IMF Conference

Summary for IMF Webinar on "VAT and Sectoral Policies"

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Keynote presentation (Mr. Mario Mansour)

Panel discussions (moderated by Mr. Ruud De Mooij)

• An ideal VAT system is characterized by a broad base, few exceptions, and a single rate. But in practice, the ideal model is rarely implemented—either for policy or administrative reasons, leading to special treatment for some sectors. This webinar delved into sectoral VAT policies through the example of four sectors that tend to receive VAT concessions or special treatment—agriculture, tourism, real estate and construction, and the public sector. Other industries—such as extractives or the financial and insurance sectors—warrant further in-depth discussions of their own.

• The assessment of sectoral VAT policies should consider practical implementation issues, as well as competitiveness and incidence considerations. The VAT is conceived as a sales tax with a credit/refund mechanism, aimed to be neutral on investment and production decisions. As a revenue source, the VAT is most effective when sector-specific policy concessions—such as exemptions, zero-ratings, reduced rates, etc.—are minimal. In practice, however, sector policies are sometimes needed to address compliance challenges or to ensure the appropriate functioning of the system. On the tax policy side, sectoral VAT policies tend to be introduced in response to concerns about the competitiveness of certain industries or to reduce the tax burden on consumers of merit goods and other necessities. Several countries also have free-zone regimes, which are intended to attract foreign investors by shielding them from dealing with the tax authority, highlighting interactions between tax administration and tax policy motives.

• The taxation of agriculture is challenging, because the sector is large in developing countries, faces peculiar political economy issues, and because small farmers often do not maintain books, making VAT compliance problematic. Policy options include taxing only large farmers, which would require introducing high VAT registration thresholds, different from the standard registration threshold, or exempting the sector. In both cases, farmers would incur VAT on their inputs which could then pass unto food prices paid by consumers. To alleviate this effect, countries that exempt farmers also tend to exempt key farming inputs, such as seeds and fertilizers, and specialized equipment and tools. All this makes the administration of the VAT very complex, with ambiguous outcomes for farmers.

• VAT rates on goods and services in the tourism sector are often subject to a “race-to-the-bottom”. Due to tax competition among countries, many have introduced VAT concessions in this sector, typically on the input side but increasingly on the output side as well (zero-rating of hotel and other tourism services), in particular where their tourism offerings are close substitutes for offers in other destinations (e.g. beaches, ski resorts, gambling). Since tourism is considered a source of export earnings, some countries choose to give refunds to foreign tourists, for purchases of goods not consumed in the tourism destination, even though taxes collected from foreigners should be of less concerns to policymakers than those collected from residents. Digitalization is another contributing factor to the VAT issues in the tourism sector as it enables transactions to take place offshore (typically through use of online platforms) escaping or undermining local taxation. A similar problem arises in countries where transactions are mostly carried out by traditional small businesses which are unregistered (including in the form of peer-to-peer transactions), as is the case in Thailand. Against this backdrop, good policies include simplifying the system to ease compliance for small businesses, involving digital platforms in the VAT collection on transactions made through the platform and removing distortive exemptions. International coordination, analogous to the Pillar Two minimum tax, perhaps on a regional scale, could also help counteract the “race-to-the-bottom”—although this outcome has proven difficult to achieve in practice.

• Real estate and construction sectors are difficult to tax, as evidenced by their large VAT compliance gap across countries. Conceptual inadequacies about the value of consumption and what constitutes a transactional supply are particularly complex in these sectors. The definition of construction activities changes by country. Sometimes it is based on the activity reported by the registered firm, and sometimes it is based on the inputs it uses. Thus, sectoral policies can be exploited by firms operating in other sectors. In real estate, applying VAT to residential real property creates a distortion between new and existing houses when the VAT is introduced, as VAT has not been levied on the latter. Special treatments in construction and real estate generate significant costs in terms of revenue losses and high administration costs (reflecting enforcement difficulties and governance issues). Options to overcome these challenges include taxing the first sale of residential immovable properties (thus leaving subsequent sales exempt), all sales of commercial immoveable property used by businesses, and all purchases of construction inputs (building materials, parts, and maintenance services). The use of registration (stamp) duties on transactions between registered persons should be avoided.

• The case for special treatments for VAT in public services is not convincing and thinking has evolved on this issue since the 1990s, with examples provided New Zealand and Australia. Exempting this sector creates distortions and unfair competition between public and private sector firms or in outsourcing certain services by public entities. Services provided by the government and non-profit organizations should be taxed, and when services are provided for free, their corresponding funding (grant or subsidy) should be treated as taxable supplies, thereby permitting the inputs to be credited. The issue of mixed supplies also comes into play when public services have special treatment because of the requirement to apportion inputs—potentially increasing the administrative burden. In this sector, strengthening administration capacity should have a priority over introducing VAT concessions.

• Sectoral VAT policies are, in general, bad practice. Experience suggests that special VAT treatments generate large revenue losses and increase administration costs. Thus, the case for introducing special VAT treatments at the sectoral level is weak. But if they are necessary, special VAT concessions are less harmful when applied at the end of the supply chain. Exemptions in the middle of the supply chain (i.e., on business-to-business supplies), potentially unravel the whole VAT chain, which may lead to VAT cascading and leakage and sometimes having the opposite effect of what was intended. Against this backdrop, other policies, such as funding subsidies are better poised to support specific sectors while keeping tax administration simple and preserving the integrity of the VAT. Moreover, the incidence of sectoral policies is uncertain: if supply is very elastic, special VAT treatments could benefit producers more than consumers; if demand is very elastic and consumer prices rise, it is generally more effective to seek support for low-income consumers through direct transfers or lower income taxes.

• The registration threshold, which purpose is to minimize unnecessary administrative burden for small businesses, is one form of a sectoral policy that is used by nearly all countries with VAT. In the absence of compelling evidence for a differentiated sectoral treatment, a single threshold for all sectors of economic activity is typically recommended. However, thinking about this has evolved, and there might be a case for, for instance, two thresholds, which could help limit the use of other sector-specific policies.

• Governments need to develop concerted action to improve VAT compliance in all sectors, which ideally means a simple VAT system with minimal sectoral concessions. Cross country experience, including from Africa and Thailand, indicate that political constraints can inhibit initiatives to limit sectoral polices.

Answers to technical questions raised during the panel discussion of Webinar 6: “VAT and Sectoral Policies.”

Presentation materials:

VAT and Sectoral Policies (in English)

Panel discussions (moderated by Ms. Katherine Baer):

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Summary for IMF/RMTF VAT Webinar on “VAT and Digital Economy”:

Keynote presentation (Mr. Alexander Klemm): “Digitalization and challenges for the VAT?” provided an overview of the tax policy and tax administration challenges resulting from the supply of digital goods and services.

• Amid accelerating digitalization, business models and consumption patterns are changing, with digital goods and services being traded, consumers importing directly via digital platforms, and increasing peer-to-peer transactions.

• The shift towards more ‘digital’ business models and consumption patterns present challenges for VAT design and administration, given the difficulties in capturing e-commerce transactions and the sharing economy for tax purposes. For tax policy, the key issues relate to the taxation of imported digital services and user-value creation. For tax administration, the lack of firms’ physical presence in a country can also complicate the revenue collection effort.

• The ease with which consumers can import goods in a digitalized world means that untaxed low value imports increasingly compete with locally supplied taxed goods, creating an unfair level playing field for local businesses. This is further exacerbated by the platform economy, which enables sales below the current VAT registration and import thresholds by small and/or disappearing sellers, complicating tax collection.

• Digitalization also entails broader tax challenges, including: i) corporate taxation, which is addressed by the OECD-led international tax agreement. Pillar One of that agreement allocates a quarter of residual profits of large multinationals to destination countries; ii) different types of digital services tax, which attempt to address destination countries’ lack of taxing rights under current international norms, but which are controversial. Resolving the tax policy challenges of the VAT is easy in comparison.

Mr. Walter Hellerstein (Professor of Taxation, University of Georgia School of Law) on tax obligations and taxing rights regarding digital products.

• All jurisdictions have the same issues and concerns in the face of digitalization – regardless of their geographical location or legal framework—including whether they have VAT/GST type consumption taxes or retail sales taxes like most states in the United States.

• The fundamental issue is to distinguish the assignment of taxing rights and the enforcement of those rights.

• The challenges for direct taxes versus indirect taxes are unique and practical. They include the lack of legal power as there are no assets to seize in the virtual world, absence of border controls, and the inability to rely on voluntary compliance.

• The OECD guidance paper Mechanisms for the Effective Collection of VAT/GST provides helpful advice to enable collection and enforcement when the supplier is not located in the jurisdiction of taxation.

• An important consideration for moving forward with the adoption of a new model is to simplify the requirements for the remote suppliers to come into the tax system.

Mr. Mark Konza (Former Deputy Commissioner, Australian Taxation Office (ATO)) shared views on administrative ease and challenges of the vendor collection, and financial institution withholding models for taxing digital services and administering tax on low value imported goods.

• Choosing an administrative collection model is one of the first issues that most countries face. Countries have a choice to use the platforms or the banking system. While banks have some data about the transaction and the consumer, it is often rudimentary. Platforms, on the other hand, have very detailed information, the capacity to collect information about all purchases, and know where the service is being delivered, thus making administration possible. Furthermore, platforms authorize the dispatch of the products and they set the terms and conditions under which the supply takes place. A big part of their business model is to present themselves as the supplier (for instance, by offering guarantees). To sum-up, administration of VAT on digital transactions is possible with the vendor collection model, given the amount of data collected and central position held by large platforms.

• VAT administrations face cultural challenges as the VAT on digital suppliers upsets many standard VAT beliefs – by imposing tax on a non-resident.

• Keeping the collection model simple is a critical element. Businesses want to comply as their reputation of being compliant is very valuable.

• The differences in administration approaches are outlined in the IMF’s May 2021 technical note Administering the Value-Added Tax on Imported Digital Services and Low-Value Imported Goods. Some of the minor differences include thresholds, technical definitions, place of supply, etc. With regard to low value goods, it is important that the Tax and Customs administration align to ensure there is harmonization on the administration of taxation of goods to avoid double or non-taxation.

Mr. Raul Zambrano (Director, Technical Assistance and Technology, Inter-American Center of Tax Administrations (CIAT)) presented regional initiatives and tools to address taxation of digital services.

• VAT is very important in Latin America and the Caribbean. We have seen different implementation of the options – i) the traditional approach whereby suppliers are invited to form a permanent establishment in the country, register and collect VAT, and benefit from input tax credits ii) rely on withholding mechanisms of financial institutions, which is a very popular model in the region and collection has been good (iii) rely on voluntary compliance where taxpayers without a physical presence register to collect VAT.

• Through work with the Organisation of Economic Cooperation and Development (OECD), the World Bank (WB), and the Inter-American Development Bank we are designing a toolkit for Latin American and the Caribbean countries to provide assistance for the development and implementation of VAT on digital supplies.

• Our recently published paper, Tax Administrations and Control of the Digital Economy estimates the revenue opportunities for countries in the region who have not already implemented a model for digital supplies to be between .02 percent to .06 percent of GDP.

• An open-source software tool, Digital Economy Compliance (DEC) System was designed to support simplified registration processes, and return and information filing. It works with different interfaces, on premises, in cloud solutions, and is available in multiple languages.

Mr. Prenesh Ramphal (Value-Added Tax Leader, South African Revenue Service (SARS)) shared the evolution of South Africa’s policy and administrative reform in implementing a digital VAT.

• South Africa is a pioneer in Digital VAT law – with the implementation of a Digital VAT law in 2014 when we moved from a consumer collection to supplier collection model.

• Through active engagement with large suppliers, we learned early on to keep the model as simple as possible – resulting in high uptake by foreign digital suppliers.

• In 2018, further analysis showed that higher revenues were possible, so we expanded the base to adopt a broader base of taxable digital supplies. We now have 550 digital suppliers on our books with just 6.8 billion ZAR ($426 million USD) and a high compliance level of filing and payment.

• SARS has learned a great deal from international experience and collaboration and is continually learning and evolving from a tax policy and administration point of view.

• For the region, the approach is being explained to other countries through the African Tax Administration Forum.

The panel discussion was followed by questions from participants. It covered key issues with important observations:

• Creating a level playing field by ensuring equal treatment of foreign and domestic suppliers is paramount to minimizing resistance to digital tax.

• For imported digital services, suppliers are not generally entitled to VAT credits or refunds in the import country because it is usually a condition of the simplified vendor collection model.

• Foreign suppliers need only provide basic identifying data for registration as they will not be seeking refunds.

• Reporting information should also be simple– to include the monthly sales and the monthly VAT collected. For compliance assurance, comparisons with domestic suppliers can be performed, bolstered by exchange of information arrangements with foreign tax administrations.

Answers to technical questions raised during the panel discussion of Webinar 5: “VAT and Digital Economy” here

Presentation materials:

Digitalization and Challenges for the VAT (in English)

Panel discussions (moderated by Mr. Juan Toro)

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Summary for IMF/RMTF VAT Webinar on “Managing VAT Compliance and Administration”:

Keynote presentation – Ms. Katherine Baer, “Managing VAT Compliance and Administration” provided an assessment of the performance of the VAT, and further insight on some important components of VAT administration:

VAT performance, based on findings of FAD analytical tools (RA-GAP, ISORA, TADAT), notes that compliance gaps are two times higher in low income countries (LIC) than in high-income countries (HIC) which corresponds to the regional differences. Construction and trade are the economic sectors that typically demonstrate the highest compliance gaps; however, hospitality, professional services, and manufacturing also demonstrate large gaps. The manufacturing sector is particularly surprising given the VAT’s inherent self-enforcement feature.
The preconditions for a well-functioning VAT include good design of VAT policy (i.e., broad based, limited exceptions and exemptions, simple rate structure), careful setting of the VAT threshold in consideration of administration capacity, self-assessment and electronic processes, robust VAT refund management procedures, including an anti-fraud strategy, extensive use of third-party data, automated cross-matching, and data analytics, that includes Customs data, and a well-resourced tax administration.
An integrated approach of the key components of the VAT builds the basis for good compliance risk management (CRM): facilitating compliance, controlling and monitoring registrations, on-time filing and payment, controlling the veracity of invoices, verifying accurate reporting through sufficient coverage and appropriate focus, and managing VAT credits and refunds effectively.
HICs pay more refunds as a percentage of gross VAT collections and have lower VAT gaps. More research is needed for confirmation, however this outcome suggests that better functioning VAT refund mechanisms (including risk-based verification processes that allow paying refunds on-time to taxpayers with a sound compliance history) reinforce credibility in the VAT system and encourage compliance, contributing to lower VAT gaps, while other factors also play a role (filing, payment, audit)
Resourcing is an important consideration for VAT enforcement. LICs are considerably less well-resourced compared to Upper Middle-Income Countries (UMIC) and HICs as measured by staff to country population and are less able to devote resources to audit and verification activities (which are intensive in labor force).
VAT administrations with a greater degree of digitalization have higher tax to GDP ratios than those with less digitalization therefore as LICs enhance digitalization capabilities their VAT performance should demonstrate improvements in the coming years.
Digitalization affects VAT performance through multiple channels by enabling many functions: better data gathering and matching, digital services (e-invoicing, cloud services, mobile devices, apps), digital tools to reduce paper and improve service (pre-filled tax returns, electronic notifications), and as a learning machine to improve taxpayer service, reduce burden, and increase transparency and accountability.

Mr. Michael Walpole (Professor of Taxation, University of New South Wales (UNSW), Sydney, Australia) on diagnosing the VAT compliance burden:[1]

As VAT is a self-assessed tax, keeping compliance burden at the lowest possible level plays a key role encouraging more compliant behaviors.
UNSW’s tool applied to 47 OECD or FTA member countries identified four possible factors that affect VAT compliance burden: i) complexity of VAT design (for instance, multiple rate structures, exemptions, low registration thresholds), ii) the number and frequency of administrative requirements, iii) capacity and capability of the tax administration (inadequate or poorly designed support provisions), and iv) monetary costs and benefits (for instance, delays of VAT refund mechanisms, low or no interest for delayed processing).

Ms. Mary Baine (Director of Tax Programs, African Tax Administration Forum (ATAF)) presented key drivers of compliance gaps in African countries based on the work of ATAF.

High VAT compliance gaps in African countries are explained most of the time by limited availability of tax data (which limit risk assessment activities), shortages on monitoring effectiveness of the audit function, constraints adopting a more automated VAT management, limited audit resourcing, lack of interdepartmental synergies and robust CRM frameworks, and the size of shadow economy.
The growth outlook for digitalization in Africa is positive despite the challenges (unstable power supply, inadequate financing, infrastructure, low taxpayer adoption rates). Most tax administrations are adopting electronic filing systems, and some have already made clear progress. Kenya has implemented data matching for input tax credits, Nigerian and Rwanda employ real-time provisioning of data for assurance purposes, and Malawi has implemented electronic fiscal devices.
Many African countries (e.g. South Africa, Kenya) are adopting frameworks that will permit the capture of VAT on cross-border transactions in consideration of international good practice and with ATAF support.

Mr. Daniil Egorov (Commissioner, Federal Tax Service of Russia (FTS) shared success factors on increasing digitalization in Russia and the resulting decrease of the VAT gap.

When embarking to digitalize tax operations, tax administrations should also take into consideration the digital maturity of stakeholders. Russia followed a phased approach to digitalize VAT operations, first making mandatory electronic filing, then imposing certain information reporting obligations (of invoices issued and received), which in turn allowed the FTS to conduct more robust cross matching of information to detect anomalies in taxpayer declarations, permitting real-time nudging, and risk-based audit referrals. Just until recently, the FTS rolled out electronic invoicing.
Going forward, the FTS will explore how it can use data even further such as populating VAT returns and reducing the administrative burden on taxpayers.
Big data offers tremendous value to tax administrations, and there are several key considerations. It’s important to understand data needs, as too much data may create distraction and noise. Skills to permit working with data and dashboards are necessary. The development of a strong data culture ensures good communication between data stakeholders. Tax Administration readiness to work with external data sources permits full data integration.

Ms. Margarita Faral, (Tax Commissioner, Dirección General Impositiva (DGI) of Uruguay) on DGII’s experience in lowering the VAT gap.

VAT in Uruguay has been around for 50 years. There is a large tax base and a simple rate structure (22 percent, 0 percent on exports). VAT represents about 45 percent of tax collections, and 9.5 percent of GDP, and tax evasion is estimated to be 14 percent.
Uruguay’s has used e-filing as a primary tool to support VAT compliance, and also employs an integrated approach to for taxpayer management.
Uruguay’s success is premised on having an up-to-date taxpayer registry, rules for businesses to document transactions and having widespread compliance controls on filing and payment obligations.
Comprehensive VAT information reporting obligations allows the DGI to conduct systematic large-scale information cross matching efforts to detect reporting inaccuracies.
Uruguay decided to adopt a multiple approach when managing VAT refunds, combining a risk-based approach to process VAT claims and use of cash refunds, Treasury notes and offsetting schemes.

The panel discussion was followed by questions from the audience. It covered important issues, with clear messaging:

Clear legislation that contains clear refund mechanisms with timelines and interest provisions is paramount.
Publication of refund requirements and entitlements builds trust.
Blockchain is a tool that should be explored to understand benefits before using it.
Careful setting of VAT thresholds is important. Low thresholds bring small businesses into the VAT net, but they may be disproportionately bearing compliance costs that may affect the economy and productivity.

Answers to technical questions raised during the panel discussion of Webinar 4: “Managing VAT Compliance and Administration” here.

Presentation materials:

Managing VAT Compliance and Administration (in English)