Right questions, wrong taxes

Apr 03, 2018

Sunday Business Post, 1 April 2018
It's about 20 years ago since I took my first ever delivery of an online product.  The product in question was a piece of software designed to convert one obsolete computer file format to another.  We wanted to publish our content, already on the market in traditional book form, on a shiny new website.  The Californian developer of the software was very keen that we would take delivery by way of file download rather than on a floppy disk.  With our superfast modem, it would only take about two or three hours. That would save us post and packaging and save him, as he put it, a few sales tax dollars.  

Even as I recount it, the whole setup involving floppy disks and modems and file formats sounds arcane and outmoded, but the tax issue is more relevant than it ever was.  Most of the tax focus in the last few weeks has been on the issue of corporation tax; how and where companies in the digital economy are brought to account for the profits they make on their sales.  This is all very well and good and important, but the challenge of applying corporation tax consistently pales into insignificance in comparison with the VAT problems associated with digital services and deliveries. 

Value added

Value Added Tax is a tax paid (mainly) by individuals rather than by businesses.  The “value added” in the title doesn't refer to the increase in price which results from applying VAT, but to the notion that as they make their way to the final consumer, various things happen to goods and services which add value.  While most of us can see, for example, how processing or refining a raw material can actually add value, the taxman considers that when a wholesaler sells to a retailer, that is also a value-added event.  Importing items from outside the EU can also be a value added exercise where VAT becomes due and should be collected.  We will be sharply reminded of this fact when the UK leaves the EU in just under one year's time.

The current VAT system suffers the same handicap as the corporation tax system.  The emergence of the high tech economy has blunted its collection capacity.  VAT was designed for 1950s concepts of goods and services, concepts which are quite different now to what they were then.  The digital economy is playing havoc with the collection of VAT on services, particularly where the division between goods and services is becoming blurred.  How is it correct for government to charge 9% VAT on your copy of the Sunday Business Post from the shop, but 23% VAT if you are reading this article using your on-line subscription?

Last year the EU commissioned a report on how much VAT is being lost across Europe, the so-called VAT Gap.  The consultants came back with an estimate of €151 billion.  While no-one is suggesting that this is entirely attributable to the cross border travails of the digital economy, even a 10% improvement would bring in far more than the €5 billion or so which it was hoped a digital corporation tax might yield.  It’s easier to squeeze more money from an old tax than a new yield from a new tax.

Little kudos

Unlike corporation tax, VAT is completely within the power of the EU Commission.  The Commission can (and does) change the rules and regulations which apply to VAT on a regular basis and the member states must observe the changes.  That begs the question as to why the EU is not focusing on what it can fix rather than what it would like to be able to fix.  The reason may be that the corporation tax debate in Europe is more about where tax is paid, rather than how much tax overall is paid.  Some larger countries would credit the Commission if there were success with the place of payment.  There is little kudos for anyone for success with the latter.

To be fair to the Commission, some changes have taken place in recent years to tighten up the rules, and particularly to ensure that VAT on some digital services is collected where those services are used.  Discussions are ongoing towards improving communications between the VAT authorities in the EU member states, in a manner similar to procedures already in place for sharing information on income tax and corporation tax. 

Last week's launch by the Commission of yet another unlikely attempt to control corporation tax revenues is a distraction from the work which is more urgently required to tighten up VAT.  It’s 20 years ago since my man in California spotted a way to sidestep a tax bill.  Those opportunities still arise. 

Brian Keegan is Director of Public Policy and Taxation with Chartered Accountants Ireland