Developments in indirect taxes in 2012June 28, 2012
At a time when many countries are still deeply affected by the financial crisis and are trying to recover from it, big tax reforms and discussions on the ideal tax mix may not seem a top priority on governments’ agendas. However, this cannot be said for indirect taxes. As we have reported in the past few years, in 2012, taxes on consumption continue to be a focus for many governments.
The continuing shift toward indirect taxation
This focus on indirect taxation is for two main reasons. Firstly, the need to increase overall tax revenues as part of fiscal consolidation programs, combined with the economic efficiency of indirect taxes, is encouraging many countries to increasingly rely on consumption taxes, both by raising headline rates and by expanding their tax bases.
Secondly, changing and evolving concepts of the function of the state are encouraging countries to steer consumers’ behavior through tax policy and incentives.
Taxes on the consumption of specific goods have proven to be efficient in this context and, not surprisingly, energy taxes, air passenger taxes, carbon (CO2) taxes or excise taxes on snack foods, alcohol and tobacco have spread globally.
Since 2008, a clear trend has emerged towards increasing indirect tax rates, involving both VAT/GST and excise duties. This will further increase the share of indirect taxes as part of total revenue for many countries in the coming years.
At the same time, governments have shown little activity in promoting other forms of taxation to meet their revenue needs. For example, housing taxes have hardly increased even though research shows that they are among the most growth-friendly and despite the fact that housing boom-and-bust episodes have been one of the root causes of recession and bank failures in the past.
Also, the intensively discussed financial taxes have not yet altered the predominant focus on indirect taxes. The increase of the indirect tax share in the economy has a number of important implications, not least an increasing impact on businesses: higher tax rates cause more severe consequences in the case of non-compliance and mistakes.
Non-recoverable indirect taxes raise the costs of doing business, make production more expensive and call for increased efficiency to make up for the increased costs. For governments, as indirect tax income becomes more important, so does effective enforcement.
The fight against fraud and the monitoring of taxpayers becomes more pressing. Also there is greater need to address the distortions in indirect tax systems because their detrimental effects weigh more profoundly.
Six common global trends for indirect taxes can be identified that are likely to be significant in 2012 and beyond.
1. Increasing VAT / GST rates
For some years now, a slow but constant shift from direct to indirect taxes has been noted on an almost global basis. In Europe, where several countries are still struggling with the aftermath of the financial crisis, this trend has even accelerated in recent years.
As a consequence, we have seen a constant rise in VAT rates worldwide, and this trend has been particularly strong in Europe. As Figure 1 shows, the average standard VAT rate across the 27 member countries of the European Union (EU) oscillated for many years around 19.5% before it started to increase steadily after 2008.
At the start of 2012, the average EU VAT rate has now passed 21%. This trend looks set to continue in 2012. So far this year, four EU countries have decided to increase their standard rates, Italy (from 21% to 23%), Ireland (from 21% to 23%), Cyprus (from 15% to 17%) and Hungary (from 25% to 27%).
France has announced a proposed increase of 1.6% later in the year, and others, e.g., Croatia (which will join the EU shortly), may follow suit. These latest increases follow on from a steady chain of VAT rate increases in the region in the past two or three years.
On a global level, the trend to raise VAT rates is less explicit, but still noticeable. Canada (Quebec), Lebanon and the Maldives have all increased the standard rate; plans to do so exist in Japan, but have recently been postponed to a later date.
A further indicator that this upward rate trend may continue in Europe is the fact that countries are now raising their standard rates to higher levels than in the past. This trend is especially marked in Hungary.
By setting the new standard VAT rate at 27%, Hungary has now broken the “magic barrier” for the top EU rate, which for a long time was believed to be 25%.
Considering that many, mainly northern, EU countries already charge 25%, it is not too hard to believe that other European countries may follow Hungary’s lead in the coming years unless economic conditions improve.
It is not just the standard VAT rate that is on the rise. One recent development is that countries are also starting to raise their reduced VAT rates. France, Greece, Italy, Norway, Poland, Portugal and the Czech Republic have all recently increased their reduced rates or removed goods and services from the scope of the lower rate.
Interestingly, this trend could eventually lead to more countries charging a single tax rate. Traditionally, European countries have applied a range of VAT rates and used reduced rates for basic needs such as foodstuffs or to favor local industries, such as tourism.
In other parts of the world, reduced rates are less common, and many countries, such as Chile, Israel and Japan, have a single VAT rate. The Czech Republic could be the first EU country to enter this “single rate circle” with its plan to merge its two existing rates at 17.5% by 2013.
In addition to raising revenue, adopting a single VAT rate could help to simplify VAT compliance for VAT taxpayers and enforcement for tax administrations.
After all, from a tax technical perspective, multiple rates complicate the VAT system and potentially introduce distortions between countries and between similar goods and services (for example, between paper books, which often benefit from reduced VAT rates, and audio and electronic books, which traditionally have not).
2. Broadening of the VAT / GST base
The range of goods and services that are subject to indirect taxes is being extended. Often, when a country decides to introduce a VAT or GST, the new tax is applied with a restricted tax base as a first step.
The tax is then extended at a later stage once the system has proved to be functioning and businesses and authorities have gained the necessary experience. Sometimes the first step is to levy a sales tax (which is usually levied on supplies of goods only) and to change to a VAT/GST system with a much broader tax base at a later stage.
This trend is especially strong in Africa, where examples include the Congo, Seychelles and Swaziland, which will all introduce a VAT/GST in the course of 2012. Once VAT/GST is in place, additional goods and services may been included in the tax base to tax consumption as broadly as possible.
This is usually achieved by restricting or abolishing tax exemptions and reduced rates. For example, Finland now taxes subscriptions to newspapers and periodicals, which previously were exempt from VAT. Belgium has removed the previous exemption for services of notaries and bailiffs, which are now taxed at a 21% rate.
At the same time, it has increased the VAT rate on pay-TV to 21% from 12%. In Malawi, a range of goods, such as newspapers, water supply, bread, meat, milk and dairy products, are now subject to VAT which were previously VAT-exempt or zero-rated. The Vietnamese government has also announced it will extend the application of VAT.
3. Refinement of consumption tax systems
Many countries are currently in the process of refining their indirect tax systems. Broadening the tax base is one aspect of this development, but there are more fundamental reforms as well.
Especially in emerging markets, which are experiencing economic developments at a fast pace, indirect tax systems need to keep pace with these developments. Doing so generally requires a reform of the system.
In India, for example, a new nationwide GST is currently being debated and is awaiting agreement between the central and state governments. The new GST is intended to replace all existing indirect taxes on goods and services levied at the state and national levels.
The proposed tax should greatly simplify the tax structure and lead to more efficient resource allocation and, consequently, higher GDP growth. Similarly, China plans to replace its current business tax (BT) on services with a broader VAT. As a preliminary, on 1 January 2012, Shanghai started a VAT pilot to trial the convergence of VAT and BT.
This is a significant step towards the planned wider VAT reform, which will allow China to reduce the cascading tax effects from its current BT and will support the development of modern services. The new standard VAT rates will be 17% and 13%, and two new reduced VAT rates at 11% and 6% will be introduced.
In the EU, where VAT has operated for many years, major reform is also in prospect. The European Commission is currently drafting a new VAT legislation, due to publish in 2012, with the intention of simplifying the system and cracking down on fraud.
But even on a smaller scale, adjustments and refinements are happening all over the world as VAT/GST seeks to keep pace with globalization and advances in technology. An example is the alignment of the VAT treatment of electronic media and print media in several countries such as Iceland and Luxembourg.
This reduces distortions caused by VAT because, for example, a printed newspaper is taxed at a reduced rate whereas buying the same newspaper as an internet download is taxed at the standard rate.
4. Increased focus on compliance and tax avoidance
The increasing importance of indirect taxes, as a result of their affecting larger parts of the economy and their being levied at higher rates, exposes them to a greater risk of fraud and tax avoidance.
Our recent survey on tax risk and controversy shows tax administrators and taxpayers view indirect taxes as a key source of risk in the coming one- and three-year periods.
Tax administrations in all parts of the world therefore are putting a greater focus on indirect tax compliance and enforcing compliance. As a result, many countries are broadening the scope of indirect tax penalties as well as imposing higher penalties. At the same time, tax authorities are intensifying their audit activities.
Increasingly, they are using precisely tailored methods and strategies to detect tax abuse and avoidance. Many tax administrations are undergoing important structural reorganizations and technology is being used more widely for effective and efficient tax collection and enforcement.
In the Netherlands, for example, in 2012 a stricter VAT penalty regime will allow the tax authorities to apply punitive sanctions to VAT errors in the case of gross negligence, even if a default penalty has already been applied, if new facts emerge.
Similar developments may be seen in Romania, Slovakia and in the United Kingdom, where the implementation of a new penalty regime for late filing of VAT returns and late payment of VAT has been announced.
5. Continuing rise in excise duties
As with VAT/GST, a clear trend in rate increases may be seen for the other main class of consumption taxes, excise duties. With the broad appearance of modern VAT/GST systems in the 1970s and 1980s, many product-related taxes were abolished.
It is only recently that specific excise duties have once again gained importance, mainly because they are seen as a good tool for steering consumption and influencing consumers’ behaviour.
There are still many products that are subject to excise duties in a number of countries (such as chocolate, coffee and orange juice), but the three principal product groups that are globally liable to excise duties are alcoholic beverages, mineral oils and tobacco products.
All three groups have seen a constant rise of the tax burden and this development is likely to continue. Since excise duties are normally part of the VAT/GST tax base, an increase of excise duty rates implies an increase of both excise and VAT/GST revenues.
Especially in the case of mineral oils, the revenues raised from taxes are high. Compared to other tax rates within the overall economy, the total tax burden on fuel (mainly excise duty plus VAT/GST) often exceeds 100% of pre-tax prices.
The development of integrated markets (e.g., the EU) and the elimination of border controls at frontiers have revealed disparate excise rates between neighboring countries to the extent that market forces are affected.
This is true not only at the international level but also within a federal structure such as the United States, where different excise rates may apply in neighboring states. In the US, a state excise tax applied to a pack of 20 cigarettes can vary by a factor of 25 depending on the state.
In such circumstances, the effects of cross-border shopping can have a significant economic impact on businesses in border areas and put pressure on affected tax administrations to seek a closer approximation of excise duty rates with their neighbors.
In addition to increased excise duties, new taxes are being introduced that seek to influence society behaviour, e.g., snack taxes on “unhealthy” food (recently introduced in Hungary and Denmark) or carbon taxes aimed at reducing climate change and air pollution (to be introduced in Australia in July).
It can be expected that, in the longer term, new taxes may continue to be introduced or existing taxes will be broadened in the public health and energy sectors as more countries adopt these strategies.
6. Decreasing customs duties from increasing free trade
Customs duties were once a primary source of revenue for most countries. But continuously growing global trade and the efforts of organizations such as the World Trade Organization (WTO) have led to a constant reduction in customs duties.
This trend continues around the world as countries conclude a growing network of free trade agreements (FTAs) and preferential trade agreements (PTAs). The WTO currently reports 380 active and pending regional trade agreements among members.
That number does not include unilateral preference programs — trade preferences granted to products imported from identified countries without reciprocal benefit required, such as the generalized system of preferences (GSP) in the EU and the US, which provide duty-free treatment to many products from developing nations.
A number of new FTAs will enter into force in 2012, further reducing the amount of customs duties levied; examples include the agreement involving Russia, Ukraine, Belarus, Kazakhstan, Armenia, Kyrgyzstan, Moldova and Tajikistan and the United States’ new FTAs with Panama, Colombia and South Korea.
We also see countries such as Israel unilaterally reducing customs duties. However, at the same time, the absolute amount of revenue derived from customs duties is on the rise in many countries.
In China, for example, revenues from customs duties jumped 29% compared to 2010 to more than 1.61 trillion yuan (approximately US$256 billion) in 2011. This increase is not surprising if one considers that the quantity and value of imported goods is steeply rising again after a short reduction in 2009.
In summing up these various indirect tax trends for 2012, it must be said that few are completely new. Although they have been in evidence for several years, their continuing importance indicates that they are now long-term developments and need to be taken seriously.
Above all, there is a need for businesses to keep abreast of the constant changes in the rules in VAT/GST and other indirect taxes around the world — a major, ongoing responsibility that requires specific attention from corporate tax functions.
The need to look at how VAT/GST is managed is particularly significant for industry sectors that, up until now, have enjoyed lower rates of tax and therefore may have treated these taxes as low priority.
The very recent trend for countries to increase and abolish their reduced VAT/GST rates and remove goods and services from the scope of the lower rate will strongly affect businesses that operate in sectors such as food processing, pharmaceuticals and tourism.
Rate rises also greatly increase costs for businesses that do not recover VAT/GST in full (e.g., because of VAT-exempt activity) such as banks and insurance companies.
They also have an increased cost or cash flow impact on companies that incur VAT/GST in foreign jurisdictions which is not refunded quickly or which they do not or cannot recover (e.g., because of an absence of refund schemes for non residents or because of complicated refund procedures).
For businesses that have not yet addressed indirect tax management as a corporate priority, now is the time to do so. As indirect tax revenues rise as a percentage of overall budgets, tax administrations are turning increased attention to enforcement — including joint audits with other taxes and even other countries.
These activities may disrupt business activity, and large assessments for underpaid tax or penalties for late filings not only have an impact on profitability, they may draw unwanted adverse publicity, even for compliant businesses. Active management of indirect tax is no longer an option, it is an imperative.
- Philip Robinson, +41 58 289 3197, firstname.lastname@example.org
This article was first published in the Ernst & Young Global Tax Policy and Controversy Briefing which can be accessed using the link below: