Application of VAT to Public Bodies

1
Application of VAT toPublic Bodies

• International Tax Dialogue VAT Conference
• Rome, March 15-16, 2005
• Satya Poddar, Ernst Young LLP

2
Public Bodies

• Include
• Government departments, Ministries, state and
  local governments, regulatory bodies
• Charities and non-profit bodies perform similar
  functions and give rise to the same issues in
  application of VAT

3
Current Systems

• Public bodies partially exempted in most
  jurisdictions
• Exceptions New Zealand and Australia
• Concerns and issues
• Competitive distortions
• Self-supply bias
• penalty on outsourcing/privatization
• Complexity
• Pressures for rebating of input taxes

4
Current System, EU
Non Taxable Activities
Supplies by Public Bodies
Taxable but Negligible
Taxable
Exempt
Derogation for taxation
Derogation for exemption
Reduced Rate
5
Canadian System

• All supplies by public bodies within the scope of
  VAT
• Specific exemptions for
• Health, education, social welfare, and certain
  public administration
• Supplies for nil or nominal consideration (i.e.,
  below direct cost)
• Most supplies by charitable organizations
• System of rebates for taxes on inputs to exempt
  activities
• Rebates originally designed to minimize net tax
  increase from VAT
• Recent enrichment of rebate (to 100 of input
  taxes) for municipalities recognizes problems
  with the basic approach

6
New Zealand and Australia

• All activities of public bodies and non-profit
  organizations within the scope of VAT
• No exemptions specifically for supplies by such
  bodies
• Expenditures budgets approved by Parliament for
  Ministries and other public bodies viewed as
  consideration for supply of public administration
  or other functions of the body

7
Rebate Systems

• Rebates allowed for input taxes related to
  non-taxable or exempt activities of public bodies
• Rebates to local bodies in UK, Norway, Denmark,
  Sweden, Finland, and Canada
• Self-funding of rebates in Norway, Denmark,
  Sweden, and Finland through allocation of rebate
  costs to local bodies

8
Issues in Taxation ofPublic Bodies

• Wide range of activities
• provision of private and public goods and
  services,
• Public administration and regulation
• Redistribution of wealth
• Supplies often made for nil or nominal
  consideration
• Activities financed from taxes, fees or
  borrowings
• Often no direct link between supplies and means
  of financing

9
CONCEPTUAL FRAMEWORK FORTAXATION OF PUBLIC BODIES

10
Broad Categories of Supplies

• A Private goods (incl. services)
• B Public goods (incl. services)
• C Transfer payments

11
Private Goods

• Feasible to charge a price
• Application of exclusion principle
• Economically desirable to charge a price
• marginal social benefit marginal social cost
  marginal private benefit price
• Generally defined to be within the scope of tax
• Examples electricity, water, transportation,
  postal services

12
Public Goods

• Not feasible to charge a price
• Difficult to apply the exclusion principle
• Economically not desirable to charge a price
• marginal social benefit marginal private
  benefit marginal social cost price
• Subject to economies of scale
• Consist of services/intangibles only
• Examples defense, education, fire protection

13
Transfer Payments

• Involve redistribution of income/wealth
• Do not constitute consumption or value added
• Should not be subject to VAT
• Services of arranging for transfer payments
  constitute consumption and need to be
  distinguished from the transfers themselves.

14
Funding

• P Combination of Price and Grants directly
  linked to supply
• G Grants not directly linked to supply
• T Taxation and Borrowings
• Funding of supplies by government enterprises
  through equity and soft loans
• Funding of local/municipal services through
  property taxation

15
Funding

• Private Goods
• P constitutes a significant component of total
  funding
• Public Goods
• Funded predominantly through G and T
  components
• All problems in taxation of public bodies linked
  to appropriate treatment of G and T

16
Taxation of Private Goods

• Economic neutrality requires similar treatment of
  supplies made by private businesses and public
  bodies
• VAT to apply on amounts charged as consideration,
  i.e., on price plus grants directly linked to
  supply.
• Other grants could also be included in taxable
  consideration
• Full input tax deduction, once supplies become
  taxable

17
Taxation of Public Goods

• Economic neutrality requires application of VAT
  to any consideration charged for such supplies,
  with full input tax deduction
• Where supplies made for nil consideration,
  neutrality condition equivalent to zero-rating
• Full input tax deduction does not result in any
  revenue loss where the government collecting the
  VAT the same as the one making the supply.
• No distortion of competition because public
  goods supplied by private businesses

18
Taxation of Public GoodsHistorical View

• Public bodies viewed as final consumers of
  supplies made for nil or nominal consideration
• Exemption of public bodies a means of collecting
  VAT on the purchase cost of inputs to a supply of
  public goods
• This view questionable
• Final consumers of public goods remain
  individuals, regardless of the price paid by them
• VAT applies on the value of consumption, not its
  physical quantum
• If value (margnial cost) is nil, VAT should be
  nil

19
Taxation of Public Goods

• Where public goods supplied by a body other than
  the one collecting the VAT, taxable consideration
  needs to be defined broadly to minimize
  incentives for substitution of nontaxable
  consideration (e.g., taxes and grants) for
  taxable amounts
• Reduction in VAT through such substitution could
  lead to redistribution among different groups of
  taxpayers
• Consideration may need to be defined broadly to
  include all grants and subsidies and some of the
  taxes
• Local taxes subject to VAT in New Zealand

20
Possible Tax Systems

• 1 Tax P only
• P Price and Grants directly linked to supply
• 2 Tax P G
• P Price and Grants directly linked to supply
• G Grants not directly linked to supply
• 3 Tax P G some of T
• P Price and Grants directly linked to supply
• G Grants not directly linked to supply
• T Taxation and Borrowings

21
Main Observations

• Economic neutrality achieved by taxation of any
  consideration for public or private goods, with
  full input tax deduction
• Consideration could be defined narrowly to
  include only price and grants directly linked to
  supply, where supply made by the body collecting
  the VAT
• To minimize redistribution, consideration could
  be defined to include all grants and some of the
  taxes, where supply made by a body other than the
  one collecting the VAT
• No economic rationale for the current exemption
  system with partial or no input tax deduction

22
Policy Options

• Full Taxation
• Full Zero Rating
• Exemption system with selective input tax rebates

23
Full Taxation

• Public bodies treated as taxable persons
• All activities of public bodies taxable
• Simple in design and operation
• Requires no definition of public bodies or of
  their activities eligible for special tax regime
• Achieves economic neutrality
• Full deduction of input taxes
• Removal of all tax cascading for B2B transactions
• Potential resistance from consumers of exempt
  goods
• Resistance could be lessened through reduced tax
  rate during transition

24
Zero-rating

• In the case of public goods supplied for nil or
  nominal consideration, equivalent to full
  taxation
• Since price is zero, output tax is nil regardless
  of the tax rate
• Economic neutrality violated for private goods
  supplied by public bodies
• Complexity of defining goods to be zero-rated

25
Exemption with Rebates

• Subject to all of the distortions and
  complexities founds under the current systems
• Rebates address the most serious issues of bias
  against outsourcing
• E.g., rebates for refuse collection activities of
  local bodies in Norway, Finland, Denmark, and
  Sweden
• Perceived redistribution of tax burden resulting
  from rebates offset through various self-funding
  mechanisms for the rebates