Donald Trump is a fan of VAT. In 2017, he told The Economist that “I like it, I like it a lot, in a lot of ways.”
Being a defining issue in the birth of the nation, tax reform is perennially on the U.S. domestic agenda, but value-added tax ("VAT") has historically been resisted by both main parties. Democrats don’t like VAT because the tax is regressive, applying equally to all; whereas Republicans have seen it as too effective, and the thin end of a big government wedge. In the words of Heritage Foundation Report of 2010, “[o]nce a VAT is in place, Congress could easily increase the VAT any time it wants more taxpayer money to pay for new programs.”
But as Trump’s comments show, the debate is shifting, with some Republicans coming to see VAT not as a straight substitute for U.S. sales tax (and complement to other existing taxes), but as a potential replacement for income taxes.
This may seem an anachronistically American view of the purpose of indirect taxation.
In Europe, the birthplace of VAT, indirect tax revenue has been crucial to financing the European social model, in which general welfare provision (from health to social security and beyond) has become a key element of the social contract between the state and its citizens. VAT income is there to buttress what can be generated from income and corporate taxation, not to undermine their existence.
Nevertheless, despite difference in starting points in attitude, there appears to be some global convergence in the relationship between indirect and other taxes.
The world, like “The Donald,” likes VAT, and likes it a lot. In a report at the end of 2018, the Organization for Economic Co-operation and Development ("OECD") confirmed that corporate and consumption taxes continued to grow at the expense of income taxes, and further remarked that as of 2016 “value-added tax (VAT) revenues continue to be the largest source of consumption tax revenues in the OECD, and have now reached an all-time high of 6.8 percent of GDP, representing 20.2 percent of total tax revenue, on average in 2016.”
These are large numbers; and the OECD predicts that they are only going to increase.
The reasons for this are not hard to find. Globalization and the technological revolution are a major challenge for tax authorities. Income and corporate taxes are notoriously harder to collect in a world where the mobility of capital is both instantaneous and international.
The perception of capitalism is changing fast: those who were once lauded as wealth generators are now derided as neoliberal vultures, vastly and disproportionately affluent “citizens of nowhere” who shamelessly exploit the people and resources of nation states, while providing little in return.
There is no escape from this message: last month, at Davos (the global elite’s own festival), economic historian Rutger Bregman took to the stage to reprimand the watching billionaires for the specific vice of not paying enough tax.
From the French Gilets Jaunes railing against tax burdens on the lower paid, to the battle of the new populist Italian government with the European Commission over its budget, Europe is experiencing an interrelated crisis of political and economic sovereignty.
Economically socialist policies (whatever their long-established track record of failure) are popular across the continent; and the demand for them is inflected with blame and rage for non-national actors, from global corporations to the humblest of immigrants. The specter of antisemitism (“the socialism of fools,” in August Bebel’s famous phrase), once more haunts Europe, and has even been a contributory factor in the recent split in the U.K.’s Labour Party.
The U.K. has been roiled by the same forces as continental Europe, but its reactions seem likely to merely exacerbate the underlying problem.
Brexit is the obvious case, but, beyond Brexit, the aspirations of some of those in the major parties seem guaranteed to further inflame disappointment and anger.
Corbyn’s Labour Party is actively considering the feasibility of introducing capital controls in the event of winning power (with all the implications that has for future investment); right-wing Conservatives look towards Singapore, and a drastically reduced tax base and state, as a model for the U.K.’s future.
Indeed, some Brexiteers have looked at Brexit as an opportunity to get rid of VAT (an imposition on the U.K. by the EU) altogether, ideally replacing it, and all other taxes, with some kind of flat tax. But even if the U.K. were to experience the blunt force trauma of a no-deal exit on March 29, it is unlikely that this would be a chosen method of reviving the economy.
VAT now generates over 100 billion pounds ($132 billion) annually for the U.K. Exchequer. Whereas other, more mobile, sources of revenue could well disappear in the event of no-deal, VAT, tethered geographically to the location of consumption, is not so footloose. Hence its attractiveness to tax authorities. It is the regressive means they depend on to finance progressive ends.
Technology to Manage the “VAT Gap”
For EU member states, limiting or decreasing the size of the “VAT gap” (the difference between VAT due and VAT collected) is a major priority. The EU’s VAT gap currently stands at approx. 150 billion pounds annually and EU institutions are terrified that technology and e-commerce will drastically worsen this position.
Consequently, there are frequent European Commission proposals to improve collection efficiency by harmonizing VAT regulations across the EU, preferably implemented via a unified technology platform.
The Commission plans to extend in 2021 its Mini One Stop Shop for VAT on electronic services to cover goods sold by EU companies to consumers in other member states (“distance sales”), thus establishing a securer foothold in e-commerce. And beyond e-commerce, the Commission’s ultimate vision for European VAT is of an overarching One Stop Shop, covering all business-to-business cross-border VAT: this is intended to be delivered in the early-mid 2020s.
The problem for the Commission is that related proposals (most recently the “EU standard VAT return”) have collapsed under pressure from member states highly disinclined to compromise their tax sovereignty. Member states may share the Commission’s overall analysis of the VAT risk issue, but some are now unilaterally implementing largely technology-based solutions to it on a non-coordinated national basis.
There is the supply of immediate information requirement in Spain, real time reporting in Hungary, the coming introduction of Making Tax Digital in the U.K., and the replacement of the regular VAT return by SAF/T in Poland. Greece and Sweden have plans to introduce related measures in the coming years.
Unharmonized new VAT reporting obligations may seem a challenge for businesses operating across Europe, but the new developments also represent an opportunity.
Because these projects are so closely involved with technology, those wishing to improve compliance and create better management information by working with transparent data will have every incentive to do so.
Likewise, technology-facilitated automated or semi-automated VAT reporting will enable corporates to more easily act as good tax citizens, and to be seen by revenue hungry authorities—and the wider public—as paying their due and doing their bit.
The goodwill and cooperation of business is essential to sustaining the European social model. Because of the immense economic and social pressures, technology is coming to tax in Europe, whether from individual member states, the EU as a whole, or, most likely, both. To be at home in Europe, businesses must respond.
Impact of Technology on U.S. Companies
VAT technology is not just an issue for European companies: global U.S businesses in particular, sometimes unfamiliar (whatever Donald Trump may desire) with complex consumption taxes, will also have to come to terms with new reporting requirements in Europe.
VAT can be quite counter-intuitive in its application; and the combination of over-arching EU-wide principles existing together with EU member states’ right to implement different VAT rates, exemptions, reporting requirements, deadlines and individual interpretations of the law, makes it difficult for those unfamiliar with VAT to make indirect tax judgments confidently and clearly.
For this reason, U.S. companies trading in Europe should take the opportunity to harness the available technology and devise an indirect tax strategy that will satisfy the increasingly stringent compliance requirements set by tax authorities.
These electronic reporting requirements tend to be highly specific. For example, under the Hungarian real-time reporting system, tiny errors or anomalies can result in submissions being rejected, which may result in increased costs in the form of penalties.
In fact, having an automated technology function in place may act as both the spur and vehicle that enables U.S. companies to properly map their transactions from a VAT perspective. In turn, U.S. businesses may start to recover the VAT they incur on goods and services they trade within the EU.
Historically, these companies may not have reclaimed their VAT either because they were unaware that they could, or because they found the process complex and burdensome. Moreover, even companies that do submit VAT claims often find their applications are rejected because of their failure to comply with the differing specified conditions or deadlines enforced by various tax authorities.
The Age of the Machine?
Professional readers may feel a shiver of concern at this prospect of comprehensive tax digitization. There are some specialists who fear falling into what Yuval Noah Harari prophesies to be the coming “useless class,” as AI-guided algorithms automate all before them, rendering decades of human experience irrelevant. But in Europe, and in VAT, this is very, very far from being the case.
Whereas VAT reporting can and should often be streamlined through technological means, the messy, inconsistent, multi-cultural, multi-jurisdictional legal structure of EU VAT means that classic professional expertise is required to get the advantages of technology. Member states dispute definitions and principles with other member states; CJEU rulings, like the Oracle at Delphi, can be simultaneously authoritative and ambiguous. Context-sensitive VAT analysis must come before introducing even limited forms of reporting automation, or the risk is run of merely fluently transmitting penalty-inducing errors to watchful tax authorities.
While those authorities reserve the right to issue contradictory edicts in the name of political sovereignty, driver-less tax technology will remain a chimera. As Accordance’s Managing Director, Lucy Franklin, says, man and machine should complement each other, not compete: “when your business works with people, you will always need people in your business.”
Implement an indirect tax plan at a global level which is fully integrated with the business. Tax authorities are collecting and analyzing big data to maximize their knowledge. You should do the same in order to stay “ahead of the game” and be able to meet new compliance obligations.
Research prospective software suppliers thoroughly. The adopted tax technology must be sufficiently robust to meet the ever-more detailed reporting obligations of different tax authorities.
Don’t keep your customers in the dark. Advise them on exactly how they are impacted by new VAT reporting compliance obligations.
Appoint an internal point of contact. It is important to ensure that tax technology communications between different departments have clarity and are universally understood.
Investigate what data analytics tax authorities use in relation to indirect tax audits. Run these analytic methods on your own data to reduce risk.
Keep a close eye on new legislative developments. VAT law, its interpretations and compliance obligations are quick to change and the trend for European countries to launch their own highly technological VAT reporting requirements is only just beginning.
Nicholas Hallam is Chairman at Accordance VAT, U.K.