) Fiscal Studies 1-16 at 11−12 (1985).
84. Godbout and St. Gerny show that with tax credits targeted at lowest income individuals in
place, the effective tax rate of consumption taxes increases with income, see C. Godbout & S.
St. Gerny, Are Consumption Taxes Regressive in Quebec?, 59(3) Canadian Tax J. 463−493
(2011).
85. Ballard and Shoven conclude using US data that using exemptions to partially offset the effects
of replacing income tax with a VAT would do little to mitigate the adverse distributional impact
of such a change: see C.L. Ballard & J.B. Shoven, The Value-Added-Tax: The efficiency cost of
achieving progressivity by using exemptions,inModern Developments in Public Finance: Essays
in Honor of Arnold Harberger 109−129 (M.J. Boskin ed., B. Backwell 1987).
Chapter 1: Ending VAT Exemptions: Towards a Post-Modern VAT §1.04[A]
23
the final supplier stage but not on the value added by the final supplier. While there are
a number of exempt supplies in this class in the traditional VAT, they are rare in
modern VAT systems.
The ‘merit’ benefits of many exempt goods and services in the traditional VAT are
questionable and to the extent subsidies by way of exemption may stimulate greater
consumption of target goods and services, the costs of subsidizing in this manner are
likely to be significant. From a legal perspective these exemptions give rise to
definitional and interpretative problems, create difficulties in calculating the portion of
deductible VAT, and constitute an incentive to engage in aggressive tax planning. For
these reasons merit exemptions tend to result in substantial – and increasing –
litigation, which in turn results in substantial compliance and administrative costs. In
Europe, the steady increase in references from national courts to the EU Court of
Justice, focusing on the interpretation of these exemptions,
86
or the application of tax
planning schemes by universities and hospitals,
87
is not only significant, but also
symptomatic of two factors. The first is the outdated nature of these exemptions, unfit
to deal with a new economic environment, where competition between public and
private bodies is a common occurrence; the second is the pressure to increase
efficiency in the provision of public services, which has resulted in an increase in
subcontracting and outsourcing.
The quantitative costs
88
and qualitative effects in terms of distortions of con-
sumption and investment decisions may be significant. The exemptions erode the tax
base, create tax cascading and create bias towards self-supply and away from outsourc-
ing. Importantly, they also tend to be inefficient mechanisms for subsidizing chosen
types of supplies, as much of the effective subsidy is likely to be capitalized into a
higher price for the exempt supplies either through inefficient production (the produc-
ers of the exempt supplies do not have to compete on a level playing field with
producers of other supplies), or profit taking as the suppliers sell the subsidized
supplies into a market that does not subsidize substitute types of consumption.
89
The results of the cost-benefit analysis as applied to merit / concessional
exemptions is therefore particularly negative: not only is it unclear whether they
86. For recent examples see cases C-86/09, Future Health Technologies Limited v. The Commis-
sioners for Her Majesty’s Revenue and Customs [2010] ECR I-5215; C-156/09, Finanzamt
Leverkusen v. Verigen Transplantation Service International AG [2010] ECR I-11733; and
C-237/09, Belgian State v. Nathalie De Fruytier [2010] ECR I-4985.
87. See for example cases C-419/02, BUPA Hospitals Ltd, Goldsborough Developments Ltd v.
Commissioners of Customs and Excise [2006] ECR I-1685; C-223/03, University of Huddersfield
Higher Education Corporation v. Commissioners of Customs & Excise [2006] ECR I-1751; and
C-63/04, Centralan Property Ltd v. Commissioners of Customs & Excise [2005] ECR I-11087.
88. See R. Bird & P.-P. Gendron (n. 17 above).
89. Whether exemptions actually affect prices downwards is unclear. This is essentially for two
reasons. Exemptions actually increase input tax costs, which will be at least partially passed on
from the suppliers to the customers. Additionally, studies on the impact on prices of reduced
VAT rates seem to indicate that concessions of this type do not necessarily affect prices, and
that prices are more likely regulated by the competitiveness of the market in question, as well
as the price elasticity of the given product: see R. de la Feria & M. Walpole, VAT Rates Structures
– A Case of Political Obstacles to Optimal Tax Policy 3−5 (Paper presented at the Australasian
Tax Teachers Association Annual Conference 2010).
Rita de la Feria and Richard Krever§1.04[A]
24
accomplish any of the social and distributional objectives that they set out to achieve,
but they also carry significant costs beyond the mere loss of potential revenue.
90
[B] Technical Exemptions
Three categories of exempt supplies found particularly in traditional VAT systems are
often explained as necessary or appropriate for technical reasons rather than as part of
a policy to deliver subsidies through the tax system. The implication is that these
activities should ideally be subject to VAT, but pragmatic considerations regarding the
perceived difficulty of subjecting these transactions to the VAT led to their exemption
from the tax. These three types of supplies are supplies of immovable property,
financial services and pooling services, including insurance and gambling. Where
these activities were not exempt as a matter of principle in order to attain specific
benefits, but because of uncertainty as to how the VAT might apply to them, a
cost-benefit analysis – similarly to that conducted for merit / concessional exemptions
– may not have been appropriate when the VAT was first adopted in Europe. This is no
longer the case. Other key questions include what are the legal and economic collateral
costs of excluding these transactions from full taxation and how might the traditional
VAT transition to include these transactions within the scope of VAT.
[1] Immovable Property
It is commonly asserted that no OECD members fully include all types of immovable
property within their VAT base
91
and that the treatment of at least some immovable
property transactions as exempt is nearly universal.
92
The common misconception
arises because some types of immovable property are taxed in modern VAT systems in
the same manner as second-hand goods, using a pre-payment system to accommodate
sales by unregistered owners of residential premises.
VAT systems commonly distinguish between two types of immovable property –
residential premises and other types of property which would include all commercial
property. Immovable property other than residential premises is usually taxable under
VAT, while residential premises are normally subject to special rules. The application
of the ordinary VAT rules to property other than residential premises ensures that input
tax credits are available on properties purchased by businesses, and that no non-
recoverable VAT is embedded in the cost of these properties. An exception to this rule
is found in the European traditional VAT system where, as a consequence of historical
factors deriving from the treatment of immovable property under predecessor turnover
90. Gendron reaches similar conclusions, see P.-P. Gendron (n. 81 above). See also S. Cnossen,
Value-Added Tax and Excises: Commentary,inDimensions of Tax Design – the Mirrlees Review
275−422 (S. Adam, T. Besley, R. Blundell, S. Bond, R. Chote, M. Gammie, P. Johnson, G. Myles
& J. Poterba eds.) (n.5 above).
91. OECD (n. 7, above) at tbl. 3.1.
92. R.F. Conrad, Comments on VAT and Housing, 63 Tax L. Rev. 471 (2010).
Chapter 1: Ending VAT Exemptions: Towards a Post-Modern VAT §1.04[B]
25
tax regimes,
93
a supply of both residential property and other (commercial) property
may be treated as an exempt supply under default rules. To overcome the problem of
embedded non-recoverable VAT for business customers, European VAT laws that use
this default rule commonly provide for optional characterization of the supply as an
ordinary taxable supply, thus providing qualifying purchasers with entitlement to
input tax credits.
94
These rules are, however, themselves problematic. The optional
nature of some of these rules results in a complex and non-transparent system that is
subject to considerable variation across Europe.
95
In addition, various European
countries apply additional or alternative taxes on transfers of immovable property, so
that extra rules are needed to prevent overlapping taxation between these taxes and the
VAT.
96
It is unsurprising that European rules on the VAT treatment of immovable
property have given rise to significant litigation.
97
Under modern VAT systems, the initial sale of residential premises is treated as
an ordinary taxable supply, while subsequent sales are deemed to be exempt supplies.
The rule that the original sale is a taxable supply and subsequent sales are exempt
supplies is intended to replicate for residential premises the ordinary VAT treatment of
second hand goods such as consumer durables. In the case of other second hand goods,
the initial sales of the new goods are usually taxable supplies made by a registered
retailer and later sales are out-of-scope sales, the equivalent of exempt supplies,
because the private owners of the goods are not registered or are not making the
supplies in the course of an enterprise.
The treatment of second-hand goods supplied by private sellers as out-of-scope
(or effectively exempt) supplies reflects the nature of consumer durables as assets with
an effective life stretching over a number of years. In a sense, the person buying
consumer durable goods is acquiring assets that amount to savings. The consumption
takes place as the assets are used (and depreciate) over their lives. In a truly
comprehensive VAT world, all consumers of durables would be registered and entitled
to input tax credits on their acquisitions and then be subject to tax as the assets are used
and generate consumption benefits to the owner. It would, however, not be feasible to
levy tax on this basis for every consumer durable purchased. Fortunately, the initial
value of an asset when acquired is equal to the present value of the future consumption
over the life of the asset and thus VAT calculated on the purchase price will equal the
present value of the tax that would have been levied on consumption over the life of the
asset.
Since the purchase price of a consumer durable equals the present value of
consumption over the entire life of the asset, the initial purchaser will have paid VAT
93. S. Cnossen, VAT Treatment of Immovable Property, in V. Thuronyi, Tax Law Design and
Drafting Ch. 7 (IMF 1996).
94. Article 137(1)(b), (c) and (d) of the EU VAT Directive.
95. For an overview of the VAT treatment of the various types of immovable property transactions,
see S. Cnossen, A Proposal to Improve the VAT Treatment of Housing in the European Union,
Ch. 7 in this volume, at Table 7.1.
96. Ibid., at Table 7.2.
97. See e.g. Cases C-269/03, Vermietungsgesellschaft and Objekt Kircheberg [2004] RCR I-8067;
C-184/04, Undenkaupungin kaupunkin [2006] ECR I-3039; and C-246/04, Turn-und Spor-
tunion Waldburg [2006] ECR I-589.
Rita de la Feria and Richard Krever§1.04[B]
26
on the entire future consumption from the asset. If the asset is sold over the course of
its effective life, the second hand price will represent the depreciated value of the
tax-inclusive price. The initial buyer will thus be able to recover from the next owner
an amount equal to the VAT component of the remaining value of the asset and the
next owner will bear a cost that includes this embedded VAT amount. The government
is indifferent as it has already received the full VAT when the asset was initially sold but
the burden of the VAT is automatically allocated correctly between all the persons who
use it as a consequence of the fact that the value of second hand goods is based on the
VAT-inclusive price of new goods.
The VAT treatment of residential premises rests on the same principles as assets
that may be sold as second-hand assets. The initial price of the property is based on the
present value of future consumption so levying VAT on the first sale of residential
premises and treating remaining sales as out-of-scope supplies (or economically
equivalent exempt supplies) should yield the appropriate VAT outcome. In practice,
therefore, taxing new residential property is a proxy for the VAT that would be payable
on the flow of housing services.
98
However, unlike ordinary consumer durables,
residential premises have a high value and the sale price of residential property will
often place sellers above the registration threshold. As a consequence, in the absence
of specific legislative measures, later sales of residential property would not be
out-of-scope supplies. To obtain this outcome, VAT systems specify that sales of
residential property other than the initial sale are exempt supplies (with European VAT
regimes sometimes extending exempt treatment to the initial sale).
While the system of taxing consumer durables at the time of purchase and
treating subsequent private sales as out-of-scope supplies should yield the appropriate
tax treatment of these assets, it may not fully tax the value of consumption from
residential premises. Unlike consumer durables that have a limited life, the underlying
real property in residential premises does not waste and most often rises in value over
the longer term, even if the physical structure on it declines in value. In theory, the
initial sale price of residential premises should include the present value of anticipated
profits that will be realized when the property is sold as second hand residential
premises, in which case the initial sale price should include the present value of
consumption by subsequent owners. It may be difficult, however, for the market to
measure all anticipated future rises in the value of a residential property as it moves
through a potentially unlimited number of subsequent owners. Also, the present value
of very distant consumption may be so low that it does not materially affect the present
price of an asset. For example, the value of a 90-year lease of residential premises may
be almost the same as the value of freehold title in the same property. If the initial sale
price of residential premises does not fully capture the value of all future consumption
from the property, later owners of property will not bear VAT on the full value of their
consumption. The general implication, therefore, is that future increases – or decreases
– in the value of residential property will be excluded from the VAT base.
98. S. Cnossen (n. 93 above).
Chapter 1: Ending VAT Exemptions: Towards a Post-Modern VAT §1.04[B]
27
Imposing VAT on the initial sale of residential premises may thus prove to be a
flawed surrogate means of taxing the full value of consumption by subsequent owners.
The theoretically correct tax could be imposed by treating all sales of residential
premises as taxable sales, registering every homeowner, allowing input tax credits on
purchase and collecting monthly VAT on the imputed rental consumption by owner-
occupiers.
99
This alternative is neither administratively nor politically feasible, how-
ever, leaving the VAT on initial sale the only second-best alternative open to govern-
ments wishing to tax this consumption.
100
One alternative approach that has been
suggested is a margin scheme that would subject the increased value of consumption
by purchasers of appreciated residential premises to VAT, replacing the transfer taxes
and stamp duties currently applicable in many countries to the sale of residential
property – which are highly distortionary.
101
The logic behind taxation of the initial sale of residential premises and out-of-
scope or exempt treatment for subsequent sales extends to rent. If the rental supply of
residential premises is treated as an exempt supply, the buyer of property will not be
able to recover the tax incurred to acquire the premises and the unrecovered VAT will
be embedded in all future rental payments. As with supplies of residential premises by
way of sale, this surrogate means of taxing consumption value may miss the full value
where property appreciates. But once again, the theoretically correct alternative, in this
case allowing all landlords to register and claim input tax credits on the purchase of
rental property and then impose VAT on rental payments, is neither administratively
nor politically feasible.
102
[2] Financial Services
All VAT tax systems have special rules for a category of supply known as financial
services, with almost all treating them as exempt supplies. There are, however,
significant differences in the definition of financial supply and the rationale for special
treatment across VAT systems. Subject to many variations on the borderline of each
type, the broad category embraces three distinct types of supply. The first comprises
99. By using owner-occupied property directly, the owner realizes a benefit equal to the benefit
that would have been received had it been rented to another person. The consumption value
or imputed rental value of owner-occupied premises is included in the income tax base of some
income taxes. However, no country applies VAT to the imputed rental value of owner-occupied
premises.
100. For an discussion of these alternatives see also S. Poddar, Taxing of Housing Under a VAT,63
Tax L. Rev. 444−470 (2010); G.J. Harley, Dilemma for GST Tax Policy Designers – Land
Transactions, in (R. Krever & D. White eds.) (n. 34 above), 213−241; M. Smith, GST and
Immovable Property Transactions in New Zealand – Some Interpretative Issues, in (R. Krever
and D. White eds.) (n. 34 above); M. Evans, The Value-Added Tax Treatment of Immovable
Property – An Antipodean Context, in (R. Krever and D. White eds.) (n. 34 above); and R.F.
Conrad and A. Grozou, Immovable Property and VAT,inVAT in Africa,81−112 (R. Krever ed.,
Pretoria University Press 2008).
101. S. Cnossen (n. 93 above).
102. For a detailed proposal on the appropriate VAT treatment of the various types of immovable
property transactions, see R. Millar, VAT and Immovable Property: Full Taxation Models and
the Treatment of Capital Gains on Owner-Occupied Residences, Ch. 8 in this volume.
Rita de la Feria and Richard Krever§1.04[B]
28
intangible ownership rights in legal persons or relations. Examples include shares,
103
interests in unit trusts or mutual funds, and interests in pension or superannuation
funds. The second comprises financial intermediary services for loans, the function of
banks and similar organizations that link lenders (depositors) and borrowers. The third
consists of pooling intermediary services such as lotteries or insurance where a service
provider collects funds from a range of persons and allocates the pool to a select group
of winners (in the case of lotteries) or losers (in the case of insurance).
[a] Investments in Ownership Rights
The first type of financial supply – investments in ownership rights – gives rise to
difficulties in the VAT system because a large number of persons acquiring these assets
are individuals who are not registered for VAT purposes. In theory, a consumption tax
should never be levied on investments; the tax is supposed to fall on consumption and
not touch savings. This outcome follows automatically if the consumption tax is
imposed as an annual expenditure tax that measures consumption as income and
withdrawals from savings minus amounts invested (everything that is not invested is
assumed to be used for consumption).
104
This is difficult to achieve, however, in a
transaction based consumption tax that relies on registration, tax invoices, and
refundable input tax credits as a means of removing tax on non-consumption acquisi-
tions. It would be administratively impossible to apply the normal VAT rules to
supplies of intangible ownership assets and then register all investors acquiring these
supplies and process input tax refunds for the VAT imposed on the supplies.
The over-taxation of investments caused by the current characterization of these
investments as exempt financial supplies undermines one of the economically desir-
able attributes of a consumption tax, namely its complete non-application to savings
and investments. A possible solution to the problem in the context of the VAT
mechanism is to treat these supplies as zero-rated. Such treatment would present its
own challenges, however. Identifying appropriate types of financial assets to be subject
to a zero-rating rule could be difficult and identifying qualifying ancillary expenses
such as legal, accounting, or investment advice would also be problematic as these
services are also used for both personal consumption and the acquisition or mainte-
nance of investments.
105
[b] Loan Intermediary Services
The second type of financial supply, the loan intermediary service offered by financial
institutions to lenders and borrowers, fits awkwardly in the ordinary VAT system for
several reasons. To begin with, it is difficult to measure the value of this service as no
103. Although not all dealings in shares are regarded as exempt under European VATs, see R. de la
Feria (n. 44 above).
104. This form of consumption tax was advocated in Institute for Fiscal Studies (J. Meade,
committee chair), The Structure and Reform of Direct Taxation (Meade Report) (1978).
105. This solution and potential difficulties are explored in detail in H. Grubert & R. Krever, VAT and
Financial Services: Competing Perspectives on What Should Be Taxed, Ch. 9 in this volume.
Chapter 1: Ending VAT Exemptions: Towards a Post-Modern VAT §1.04[B]
29
explicit fee is charged for it. Rather, lenders and borrowers pay for it in the spread
between interest paid to lenders and by borrowers. While it is possible to measure the
value on an institutional basis and have the institution remit VAT implicitly charged to
customers, it is difficult to attribute specific charges to individual depositors and
borrowers, a step that would be necessary for the intermediary to issue tax invoices so
investors and business customers could recover the VAT.
These difficulties explain in part why the traditional VAT treated loan interme-
diation supplies as exempt supplies and why most modern VATs followed suit. The
result was over-taxation of business borrowers and lenders and private depositors (all
of whom in theory should have borne no VAT burden on their investments or
borrowings) and under-taxation of private borrowers. Some jurisdictions that have
followed the modern VAT model have since shifted to alternative rules to try and
mitigate these outcomes. For example, the tax borne by registered business customers
can be removed by zero-rating loan intermediation services provided to these custom-
ers or treating all services that are not strictly intermediary services paid by way of
interest rate spreads as ordinary taxable supplies.
106
It is likely that other countries using the modern VAT model will shift to these
post-modern VAT rules over time. Europe has considered these and other reform
options,
107
with some European countries already giving financial institutions an
option to be taxed under VAT.
108
Reform has stalled in recent times, however, more for
fiscal reasons than for theoretical or practical considerations. Treating loan interme-
diation services to business customers and private investors may be wrong as a matter
of policy and may lead to significant economic distortions, particularly where the tax
compounds along the supply chain, but the over-taxation does generate a lot of
revenue.
109
The revenue loss that would result from the return of input VAT to business
106. For a description of the New Zealand experience, the first jurisdiction to zero-rate intermediary
financial supplies to business customers, see M. Pallot, Financial Services under New Zealand’s
GST, 5 Intl. VAT Monitor 310−315 (2011). Singapore has an alternative regime intended to ac-
complish the same result; Australia provides financial institutions with generous input tax cred-
its on a range of inputs used by financial intermediaries, see M. Walpole, The Miraculous
Reduced Input Tax Credit for Financial Supplies in Australia, 5 Intl. VAT Monitor 316−323
(2011); and South Africa treats all financial services as taxable supplies if the fees for the services
can be identified. For a comparative analysis of these alternatives see also A. Schenk & H.H. Zee,
Financial Services and the Value-Added Tax,inTaxing the Financial Sector – Concepts, Issues,
and Practices 60−74 (H.H. Zee ed., International Monetary Fund 2004); T. Edgar, Exempt Treat-
ment of Financial Services Under Value-Added Tax: An Assessment of Alternatives, 49(5) Cana-
dian Tax J. 1133−1219 (2001); and H.H. Zee, VAT Treatment of Financial Services: A Primer on
Conceptual Issues and Country Practices, 34(10) Intertax 458−474 (2006).
107. For a review of attempted reforms over time, see R. de la Feria, The EU VAT Treatment of
Insurance and Financial Services (Again) Under Review, 2 EC Tax Rev. 74−89 (2007). One of
the reforms which was under strong consideration was the transplantation of the Australian
system: see R. de la Feria & M. Walpole, Options for Taxing Financial Supplies in Value Added
Tax: EU VAT and Australian GST Models Compared, 58(4) Intl. & Comp. L. Q. 897−932 (2009).
108. For an analysis of the option to be taxed applied in some EU Member States, see R. de la Feria
& B. Lockwood, Opting for Opting In? An Evaluation of the Commission’s Proposals for
Reforming VAT for Financial Services, 31(2) Fiscal Stud. (2010).
109. The revenue collected through over-taxation resulting from exemptions has been calculated in
the United Kingdom to be 15% of the total VAT yield: see R. de la Feria, Partial-Exemption
Policy in the United Kingdom, 21(2) Intl. VAT Monitor 119−123, at 22 (2010).
Rita de la Feria and Richard Krever§1.04[B]
30
consumers of financial intermediary services and private depositors might not be as sig-
nificant as feared, as full taxation of financial services provided to final consumers might
go some way to compensate for removal of the over-taxation of business depositors and
borrowers and private depositors.
110
There could nevertheless be a net revenue loss and
governments seeking to reform the current treatment would thus need to find the politi-
cal courage to recover the lost revenue elsewhere either through base-broadening or
higher rates and furthermore to explain that the broadening or rate increases are needed
to relieve banks and business of tax, a difficult sell at the best of times.
111
Many VAT systems, particularly those following the traditional VAT model,
compound the problem of over-taxation of businesses and investor users of loan
intermediary services and under-taxation of customer users by extending exempt
supply treatment to a range of ancillary services offered by financial institutions and
similar organizations even though the value of these ancillary services can be easily
ascertained and the ordinary VAT tax rules applied to these supplies.
112
Refining the
definition of financial services in these jurisdictions so these ancillary supplies are no
longer treated as exempt supplies would be a relatively simple way to begin reform of
this area.
113
Europe is taking a step in this direction, with negotiations ongoing with a
view to approving legislation which would redefine financial supplies for the purposes
of exemptions.
114
110. See calculations for loss of revenue under the current European Commission’s proposals for
reform of VAT on financial and insurance services in R. de la Feria & B. Lockwood (n. 108
above). In a recent paper, Buettner and Erbe provide an analysis of revenue and welfare effects
associated with the application of a VAT exemption to financial services using a general
equilibrium model. Using German data, they conclude that the revenue effects of removing the
exemption would be positive, but quite small: see T. Buettner & K. Erber, Revenue and Welfare
Effects of Financial Sector VAT Exemption, CESifo Working Paper (June 2012). It is worth
noting however that Germany is one of the few European countries that already allow financial
institutions an option to tax their financial supplies, a factor that could help explain these
limited revenue effects.
111. Concern about the undertaxation of the financial sector is now at the centre of the discussions
on the introduction of a new tax on the financial sector, see in particular European Commis-
sion, Proposal for a Council Directive on a common system of financial transaction tax and
amending Directive 2008/7/EC, COM(2011) 594 final, of 28 September 2011, and accompany-
ing documentation; J. Vella, C. Fuest & T. Schmidt-Eisenlohr, The EU Commission’s Proposal
for a Financial Transaction Tax, 6 British Tax Rev. 607−621 (2011); and M. Keen, Rethinking
the Taxation of the Financial Sector, 57(1) CESifo Econ. Stud. 1−24 (2011).
112. While the bundling of ancillary services under the financial services umbrella has been
significantly limited in Europe by the ruling of the Court of Justice in Accenture, Case C-472/03,
Staatssecretaris van Financien v. Arthur Andersen & Co. Accountants c.s. [2005] ECR I-1719, the
EU VAT Directive itself – and the interpretation given to it by the EU Court of Justice – deems
many transactions that are not strictly intermediary services to be exempt financial services:
see R. de la Feria (n. 107 above).
113. Edgar better summarizes the tax policymakers technique at play: ‘modify the application of
exemption through partial reform alternatives intended to suppress one of the perceived
distortions’, in T. Edgar, The Search for Alternatives to Exempt Treatment of Financial Services
Under a Value-Added Tax, in (R. Krever and D. White eds.) (n. 34 above), 131−161, at 147.
114. The legislative proposals currently on the table envisage the re-definition of financial services,
introduction of a cost-sharing group allowing economic operators to pool investments and
re-distribute the costs of these investments to the members of the group, exempt from VAT, and
introduction of an option to tax: see Commission of the European Communities, Proposal for a
Council Regulation laying down implementing measures for Directive 2006/112/EC on the
Chapter 1: Ending VAT Exemptions: Towards a Post-Modern VAT §1.04[B]
31
Much more is known today about how to tax financial supplies under VAT than
was the case just 20 years ago. The experience of some modern VAT jurisdictions with
methods to prevent overtaxation of financial intermediary services to registered
businesses may lead to general agreement that businesses should not bear tax on these
services under a post-modern VAT. Developing a consensus on the optimal method of
taxing loan intermediary services provided to unregistered consumers may prove more
elusive.
[c] Intermediary Pooling Services
Intermediary pooling services are found in arrangements such as gambling lotteries or
insurance where a service provider collects funds from a range of persons and allocates
the pool to selected participants in the arrangements. In the case of insurance, a
financial intermediary pools contributions from policy holders and distributes amounts
from the pool to those who suffer losses. In the case of gambling, the financial
intermediary pools contributions from gamblers and distributes amounts from the pool
to winners.
The traditional VAT exempted insurance services for technical reasons – at the
time the VAT was adopted, policy makers had to consider ways of measuring and
taxing the value of intermediary services while reconciling options with the separate
insurance taxes in place in many jurisdictions. As is the case with loan intermediation
services discussed earlier, customers of insurance services are businesses that would
be over-taxed if these services were treated as exempt services or consumers who
would be undertaxed. This exemption gives rise to significant difficulties, and over the
years it has been the source of much litigation in Europe.
115
In fact, it was a decision
from the EU Court of Justice on the interpretation of the insurance exemption in a case
concerning outsourcing, which led to the ongoing review of the exemptions applicable
to financial and insurance services.
116
As a result, current negotiations include
proposals to include some insurance services in the tax base.
117
common system of value added tax, as regards the treatment of insurance and financial services,
COM(2007) 746 final, 28 November 2007; and Commission of the European Communities,
Proposal for a Council Directive amending Directive 2006/112/EC on the common system of
value added tax, as regards the treatment of insurance and financial services, COM(2007) 747
final, 28 November 2007. However, negotiations at the Council of Ministers have concentrated
primarily on discussions over clarification and re-definition of exemptions.
115. See amongst others Cases C-349/96, Card Protection Plan Ltd (CPP) v. Commissioners of
Customs and Excise [1999] ECR I-973; C-240/99, Forsakringsaktiebolaget Skandia (publ)
[2001] ECR I-1951; C-8/01, Assurandor-Societetet, acting on behalf of Taksatorringenv Skat-
teministeriet [2003] ECR I-13711; C-308/01, GIL Insurance Ltd, UK Consumer Electronics Ltd,
Consumer Electronics Insurance Co. Ltd, Direct Vision Rentals Ltd, Homecare Insurance Ltd,
Pinnacle Insurance plc v. Commissioners of Customs and Excise [2004] ECR I-4777; C-425/06,
Ministero dell’Economia e delle Finanze v. Part Service Srl [2008] ECR I-897; and C-242/08,
Swiss Re Germany Holding GmbH v. Finanzamt München für Korperschaften [2009] ECR
I-10099.
116. Case C-472/03, Staatssecretaris van Financien v. Arthur Andersen & Co. Accountants c.s. [2005]
ECR I-1719. For a detailed analysis of the background to the ongoing review see R. de la Feria
(n. 107 above).
117. See n. 114 above.
Rita de la Feria and Richard Krever§1.04[B]
32
The technical problems that led to the classification of insurance services as
exempt within the traditional European VAT appear to have been solved by VAT
designers in many modern VAT systems and to avoid the overtaxation and undertaxa-
tion problems that flow from exempt treatment, modern VAT systems commonly treat
non-life insurance services as ordinary taxable supplies. The inclusion of insurance
intermediary services within the scope of the VAT has not, however, been extended to
intermediary services for life insurance which are so far universally exempt, perhaps in
part due to the savings component in some types of life policies.
The traditional VAT also exempted gambling services in part because of uncer-
tainty by the designers over how the intermediary services should be measured and
taxed.
118
However, as with loan intermediation services, it is possible to measure and
collect tax on the value of the service to all customers, if that value is calculated at the
level of the pooling service provider. Since all participants in a gambling pooling
arrangement are assumed to be final consumers, there is no need to allocate the value
to individual participants and issue tax invoices. Accordingly, many modern VAT
systems have relatively simple rules to impose tax on gambling services (including the
provision of casino gambling and lotteries), with the value of the service being the
difference between bets collected by the intermediary service provider and winnings
paid out.
119
Although the EU VAT Directive provides EU Member States with an option
to tax gambling services, exemption remains the more common approach in the
traditional VAT. Judicial interpretations have limited the possibility of extending the
exemption to ancillary activities,
120
but conversely also limited the ability of EU
Member States to selectively remove the exemption from particular types of gambling,
on the basis of the respect for the principle of fiscal neutrality.
121
§1.05 CONCLUSION: TOWARDS A POST-MODERN VAT
Exempt supplies and out-of-scope supplies with economic outcomes similar to those of
exempt supplies are found in abundance in the traditional VAT and to a lesser extent
in the modern VAT. These lead to overtaxation of business and undertaxation of final
consumers. The efficacy of explicit exemptions that supposedly further equity or merit
good objectives is questionable and the logic for retaining all exemptions supposedly
needed for technical reasons is no longer convincing.
118. Article 135(1)(i) of the EU VAT Directive.
119. See A. Schenk, Gambling and lotteries, in (R. Krever ed.) (n. 72 above), 47−70. There is an
argument that this approach undertaxes the consumption of gamblers and that the gross
amount should be taxed, rather than merely the margin. This issue is explored further in Y.
Margalioth, VAT on Gambling, Ch. 6 in this volume.
120. See Case C-89/05, United Utilities plc v. Commissioners of Customs & Excise [2006] ECR I-6813.
121. See Cases C-283/95, Fischer, Karlheinz v. Finanzamt Donaueschingen [1998] ECR I-3369;
C-453/02, Finanzamt Gladbeck v. Edith Linneweber [2005] ECR I-1131; C-58/09, Leo-Libera
[2010] ECR I-5189; C-260/10, Commissioners of Her Majesty’s Revenue and Customs v. The
Rank Group plc [2011] ECR I-000; C-464/10, Belgian State v. Pierre Henfling and Others [2011]
ECR I-000. For a recent analysis of these cases see R. de la Feria, Rank Group. VAT exemption
on gambling. Principle of fiscal neutrality. Court of Justice, 1 Highlights & Insights European
Taxn. (2012).
Chapter 1: Ending VAT Exemptions: Towards a Post-Modern VAT §1.05
33
It has been said that ‘the taxation systems of the major developed countries will
grow to resemble each other more and more’, with the spread of VAT being offered as
an example of this phenomenon.
122
A close examination of VAT systems, however,
reveals significant divergences in practice. Historical factors that led to multiple rates
and multiple exemptions in the traditional European VAT were not present in most
jurisdictions outside the EU and adopters of a modern VAT model were able to avoid
these features of the traditional VAT, for the most part adopting single rates and
substantially limiting the number of exemptions. Even these more limited exemptions
have imposed economic and administrative costs, however, prompting some modern
VAT jurisdictions to explore post-modern alternatives, particularly in the sphere of
financial supplies, but also in respect of supplies by SMEs and registration thresholds.
At present the attention is on another possible tax policy transfer, this time in the
opposite direction: from modern VATs to the traditional VATs, a transplantation of the
modern VAT model for taxing traditionally exempt transactions to the traditional VAT
systems. However, there are intrinsic complications to tax policy transfer and regional
specificities are a normal occurrence. This is precisely one of the reasons public policy
transfer in general, and tax policy transfer in particular, is perilous at the best of
times.
123
Lack of information on the real effects of the tax policy in the country of origin
will aggravate the dangers. In this context, a debate regarding the adoption by
traditional European-style VATs of the modern VATs’approach of taxing specific
supplies must be well-informed. Accepting the inherent risks of tax policy transfer in
this case might be unavoidable if reform is ultimately the wisest way forward. If such
a transfer is going to succeed, however, it is necessary to realize not solely what are the
advantages of the modern VAT model but equally what are its limitations. Understand-
ing their weaknesses might lead to a post-modern VAT: one which takes into account
the weaknesses of modern VATs and aims to overcome them.
Indeed, there is already a realization that modern VATs are not a complete
panacea. Undoubtedly they are an improvement on the traditional VAT exemption
model. They have solved some of the difficulties encountered under the traditional
VAT but it is less clear whether they have solved all, or to what extent they have given
rise to new problems. Various chapters in this volume draw attention to some of these
problems such as the difficulties caused by the rebate system applicable to public sector
bodies and charities in Canada or the definitional and planning problems caused by the
input tax credits model applied to Australian financial services. Additionally recent
research has shed new light over the VAT treatment of some transactions which until
now had been relatively untapped; this is the case for example with the treatment of
supplies by SMEs and the optimal level of registration threshold.
Table 1.1 summarizes the treatment of specific transactions under traditional,
modern, and post-modern VAT. The transactions highlighted in grey represent those
where significant departures between modern and post-modern VAT are proposed.
122. See R.K. Osgood, The Convergence of the Taxation Systems of the Developed Nations, 25(2)
Cornell Intl. L. J. 339−347, at 339 and 343 et seq. (1992).
123. See D.P. Dolowitz & D. Marsh, Learning from Abroad: The Role of Policy Transfer in
Contemporary Policy-Making, 13(1) Governance: Intl. J. Policy & Admin. 5−24 (2000).
Rita de la Feria and Richard Krever§1.05
34
One recurrent issue throughout this volume and during the conference discus-
sions at Oxford which preceded it – particularly insofar as technical exemptions are
concerned – is the definition of consumption. In all chapters regarding technical
exemptions the key when considering alternative designs has been the concept of
consumption. It has therefore become clear that one of the main challenges of the
post-modern VAT will be a rather unexpected one: not about feasible legal designs or
about economic consequences, but one with an intrinsically philosophical nature, one
about philosophy of tax. That is, how to conceptually define what constitutes con-
sumption for the purposes of a consumption tax.
Chapter 1: Ending VAT Exemptions: Towards a Post-Modern VAT §1.05
35
Table 1.1 Treatment of Specific Supplies under Traditional, Modern and Post-modern VAT
Traditional VAT Modern VAT Post-modern VAT
Treatment Rationale Treatment Treatment
No direct consideration Out-of-scope supplies Out-dated legal wording
and judicial interpretation
Full taxation Full taxation
SMEs Out-of-scope suppliers
(varying thresholds)
Vertical equity versus
widening of tax base
Out-of-scope suppliers
(varying thresholds)
Out-of-scope suppliers
(high threshold)
Non-business enterprises Out-of-scope suppliers Out-dated legal wording
and judicial interpretation
Full taxation Full taxation
Public sector bodies Out-of-scope suppliers Out-dated legal wording
and judicial interpretation
Full taxation Full taxation
Merit goods and services Exempt Vertical equity
Positive externalities
Full taxation (or exempt or
zero-rated)
Full taxation
Immovable property Exempt (option to tax
commercial property)
Difficult-to-tax Full taxation of commercial
property
Exemption of residential
property (except first sale)
Full taxation of
commercial property
First sale of residential
property taxable
Financial intermediary
services
Exempt(option to tax) Difficult-to-tax Exemption model
Zero-rating of B2B model
Full taxation
Non-life insurance
services
Exempt Difficult-to-tax Full taxation Full taxation
Gambling Exempt Difficult-to-tax Full taxation Full taxation (margin
model)
Rita de la Feria and Richard Krever§1.05
36
