Wednesday, August 20, 2014
Wednesday, August 20, 2014
Key Policy and Administrative Elements of the VAT Bill
As I stated at the time of the tabling of the VAT Bill on July 23rd, we indeed find ourselves at an historic moment in the history of our small nation. For, after seemingly countless years of seemingly endless discussion, debate and study, we are finally moving forward with fundamental reform of our system of taxation to bring it up to the modern standards of the 21st century.
I would go further in this vein and suggest that our intensive and extensive deliberations on the matter have truly borne fruit in that we have settled on the very best option for our country from both an economic and a fiscal perspective. In the words of Professor Richard Bird, an internationally renowned expert on VAT and taxation in general, the implementation of VAT has been, without a doubt, the most successful fiscal innovation since 1950. Allow me to repeat and stress the key words in the previous statement: without a doubt, the most successful fiscal innovation in over half a century.
More specifically, he asserts that:
“no other significant tax, not even the income tax, spread so rapidly and quickly around the world to the point where VATs currently exist in over 150 countries”.
And why has this occurred? Professor Bird attributes this phenomenal success to the fact that every country needs a tax on mass consumption to finance government programmes and services. More importantly, he states that, in addition, experience has shown that the VAT is the least distorting consumption tax and it is the tax that can be administered most effectively. In other words, VAT is the most economically efficient way to collect tax revenues and the cost of doing so is generally lower than for other forms of taxation.
According to an IMF tax policy mission that visited this country in March of this year, revenue yields from VAT generally outperform other types of taxes and this has been demonstrated in several Caribbean countries. For example, following VAT introduction, indirect tax revenue increased by at least 3 per cent of GDP in Antigua and Barbuda, Belize, Dominica and St. Vincent and the Grenadines. In the case of St. Kitts and Nevis, the increase was on the order of 6 per cent of GDP, on the basis of a VAT imposed at a rate of 17 per cent.
We have now deliberated on VAT for well over a year, since the release of the White Paper in February 2013. Following the issuance of the draft VAT legislation late last year, we have had consultations with the private sector. We have also had the benefit of further in-depth studies of VAT in the Bahamian context.
As well, our internal deliberations have been informed by experience gained in numerous other countries over the past many years. That experience has been catalogued in a best-practice framework that is generally acknowledged to be optimal. Interestingly, of all the VAT nations around the globe, New Zealand is the one country that has adhered as closely as possible to that so-called optimal VAT framework and it is thus rightfully and widely recognized as having the very best VAT system in existence.
It is for that very reason that the Prime Minister sought concurrence from his New Zealand counterpart for timely and focused policy and technical advice from VAT experts from that country. I have previously provided details on the findings and recommendations of the New Zealand tax mission and their final report is available on the Government website. I would at this time merely recap the key conclusions.
The success of the New Zealand VAT, and there are important lessons for us here, was very largely due to:
➢ an extensive education programme aimed at both the business sector and the wider public, with the programme largely driven by respected members of the private sector;
➢ a Government commitment to minimize the compliance costs involved with the new tax, particularly by having virtually no exemptions; and
➢ a Government commitment to offset the effect of VAT on the cost of living by reducing income taxes and, for families not paying income tax, introducing a form of negative income tax or cash transfer system.
As was explained in the Budget Communication, the government has accepted the New Zealand recommendation to enlist the private sector in the public education campaign. A three person Task Force will oversee this process and will be tasked to assist in explaining the VAT to the business community and the wider public. The Task Force will have a budget of $150,000 at its disposal to deliver the proposed campaign by the end of December 2014.
As for a VAT in The Bahamas, the New Zealand experts recommended that:
➢ while the Ministry of Finance VAT Implementation Team could likely cope with implementation as early as October 1, they are more likely to require time beyond then if there are design and implementation changes made in response to the draft legislation upon tabling.
➢ Moving to a single rate of VAT, other than zero for exports, with very limited exemptions would enormously reduce the compliance costs of the private sector and the enforcement costs for the public sector. This would also permit a potentially large reduction in the single rate of VAT, almost certainly to 10 per cent and quite possibly to below that figure.
➢ While the above approach would minimize compliance costs and allow a lower rate, it could also have negative effects on the well-being of low-income households. It would thus be vital to introduce mechanisms to protect such households. The team estimated that our proposed reforms to social assistance programmes appear to provide a suitable delivery mechanism for such assistance.
The impact of VAT structure and simplicity/complexity on private sector compliance costs is indeed critical. The issue has been documented in a study undertaken by Price Waterhouse Coopers on the basis of data collected by the World Bank as part of its Paying Taxes 2010 project. The study concluded that it is very important to streamline the compliance burden and reduce the time needed by business to comply if a VAT system is to work efficiently. The key underlying findings are that:
- Where electronic filing and payment is available and is used, the average time to comply with VAT is some 30 per cent lower;
- The frequency of returns is also important; where bi-monthly or quarterly returns are available, compliance time falls by some 35 per cent;
- The requirement to submit invoices and other documentation with VAT returns increases the time required to comply by a factor of 2; and
- Prompt refunds tend to reduce the time required by businesses to comply.
I am pleased to report that the VAT administrative framework that is in development for this country features a number of measures that will ease the compliance burden on business. We will, for instance, have electronic filing and payment; three options for filing frequency based on the size of a business; no invoices and supporting documentation will need to be filed with VAT returns but merely retained for audit purposes; and refund procedures have been accelerated.
The VAT policy and administrative framework that is presented in the VAT Bill has been duly shaped to reflect the very best advice that we have had at our disposal. As I did at the time of tabling, I will now briefly review the key features of the Bill for the benefit of Honourable Members.
The VAT will be administered by the VAT Department under the Ministry of Finance. This structure will function under an MOU with the Department of Inland Revenue which will allow a relatively seamless transition to the Central Revenue Administration that will in time emerge and encompass both VAT and Inland Revenue.
I want to stress that the Government clearly still adheres to its goal of creating the CRA but judges that an interim move to a VAT Department is prudent in the near term in order to secure the successful introduction and implementation of the VAT. A VAT Appeal Commission will adjudicate on tax matters and appeals will be possible to the Supreme Court on matters of law.
There will be one single rate of VAT at 7.5 per cent across the board. As is done around the world, exports will be zero-rated, thus allowing exporters to claim credits for VAT paid on inputs and thereby maintaining their international competitiveness. We judge a lower VAT rate than originally proposed to be desirable from both an economic and social perspective.
The importance of simplicity has been demonstrated in Switzerland which undertook a fundamental assessment of its VAT system in 2007. One part of the proposed reform involved transforming its three-rate structure of 2.4 per cent, 3.6 per cent and 7.6 per cent into a single rate of 6.1 per cent. It would also remove 20 of the 25 existing exemptions. Independent studies revealed that the introduction of a single VAT rate would be expected to reduce business compliance costs by at least 20 per cent and up to 30 per cent, and increase economic growth by 0.1 per cent to 0.7 per cent.
Zero-rating (i.e. applying zero VAT and allowing credits for VAT paid on inputs) should definitely be applicable to exports as a VAT is designed to tax domestic consumption. Other than that, zero-rating should be strictly limited, if utilized at all.
Adding other items to the zero-rated list undermines the VAT as a broad-based, neutral tax on consumption. It also adds to the compliance costs of the private sector, as well as the administration costs to government, by increasing the volume of VAT collections which are subsequently refunded. Zero-rating also provides opportunities for fraud.
VAT refunds have been frequently referred to as the potential Achilles heel of a VAT system and, accordingly, experts have argued against extensive zero-rating in order to minimize the magnitude of refund claims and payments.
Items that are exempted under a VAT are not subject to VAT but credit for VAT paid on inputs is not allowed. As such, exemptions are inconsistent with the fundamental logic of VAT and they break the VAT chain, thus making enforcement more difficult. Accordingly, the consensus view of tax experts is that a VAT should exempt as few sectors as possible. As seen in other countries, it is often the proliferation of exemptions that over-complicates a VAT and thereby undermines its chances of success.
The main drawbacks of exemptions are that they:
- narrow the VAT tax base, thereby necessitating a higher standard VAT rate to meet revenue requirements.
- lead to cascading: if an intermediate seller is exempt, it cannot claim credit for VAT paid on its inputs. The upstream producer then ends up charging VAT on VAT paid on those inputs.
- increase administration costs to government and compliance costs to the private sector, especially firms that sell both taxed and exempt goods and services.
- violate the destination principle for internationally traded items, where exports embody exempted inputs (exports are thereby disadvantaged in a competitive sense).
- lead to exemption creep as non-exempt sectors lobby for exemptions, which can quickly undermine the success of the VAT system.
Accordingly, we have decided, along with the significantly reduced VAT rate, that the list of exemptions should be pared substantially, compared to what was initially proposed. Specifically, no goods will be exempted. As for services, the list of exemptions has been tightened to include only the following:
• Financial services, i.e. credit and deposit/savings products. This covers all forms of lending and savings products issued by banks, insurance companies and other financial institutions. For insurance, the products affected are, in particular, life policies and annuities. In order to give the industry time to prepare, exemptions on non-life insurance and annuities (such as property, health and casualty) are to be preserved until June 30, 2015.
• The sale or rental of a dwelling.
• Education services, specifically only for explicit tuition-funded courses of study for enrolled students in pre-school, primary and secondary school; and in programs of study leading to the award of graduate or undergraduate degrees at the tertiary level. This does not include services or goods paid for outside of the tuition (such as meals, books, extracurricular activities), tutoring, professional development and continuing education, seminars, or diploma and certificate courses.
• The sale of vacant land; the stamp tax on transfers remains in place.
• A lease of land to the extent that such land is principally used, or intended for use, for accommodation as a dwelling which is erected or to be erected on such land.
• Any services by a ministry, department, statutory body, agency, local government council, or other entity of Government, in connection with a taxable activity where the consideration for such services is —
o (a) nominal in amount; or
o (b) not intended to recover the cost of such goods or services.
• Services rendered by a daycare business, including the provision of after-school care.
• Services provided directly by a facility to persons in need of care, being persons who are —
• Health care, specifically for public services provided to “public patients” receiving free care at public facilities including children of school age or younger, the indigent, aged, government employees and other persons identified by the Minister of Health.
• Religious services by an institution of religious worship.
• Services by a recognized charity to the extent that such services relate directly to the charitable function of the charity.
• Games of chance, gambling and lotteries.
The New Zealand mission also brought the spotlight back to exemptions, an area on which we had a significant private sector lobby. Exemptions when they are socially motivated are intended to reduce the burden of consumption taxes on persons with lower incomes. The points that the mission reinforced however, are the following:
➢ The first is that it is a costlier method of trying to help the poor, because more revenue is sacrificed in the process to those who are not poor. Take food for example. While a low-income family spends a higher proportion of its income on food, a high-income family spends much more on food in absolute terms. So exempting food from VAT would provide a much larger dollar benefit to a high-income family than to a low-income family. Having the means to provide direct assistance to low-income families is thus a far more efficient mechanism than exempting necessities from VAT.