Changes in VAT may not have in­tended ef­fect

Business Day - Business Law and Tax Review - - BUSINESS LAW & TAX REVIEW - Ferdie Schneider

The ben­e­fit prin­ci­ple is of­ten used to jus­tify the im­po­si­tion of in­di­rect tax­a­tion

RE­CENT re­ports in the me­dia sug­gest that we may ex­pect changes to the Value-Added Tax (VAT) rate, es­pe­cially against the back­ground that SA will need to in­crease tax rev­enue to fund the pro­posed na­tional health in­surance scheme to be in­tro­duced in 2012.

Cer­tain South African tax com­men­ta­tors ar­gue for a mul­ti­ple VAT rate sys­tem (over and above the 14% and 0%) which should in­clude a lux­ury rate ap­pli­ca­ble to lux­ury goods and ser­vices. Views have also been expressed that the scope of ex­empt and zero-rated sup­plies should be ex­tended. Ex­am­ples men­tioned in­clude crit­i­cal goods and ser­vices which re­late to med­i­cal care and ed­u­ca­tion. The ar­gu­ment is made that ex­tended ex­emp­tions and zero rat­ings would make these goods and ser­vices more af­ford­able to ev­ery­one, not only the poor, and that it could be funded by the VAT col­lected on lux­ury goods and ser­vices which would re­sult in a nil net cost to the fis­cus. It was also mooted that the VAT rate should be marginally in­creased to 15%.

Adam Smith ar­tic­u­lated the prin­ci­ples of a good tax­a­tion sys­tem in 1776 in his “An In­quiry into the Na­ture and Causes of the Wealth of Na­tions” which gave mod­ern tax spe­cial­ists and au­thor­i­ties guide­lines to de­velop and ad­min­is­ter tax sys­tems. Smith for­mu­lated canons of tax­a­tion which mea­sure a good tax sys­tem against its com­pli­ance with neu­tral­ity; equal­ity; in­vis­i­bil­ity; cer­tainty and sim­plic­ity; and min­i­mum com­pli­ance and ad­min­is­tra­tion costs.

A tax sys­tem com­plies with the prin­ci­ple of neu­tral­ity if the im­po­si­tion or in­crease of the tax does not ma­te­ri­ally al­ter con­sump­tion or ex­pen­di­ture pat­terns. In­ter­fer­ence by the tax in­stru­ment in the eco­nomic choices of tax­pay­ers of­ten causes un­wanted eco­nomic ef­fects or dis­tor­tion, which leads to the mis­ap­pli­ca­tion of the scarce re­sources avail­able. The equal­ity prin­ci­ple en­cap­su­lates the “abil­ity to pay” and the “ben­e­fit” prin­ci­ples.

The ben­e­fit prin­ci­ple is of­ten used to jus­tify the im­po­si­tion of in­di­rect tax­a­tion and man­dates that those who ben­e­fit from the use of com­modi­ties or ser­vices should be re­quired to pay for such ben­e­fit or use. The prin­ci­ple of in­vis­i­bil­ity re­lates to the no­tion that the best taxes are those which ex­tracts the spend­ing power from the pri­vate sec­tor be­fore it has ac­crued too ob­vi­ously to any par­tic­u­lar in­di­vid­ual.

The prin­ci­ple of cer­tainty and sim­plic­ity de­mands that the na­ture and quan­tum of a tax­payer’s li­a­bil­ity and the ad­min­is­tra­tion costs of the tax sys­tem should be sim­ple to de­ter­mine and ob­serve. The tax sys­tem should there­fore be as trans­par­ent and sim­ple as pos­si­ble. The prin­ci­ple of cer­tainty and sim­plic­ity ne­ces­si­tates that the as­sess­ment, col­lec­tion and ad­min­is­tra­tion of a tax should be cer­tain and sim­ple so as to keep the costs to the tax­payer and the fis­cus as low as pos­si­ble.

By its very de­sign, any tax sys­tem re­sults in ad­min­is­tra­tion costs for govern­ment and com­pli­ance costs for the tax­payer.

One should first as­sess the dif­fer­ence in ef­fect be­tween ex­tend­ing VAT ex­emp­tions as op­posed to ex­tend­ing zero rat­ings and then as­sess the de­sir­abil­ity of such ex­ten­sion and an in­crease in the num­ber of VAT rates against the canons of tax­a­tion.

Al­though VAT ex­emp­tions and zero rat­ings may seem­ingly have the same “no VAT” ef­fect, noth­ing can be fur­ther from the truth. VAT ex­emp­tions re­move VAT from the sup­ply but blocks re­lated VAT on ex­penses in­curred in the hands of the sup­plier as in­put tax de­duc­tions. Where the sup­plier pushes some or all of this VAT cost (in­di­rectly through in­creased prices) to the re­cip­i­ent, the ul­ti­mate cost of the sup­ply is par­tially or fully in­flated by the VAT cost. VAT ex­emp­tions are, as a re­sult, gen­er­ally dis­tortive and not ad­vis­able. Ex­emp­tions can, how­ever, not be com­pletely avoided in a VAT sys­tem and ex­am­ples of these in­clude the com­po­nents in fi­nan­cial ser­vices which does not con­sti­tute fi­nal do­mes­tic con­sump­tion. Ex­emp­tion in­creases the cost of com­pli­ance of the sup­plier as it af­fects sys­tem cod­i­fi­ca­tion and con­trols and also has a VAT ap­por­tion­ment ef­fect.

Zero rat­ing, on the other hand, has quite the op­po­site ef­fect. While zero rat­ing also re­moves VAT from the sup­ply, re­lated VAT on ex­penses in­curred can be claimed as in­put tax de­duc­tions by the sup­plier. This frees the sup­ply from any VAT cost and pushes (sup­pos­edly) the VAT ben­e­fit through to the fi­nal con­sumer. Zero rat­ing also in­creases the cost of com­pli­ance as it im­pacts sys­tem cod­i­fi­ca­tion and con­trols but does not ef­fect ap­por­tion­ment.

As­sess­ing the ex­ten­sion of the scope of zero rat­ings and in­creas­ing the num­ber of VAT rates against the canons of tax­a­tion tends to demon­strate that it may not al­ways be de­sir­able. How­ever, in spe­cific in­stances one could jus­tify the ex­ten­sion of VAT zero rat­ings.

The ex­is­tence of a mul­ti­ple VAT rate sys­tem or ex­ten­sion of the scope of zero-rated sup­plies may dis­tort con­sump­tion or ex­pen­di­ture pat­terns and may, as a re­sult, not al­ways com­ply with the neu­tral­ity prin­ci­ple. A mul­ti­ple VAT rate sys­tem and the ex­ten­sion of the scope of zero-rated sup­plies may strictly also not ad­here to the equal­ity and more specif­i­cally the ben­e­fit prin­ci­ple of tax­a­tion as a mul­ti­ple VAT rate or ex­tended zero rate sys­tem could be seen to favour cer­tain and dis­crim­i­nate against other com­modi­ties. Fi­nally, the im­po­si­tion of mul­ti­ple VAT rates or ex­ten­sion of the scope of zero-rated sup­plies def­i­nitely de­creases the sim­plic­ity of the tax while in­creas­ing the com­pli­ance and ad­min­is­tra­tion costs ev­i­denced by sys­tems, cod­i­fi­ca­tions, and con­trols.

Ferdie Schneider is a part­ner at KPMG Ser­vices.

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