Im­pli­ca­tions of value added tax for the pub­lic sec­tor

Oman Daily Observer - - FRONT PAGE -

One of the main pol­icy de­ci­sions to be made is how to treat gov­ern­ment pro­cure­ment and sup­plies made by pub­lic bod­ies. The ac­tiv­i­ties of the pub­lic sec­tor can be di­vided into three groups: (a) wealth;

(b) pro­vi­sion and ser­vices; and

(c) pro­vi­sion of goods and ser­vices sim­i­lar to those supplied by the pri­vate sec­tor.

The first cat­e­gory (a) does not con­sti­tute con­sump­tion or cre­ate any value added but is ef­fec­tively a trans­fer of funds be­tween dif­fer­ent in­come groups via the in­ter­me­di­a­tion of the gov­ern­ment. As such, it should re­main out of the scope of VAT and, con­se­quently, within the cur­rent VAT sys­tem, no (di­rect) re­cov­ery of in­put VAT would be pos­si­ble.

The pro­vi­sion of goods and ser­vices in com­pe­ti­tion with the pri­vate sec­tor (c) should ide­ally be taxed to meet the re­quire­ment of eco­nomic neu­tral­ity. The tax base should in­clude any grants and taxes di­rectly re­ceived as con­sid­er­a­tion for these sup­plies, and re­dis­tri­bu­tion of in­come and of pub­lic goods pub­lic bod­ies should be el­i­gi­ble for full credit of in­put VAT in­curred in re­la­tion to the pro­vi­sion of pri­vate goods and ser­vices.

The sup­plies of pub­lic ser­vices and goods (b) con­sti­tute con­sump­tion by the in­di­vid­u­als re­ceiv­ing them and should in prin­ci­ple be taxed. How­ever, special treat­ment for pub­lic bod­ies, whether by ex­empt­ing or through zero rat­ing their out­put, is cur­rently the norm. Nat­u­rally this com­pli­cates the VAT sys­tem.

Un­der zero-rat­ing, eco­nomic dis­tor­tions may oc­cur when pub­lic bod­ies are al­lowed to make VAT-free sup­plies in re­la­tion to ac­tiv­i­ties that com­pete with the pri­vate sec­tor. Such sit­u­a­tions are rather fre­quent.

Most no­tably are ed­u­ca­tion, health­care and so­cial ser­vices, but also trans­porta­tion, waste man­age­ment, car park­ing, air traf­fic con­trol, ra­dio and tele­vi­sion broad­cast­ing, re­cre­ation, and util­i­ties. Even when the gov­ern­ment is the exclusive sup­plier of cer­tain ser­vices as may be the case with rail­way trans­porta­tion, dis­tor­tion may still oc­cur in­so­far as rail­road trans­porta­tion com­petes with pri­vately owned bus lines for pas­sen­ger trans­porta­tion or with truck­ing com­pa­nies and river barges for the trans­porta­tion of com­modi­ties.

In many in­stances, a level com­pet­i­tive play­ing field is cre­ated by pro­vid­ing sim­i­lar re­lief to pri­vate providers ren­der­ing the same ser­vices as pub­lic bod­ies. This is typ­i­cally the so­lu­tion cho­sen for ser­vices considered to be mer­i­to­ri­ous in na­ture, such as ed­u­ca­tional and health­care ser­vices. How­ever, this only en­larges the scope of the dero­ga­tions from the gen­eral VAT sys­tem.

Ex­empt­ing gov­ern­ment out­put evokes the same ad­verse ef­fects as ex­empt­ing the pri­vate sec­tor. Clas­si­fi­ca­tion prob­lems may likely arise be­tween what con­sti­tutes a com­mer­cial ac­tiv­ity and a pub­lic ser­vice.

Out­sourc­ing is dis­cour­aged and in­sourc­ing (self-sup­ply) pre­ferred, lead­ing to eco­nomic in­ef­fi­cien­cies. In­put tax al­lo­ca­tion is­sues may arise where a pub­lic body is en­gaged in both com­mer­cial and gov­ern­ment ac­tiv­i­ties. More­over, the in­el­i­gi­bil­ity to in­put tax re­cov­ery leads to tax cas­cad­ing when sub­se­quent sup­plies are made to the busi­ness sec­tor.

Fi­nally, pub­lic bod­ies may en­gage in tax-avoid­ance planning to avoid the cost of the in­put-VAT.

The les­son to be learned is that it is best from both a the­o­ret­i­cal and a prac­ti­cal per­spec­tive to in­clude gov­ern­ment in the VAT sys­tem to the widest ex­tent pos­si­ble.

New Zealand and Aus­tralia are the only coun­tries that ap­ply a VAT sys­tem that in­cludes the pro­vi­sion of goods and ser­vices by the pub­lic sec­tor. The ra­tio­nale for tax­ing pu­bic bod­ies can be found in ad­min­is­tra­tive sim­plic­ity, ac­count­abil­ity and trans­parency of gov­ern­ment op­er­a­tions; com­pre­hen­sive­ness of cov­er­age; and sound eco­nomic man­age­ment.

Sev­eral coun­tries have re­sponded to these dif­fi­cul­ties by re­im­burs­ing pub­lic bod­ies for the VAT in­curred on in­put re­lated to their ex­empt ac­tiv­i­ties. The GCC Frame­work Agree­ment al­lows mem­ber states to de­ter­mine that gov­ern­ment en­ti­ties can make pur­chases with­out pay­ing VAT or re­ceive a re­fund of VAT paid.

Dr. Robert F van Brederode is of coun­sel to Hor­wath Mak Ghaz­ali in Oman. He is a tax lawyer, prac­ti­tioner and scholar with over 30 years of ex­pe­ri­ence in global VAT.

He served Crowe Hor­wath In­ter­na­tional as the global in­di­rect tax leader, and was the na­tional prac­tice leader of the US mem­ber firm. Robert is the au­thor of dozens of aca­demic jour­nal ar­ti­cles and 8 books. He can be reached at Robert.brederode@ crowe­hor­wath.om.

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