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Rethinking Tax: The shift to indirect tax

Edward D. Roguel Edward D. Roguel 29 Mar 2016

For 2016, the Philippines’ national budget is around P3 trillion and the Bureau of Internal Revenue (BIR) is tasked to collect around P2 trillion. Out of the BIR’s total collection target, about P1.243 trillion is expected to come from income taxes. That is how important income taxes are for the country, accounting for around 41% of the national budget.

It is interesting to note, however, that a lot of countries are now shifting their focus to indirect tax. The primary reasons behind the global shift to indirect tax are discussed in an article released by Grant Thornton International (Grant Thornton) entitled “Rethinking Tax: The shift to indirect tax,” and I would like to share this article with you.

The global tax landscape is going through a period of fundamental change. Governments are now rethinking how taxes are levied. Changes have been triggered by the rapid spread of technology, new supply chains, debt pressures, and an increased scrutiny of multinational tax practices. Tax is a top priority for businesses, as sweeping changes, brought in through the Organisation for Economic Co-operation and Development’s (OECD’s) Base Erosion and Profit Shifting (BEPS) recommendations, transform the way they operate.

While corporate tax avoidance continues to grab headlines, some of the biggest reforms are in fact occurring within indirect tax. This year, two of the world’s most populous countries -- China and India -- are expected to transform their indirect tax systems. China is set to complete the final stage of its Value Added Tax (VAT) reform, while India is expected to introduce its long-awaited comprehensive Goods and Services Tax (GST) system.

Meanwhile, Bangladesh has plans to implement a new VAT in July. The Middle East is also expecting momentous changes. In a move to generate additional revenue and diversify the economy, the Gulf Cooperation Council (GCC) countries -- Saudi Arabia, Kuwait, the United Arab Emirates, Qatar, Bahrain, and Oman -- are expected to levy VAT from 2018.

These upcoming changes are all off the back of Malaysia’s successful GST regime introduction in April 2015 and Puerto Rico, where a VAT regime is scheduled to take effect starting on April 1. Puerto Rico’s adoption is particularly momentous as it will bring VAT close to the shores of the United States -- the only member of the OECD which does not have a VAT system. Indeed, even The Bahamas, traditionally seen as a ‘tax haven’, introduced VAT in 2015. While some will dismiss the rise of indirect taxes as a simple tax grab, there are underlying reasons behind this trend. The following discusses the primary reasons behind the global shift to indirect tax.

DEFINING INDIRECT TAX

Indirect tax is increasingly becoming the new direct tax. More than ever, governments are relying upon indirect taxes to generate tax revenue. Today, VAT -- the most popular form of indirect tax -- raises approximately 20% of worldwide tax revenues (1-2 OECD (2014), Consumption Taxes Trends 2014, OECD Publishing), and the number is growing. The shift to indirect tax is transforming the way we view taxation itself. Taxation is no longer just about profits, income and wealth. It is about transactions, production and distribution.

Indirect taxes can be defined as a class of taxes which are not solely levied directly on the person who bears the ultimate economic burden of the tax. VAT is a multi-stage tax levied on the ‘value added’ to goods as they pass through the various stages of production and distribution, and to services as they are performed. VAT is a tax on consumption, not business, meaning the ultimate cost of the VAT will usually be borne by the final customers. Whilst VAT is generally considered a ‘wash-through’ tax or ‘neutral’ to most businesses, it should not assume a lower priority in a company’s tax function. It is the business that ultimately carries the risk of noncompliance. A business acts as an unpaid collector of the tax on behalf of tax authorities, and can receive assessments, penalties and interest for under-collected VAT, or incorrect input tax credits taken.

Why the change?

REVENUE RAISING

VAT raises substantial amounts of revenue for governments. The numbers are staggering. On average it accounts for 6.6% of Gross Domestic Product (GDP) amongst OECD countries [Ibid] whilst in the European Union (EU), it is around 7.5% of GDP amongst Member States.

THE GROWTH FRIENDLY TAX CHOICE

VAT is often described as a ‘growth-friendly’ and ‘efficient’ tax. According to the International Monetary Fund (IMF), broad-based consumption taxes have the advantage of not discouraging saving and investment decisions. (International Monetary Fund, ‘Growth-Friendly Fiscal Policy’)

The IMF, in contrast, states that corporate income taxes tend to discourage two of the most important contributing factors to business growth: capital investment and productivity improvement.

Other studies have shown that corporate income taxes can reduce foreign direct investment. (Dana Hajkova et al, ‘Taxation and Business Environment as Drivers of Foreign Direct Investment in OECD Countries’ (Economic Studies No. 43, Organisation for Economic Cooperation and Development, 2006).

GROWTH IN THE DIGITAL ECONOMY

Globally, governments have increasingly sought to tax the ever growing digital economy where consumption takes place. This has not only been fueled by a need to raise more revenue, but also to ‘level the playing field’ between resident and non-resident suppliers of digital services. Although this trend first started in 2003 when the EU bought in specific rules to tax non-resident suppliers, today the list of countries with similar legislation is growing, e.g., South Africa, South Korea, Norway and Japan.

The Australian government recently introduced measures seeking to address the revenue ‘gap’ that is occurring from the growth in the digital economy by consumers. The proposed amendments to the GST provisions will result in offshore suppliers of digital or intangible services charging and collecting GST on services provided to Australian consumers from July 2017.

RACE TO THE BOTTOM

Corporate income tax rates have declined dramatically over the last two decades. In the early 1980s, the average rate amongst OECD countries was 47.5% (OECD (2014), Consumption Taxes Trends 2014, OECD Publishing). Today, the average rate has almost been halved. A major reason behind the dramatic decline is the so-called ‘race to the bottom’ phenomenon. In order to attract the inward flow of capital and mobile profit from multinational corporations, countries compete with each other by making their tax systems more attractive, which generally involves reducing their corporate income tax rates.

While the inward flow of capital has a positive impact on a country’s economy, the decline in corporate income tax rates obviously has a negative effect on the government’s tax revenue. In order to close this gaping hole, governments have shifted their attention to consumption taxes, particularly VAT.

OUT WITH THE OLD, IN WITH THE NEW

Not all indirect taxes are ‘efficient’ and ‘growth-friendly’. Various forms of indirect taxation can lead to revenue leakage, economic inefficiency, and double taxation. A major reason behind the current shift to GST in India and VAT in China is to eliminate these issues.

Changes are happening for a number of reasons and governments are shifting their focus to indirect taxes. With significant changes occurring in the area of indirect taxation, businesses need to actively monitor for updates and prepare accordingly when operating or expanding overseas.

Edward L. Roguel is a partner with the Tax Advisory and Compliance division of Punongbayan & Araullo.

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