Tuesday, July 2, 2013

New series of papers on why government can and should bring financial services into the tax base

The Victoria University of Wellington (Australia) has a new SSRN issue of interest, featuring a series of papers by Sybrand van Schalkwyk and the ever-prolific John Prebble, all on the topic of consumption tax and financial services. The first of these is the big picture:

"Value Added Tax and Financial Services" 
Asia-Pacific Tax Bulletin, Vol. 10, pp. 363-370, 2004
Victoria University of Wellington Legal Research Paper No. 29/2013
Value added tax (VAT) is a relatively modern development. Designers of VAT recognized from the outset that the way in which financial institutions are remunerated creates significant difficulty when the tax is applied to their services. Administrative difficulties relate to imposing invoice-based VAT on service fees charged as part of the margin between buy and sell rates. Theoretical reasons relate to arguments that financial services should not be taxed under a consumption tax because, it is argued, financial services are not consumed in the way in which goods and services are consumed. Because of these difficulties, most jurisdictions have opted to exempt financial services from VAT. However, the commonly accepted reasons to exempt financial services from VAT are not compelling, since financial services are no different in relevant respects from other services. Moreover, there are methods by which financial services could be brought within the VAT base. Furthermore, although exemption is the simplest way for a VAT to treat financial services, it causes significant distortions in the economy. 
This paper is of special interest to me because it confirms my own view that societies are increasingly accepting tax systems that intentionally tax the "easy-to-tax" most vigorously, the "hard-to-tax" much less vigorously and more randomly, and the "impossible-to-tax" not at all, and that these categories have been intentionally constructed from regulatory decision-making that renders various activities to a given category in systematic and purposeful ways.

There are fundamental justice issues at stake in these regulatory outcomes. If Prebble and van Schalkwyk are correct that exempting financial services from VAT is a policy choice that has been made on the basis of an unexamined theory that these flows are hard or impossible to tax which in turn has been decided because of a failure to institute measures that would make them easy (or at minimum easier) to tax, then the failure to include financial services within existing VAT systems is a grave source of injustice within that tax policy choice (that is, in addition to and apart from the question about whether consumption taxation is itself a violation of justice in the exercise of taxation by states).

The papers that follow focus on various ways to increase the coherency of the taxation of financial flows--what I would suggest is an effort to show us that financial flows could in fact be easier to tax, if not "easy-to-tax," given various regulatory reforms:
"Defining Interest-Bearing Instruments for the Purposes of Value Added Taxation"  
Asia-Pacific Tax Bulletin, Vol. 10, pp. 418-426, 2004Victoria University of Wellington Legal Research Paper No. 30/2013 
This is the second of a series of four articles on the taxation of financial services under a value added tax. The first article considered whether, from a theoretical viewpoint, financial services should be included under a value added tax. It concluded that the arguments in favour of treating financial services in the same manner as any other service outweighed the arguments against doing so.

This second article considers the definition of interest bearing financial instruments in some detail. It also considers the kinds of activities that qualify as financial services in relation to the instruments. The definition of financial services is important where a different type of treatment is applied to financial services. If financial services were taxed like any other service, then no definition would be needed. However, where, as in New Zealand, supplies of financial services can be exempted, the definition of financial services becomes very important. Alternatively, if some financial services are to be zero rated or taxed but not others, then it is necessary to have a global definition of financial services followed by individual definitions of the particular kinds of service that are to be brought within the tax base one way or the other. This article begins by considering interest-bearing instruments. 
"Imposing Value Added Tax on Interest-Bearing Instruments and Life Insurance" 
Asia-Pacific Tax Bulletin, Vol. 10, pp. 471-468, 2004
Victoria University of Wellington Legal Research Paper No. 31/2013
 
Exemption of financial services from Value Added Tax (VAT) is commonly accepted as being an anomaly in the New Zealand goods and services tax legislation. While exempting financial services from VAT is attractive to the legislature because it is a simple way of addressing the difficulties of applying VAT to financial services, it causes significant distortions, for instance tax cascading, which in turn causes price distortions. The application of VAT to interest-bearing financial instruments and life insurance is complicated by the way in which financial intermediaries charge for these services.

The first part of this article investigates how interest-bearing instruments can be taxed under VAT, and the second part how life insurance can be taxed under VAT. There are several options for the treatment of interest-bearing instruments. They can be exempted, zero-rated, or included in the tax base. In this last category, there are three possible methods of including interest-bearing instruments: the invoice, cash flow, and truncated tax flow systems. The last is recommended because policy makers have come to realize that the cash flow system cannot be applied without significant modification. 
"Imposing Value Added Tax on the Exchange of Currency" 
Asia-Pacific Tax Bulletin, Vol. 10, pp. 469-483, 2004
Victoria University of Wellington Legal Research Paper No. 32/2013
 

Exemption of financial services from Value Added Tax (VAT) is commonly accepted as being an anomaly in the New Zealand goods and services tax legislation. While exempting financial services from VAT is attractive to the legislature because it is a simple way of addressing the difficulties of applying VAT to financial services, it causes significant distortions, such as tax cascading, which in turn causes price distortions. The application of VAT to services that bring about the exchange of currency is one instance where financial services could be included in the VAT base. Services bringing about the exchange of currency are a species of financial service, but are inherently different from other financial services since they are relatively simpler than other financial services. Reasons advanced for exempting financial services in general do not necessarily apply to services bringing about the exchange of currency.
Bravo to the authors--this represents a lot of work and adds much to the discussion of how economically-integrated yet politically independent nations can approach the subject of taxation from the perspective that justice matters in policy decisions.

2 comments:

  1. This very issue is playing out right in your neighborhood at the moment. Canada is one of the only countries with a VAT to partially include financial services in its VAT base. It does so by denying input tax credits to most financial services companies considering financial services to be exempt not zero rated(Like college tuition at McGill is other than the fact banks don't get a MUSH/MASH GST/HST rebate like McGill does). Input tax credits are only available to the limited degree that financial services are being "exported" by a particular registrant outside of Canada. This system is replicated in Ontario and the Atlantic provinces where provincial VAT's(HST) have been introduced under the aegis of Ottawa and CRA. Quebec however, since the introduction of the GST in 1991 has had its own VAT tax called TVQ. TVQ since instead of following Canadian practice of denying ITC's choose to follow global practice of making financial services zero rated.

    In the past few years(2010) after Ontario harmonized with the GST with heavy federal financial compensation Quebec which had never received such compensation for the original introduction of TVQ cut a deal with Ottawa to receive similar funding. One condition of Ottawa was while the TVQ could remain a "separate" tax Quebec would have to switch to the "Canadian" system of not zero rating financial services. Some Quebec insurance broker though are not particular happy with this as the below link shows.

    http://www.newswire.ca/en/story/1197925/rccaq-welcomes-the-finance-minister-s-tax-harmonization-mitigation-measures

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  2. http://www.newswire.ca/en/story/1197925/rccaq-welcomes-the-finance-minister-s-tax-harmonization-mitigation-measures

    The Regroupement des cabinets de courtage d'assurance du Qu├ębec (RCCAQ) welcomes the measures announced yesterday by Nicolas Marceau, Quebec's Minister of Finance and the Economy, aimed at mitigating the negative impacts of QST/GST harmonization, which went into effect on January 1, 2013. These measures include abolishing the compensation tax and introducing a temporary refundable tax credit for damage insurance brokerages.

    "Quebec-based brokerages, most of which are small businesses, have been hard hit by QST harmonization, which represents an additional operating cost of nearly 10% of their taxable expenditures. We are relieved that Mr. Marceau realized the full implications of this situation and took concrete measures to rectify it," said RCCAQ chair Michel Duciaume.

    Since the beginning of the year, brokerages had no longer been able to claim a refund of the QST they pay on purchases of goods and services they need to carry out their activities; this refund policy had been in place for nearly 20 years. That was one of the insidious effects of the QST/GST harmonization agreement signed in October 2012.

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