Indirect tax in 2013: with change comes complexity

October 4, 2013

It is probably unprecedented in the long history of taxes that a specific tax mechanism, such as value-added tax (VAT), has spread around the world in less than a half century. Limited to less than 10 countries in the late 1960s, VAT – or, in several countries, goods and services tax (GST) – is today an essential source of revenue in more than 150.

Despite its importance, VAT/GST is not the only indirect tax. Taxes on specific goods and services – consisting primarily of excise taxes, customs duties and certain special taxes – form the other important leg of indirect taxes. Among Organisation for Economic Co-operation and Development (OECD) member countries, indirect taxes make up about one-third of the total tax take (Figure 1).

We believe that the importance of indirect taxes will continue to grow. The economic crisis has caused many governments to find sustainable ways to rebalance their budgets and stimulate growth.

This would imply that governments will continue the shift from direct to indirect taxes – which are less harmful for growth – look to improve the efficiency of indirect taxes and take action to combat fraud and avoidance.

Increasing VAT/GST rates

Around the world, many countries are relying more and more on indirect taxes to finance their budgets. Coupled with the ongoing economic crisis, VAT/GST rates have increased exponentially in recent years as a result. At the same time, the scope of VAT has broadened in many countries.

The trend in rising VAT rates has been particularly strong in Europe, especially in the European Union (EU). As a result of consistent rises, between 2008 and 2012 the average EU standard VAT rate increased from around 19.5% to more than 21% (Figure 2, p10).

In Asia-Pacific, the upward VAT/GST rate trend is less explicit, but still noticeable. Japan, for example, which is struggling with a massive budget deficit, decided in August 2012 to increase the current VAT rate from 5% to 8% effective 1 April 2014, and to 10% effective 1 October 2015. Thailand has also announced a VAT rate rise from 7% to 10%.

In contrast, VAT/GST rates in the Americas remain relatively stable. In South America, where VAT systems are widespread and have been in use for some time, rates have not changed much in recent years. One exception is in the Dominican Republic, where the rate is set to increase from 16% to 18% this year and next year.

Broader base

The scope of VAT/GST is also widening in many countries. This is being achieved through the “reclassification” of certain goods or services to apply a different rate and by removing exemptions.

Examples of countries where the scope of the zero-rate (0% rate) was reduced in 2013 include Croatia, Norway and Kenya. In the Dominican Republic, Jamaica and Zambia, exemptions have been removed; and in Iceland, Italy and Poland, the application of the standard rate has been widened to goods that were previously taxed at reduced rates.

The impact on business

The immediate significance of this trend for consumers is clear: retail prices rise. But its impact on businesses is equally important: higher VAT/GST rates increase the compliance risk. Companies must ensure that all the increases are properly dealt with in their accounting and reporting systems.

Errors frequently arise when rates change. These result, for example, from incorrect product or tax codings or confusion about the correct rate for supplies that span the change. More generally, rate increases mean the amount of VAT/GST “under management” also increases, as do penalties for errors that are based on the amount of tax payable.

Changing law and practice

Many countries are currently in the process of refining their indirect tax systems. In developed markets, longstanding VAT systems need to adapt to the demands of a 21st century digital economy. In emerging markets, which are developing quickly, indirect tax systems need to adapt to keep pace.

In India, for example, a new nationwide GST is ready to be implemented and only awaits agreement between the central and state governments. The new Indian system is intended to replace almost all existing indirect taxes levied at the state and national levels, minimize exemptions and do away with the current multiplicity of taxes.

Similarly, China is in the process of replacing its current business tax on services with a broader-based VAT through a series of pilots. In the end, it is intended to amalgamate all forms of China’s turnover taxes into the VAT.

In the EU, the European Commission has launched a comprehensive reform of the existing VAT system. The Commission has identified no fewer than 26 priority areas for further action in the coming years.

The aim is to move to a more modern VAT system, which should be simpler, more efficient and more robust. Significant changes can be expected in the near future, such as the adoption of a one-stop shop registration for all taxpayers’ duties or a standardized EU VAT return.

The US is still a long way from implementing a federal VAT. Currently, states apply their own consumption taxes, most of which are single-stage taxes on the sale of goods. But, even in the US, a trend can be seen toward states extending the scope of their current sales taxes.

While sales taxes, by definition, only apply to purchases of physical goods, it is the market in electronically supplied services (such as digital music distribution, internet downloads and telecom services) that is growing fastest.

An increasing number of states are, therefore, trying to expand their current sales tax to cover electronic goods and services, or are trying to create a “nexus” for out-of-state vendors to compel sellers to collect sales taxes on remote sales.

The full version of this article is published in EY´s Global Tax Policy and Controversy Briefing, issue 12 (PDF, 7.39 MB)

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