A Digital, Automatic Alternative to VAT?

Value added tax was intended to be a final tax on consumers, yet the compliance and cash flow costs on business grow ever more steep in the 150-plus countries around the world that implement a value added tax system.

Time for a radical rethink? Legal academics Charlène Adline Herbain and Marie Lamensch propose a technologically-driven alternative -- An electronic payment system that would track payments throughout the distribution chain, but would levy consumption tax only on business-to-consumer (B2C) transactions.

They discuss this proposal in Reforming the VAT System for the 21st Century, published in the August, 2015 edition of BBNA’s Tax Planning International Indirect Taxes Journal.

At the time VAT was introduced – initially, in 1948, in France – it was probably the best method of levying a tax on consumption while avoiding fraud and economic distortion, because it gave every participant in the distribution chain an incentive to document and collect.

However, the rise of a global economy has multiplied opportunities for tax fraud – which the government has combated with anti-evasion measures that become increasingly burdensome for honest taxpayers. Compliance is particularly onerous in the growing sector of internet sales.

Herbain and Lamensch suggest that while traditionally, one-off retail sales taxes were less enforceable than VAT, today, automated systems enable any point in the distribution chain, including retail sales, to be monitored to meet the revenue needs of the government while slashing administrative costs for all parties. 

The automated system Herbain and Lamensch propose has the following features:

  • VAT is suspended up until the retail stage.
  • VAT is charged and collected on all EU B2C sales.
  • All sales are recorded via a real-time data processing system. For business-to-business (“B2B”) sales, tax is waived provided the taxable status of the customer as a business is established by means of an electronic certificate. For B2C sales, the status and location of the customer must be ascertained for a correct calculation of the tax.
  • Automated audit software establishes an electronic trail for each transaction, replacing the current paper trail.
  • Where payment is made by a private (non-certificated) customer, the data processing system functions to ascertain the customer’s place of residence (generally available to financial institutions under anti-money laundering legislation), determine the applicable rate, and deliver the instruction to charge VAT.  
  • VAT charged to customers is automatically directed to the Treasury without ever touching the bank account of the supplier, so as to enhance enforcement. The mechanism is broadly similar for both conventional and internet sales. 

Their proposal contains a number of features to accommodate, for example, B2B cash payments, or circumstances in which the supply is to be consumed onsite, rather than at the place where the customer is established.

Herbain and Lamensch also contemplate broader proposals for harmonizing and simplifying VAT across Europe, including a uniform EU-wide rate to be introduced in conjunction with replacing the current destination principle with a tax at the point of origin. Origin-based taxation would avoid the necessity of multiple registrations, administratively complex one stop shop schemes, and the challenges of identifying the location of the consumer, but is not feasible in a system where differences in VAT rates promote jurisdiction shopping.

In sum, modern technology and a global economy make the current VAT system increasingly cumbersome, open to fraud, and administratively expensive – but they also open the possibility for new approaches that would better serve the needs of tax authorities and taxpayers alike.

Charlène Adline Herbain teaches at the University of Luxembourg and at the Faculty of Law of Lorraine University and works as a post-doctoral researcher at the Catholic University of Louvain in Belgium. Marie Lamensch teaches and is a Senior Researcher at the VUB Institute for European Studies and at the Catholic University of Louvain.  Their article, Reforming the VAT System for the 21st Century, is published in the August, 2015 issue of BBNA’s Tax Planning International Indirect Taxes Journal.

by Joanna Norland, Technical Tax Editor, Bloomberg BNA