1. National Institute of Public Finance and Policy VAT coordination in federations and common markets: lessons for India Sijbren Cnossen

2. VATs in federations and common markets: from good to bad to ugly 1. Canada (federal + provincial GSTs) 2. European Union (state VATs) 3. Brazil (federal + state VATs) ¶Unitary systems: Australia, Germany, Russia, Switzerland $United States? India?

3. Starting from first principles: revenue allocation principles  Choice between -destination principle: imports taxed, exports not taxed; and -origin principle: exports taxed, imports not taxed  Consensus that origin principle is distortionary and is likely to become an administrative nightmare  Destination principle preferred, but requires border tax adjustments (BTAs)

4. European experience  Each member state has its own VAT based on the Common VAT Directive  EU does not have overarching VAT as in Canada and proposed for India  VAT is administered by the member states themselves on a destination basis  This requires BTAs in the form of deferred payment or reverse charging

5. BTAs for B2B transactions  BTAs for goods: at physical borders or through deferred payment system – implicitly or explicitly  BTAs for services: always on a reverse-charge basis – implicitly or explicitly, except immovable property, cultural services, education, restaurants, catering, transportation of persons, short-term vehicle rentals ¶ deferred payment = reverse charging = postponed accounting

6. VAT treatment of interstate B2B transactions Exporter in Austria Importer in Estonia Export transaction Interstate export of €100 VAT zero-rated for export Self-declared VAT VAT declared on acquisition from Austria at Estonian rate of 18% = €18 (18% x €100) with simultaneous credit VAT liability €18 on acquisition – €18 on inputs = €0 VAT Domestic sale Sale of €150 + €27 VAT = €177 price for final good VAT liability €27 VAT on sale – €0 VAT on import = €27 VAT €100 €177 VAT revenue in Austria = 0VAT revenue in Estonia = €27

7. BTAs for B2C transactions Goods  Cross-border purchases taxed on an origin basis  Exceptions for means of transport, mail order purchases, and exempt entities Services  Cross-border purchases taxed on an origin basis, except immovable property, cultural services, education, restaurants, catering, transportation of goods and persons, short-term vehicle rentals

8. Do BTA methods increase VAT fraud? Forms of fraud  Shadow economy fraud  Suppression fraud  Insolvency fraud  Carousel fraud  Bogus traders Extent of fraud? National accounts or operational estimates

9. Germany and United Kingdom: Estimates of VAT fraud and evasion in 2001–02 Type of non-complianceRevenue loss as percent of full-compliance VAT GermanyUK Shadow economy, including consumption through the business and non-registration 5.5 5.3 Suppression and insolvency fraud 2.3 3.9 Abuse of tax credits 2.1.. Carousel fraud 1.1 3.2 Non-registration.. 0.6 Total revenue loss 11.112.4

10. Measures to combat fraud Legal  Refusal of right to tax credit  Provision of financial security  Joint and several liability rules Administrative  VAT Information Exchange System (VIES)  Central Liaison Offices  Secondment of auditors to investigation units in other member states

11. Continued criticisms, focusing on carousel fraud  Keen and Smith: current arrangements are “ad hoc enforcement strategies” and should be rejected in favour of [their] deep solution which would “fix the VAT chain by ending the zero- rating of trade between member states”  Taxation of exports is called “exporter rating,” which is meant to repair “break in the VAT- collection chain”

12. Exporter rating Export transaction Export sale of €100 VAT imposed on export to Estonia at Austrian rate of 20% VAT liability 20% x €100 = €20 Intrastate import price = €120 Domestic sale Sale of output €150 + 18% VAT = €177 price for final good VAT liability €27 on sale - €20 VAT on import = €7 VAT €177 Exporter in Austria Importer in Estonia VAT revenue in Austria = €20 VAT revenue in Estonia = €7 Clearing house flow: €20 from Austria to Estonia Net revenue in Austria = 0 Net revenue in Estonia €20 + €7 = €27

13. EU Commission’s exporter rating proposals 1.Clearing house (Cnossen, 1983) based on aggregation of individual invoices (complex, costly, adverse impact on enforcement incentives) 2.Home-state taxation (Smith, 1996) Single place of taxation and clearing based on aggregate consumption statistics (perverse effect on choice of business location)

14. Exporter rating proposals in the tax literature  Viable integrated VAT (VIVAT)  Compensating VAT (CVAT)

15. Viable integrated VAT (VIVAT) EU-wide uniform VAT rate on all intermediate transactions, supplemented by state-specific retail sales taxes; clearing in line with consumption statistics Comments - repairs break-in-the-VAT chain, but leaves break- in-the-audit chain intact: fake export invoices may be replaced by fake import invoices - traders have to make onerous distinction between intermediate and retail sales - implications of differentiated rates not considered - taxation of intermediate transactions vs. products

16. Compensating VAT (CVAT) Retention of deferred payment for state VATs but imposition of central tax on cross-border transactions “to protect integrity of VAT and to prevent households and unregistered traders from masquerading as registered traders located in other member states” (McLure, 2000) Comments - central bureaucracy for no-revenue-raising tax - requires distinction between instate and out-of- state sales to registered or non-registered persons

17. Further analysis by European Commission  Transfers of VAT revenue to other member states  Advance payment of VAT by exporters  Possible trade diversion  Increase in administrative and compliance costs  Mismatches between supply and acquisition (purchase) listings  Incentive to produce false import invoices

18. Dual VAT (DVAT)  Concurrent central and state revenue-raising VATs as in Canada  Central VAT administered by state or centre  State VATs administered by states themselves or by centre on a destination basis  Central VAT monitors interstate transactions Comments - not exporter rating, but deferred payment for state VATs - similar to CVAT, but central VAT raises revenue - central involvement OK for India (if not for EU)

19. Comprehensive reverse charging (proposed by Germany and Austria)  Instead of seller, purchaser should always be liable to VAT  Means that VAT is converted into retail sales tax  Combined with universal cross-checking and possibly VAT bank accounts ¶System change does not improve verification and audit of existing VATs

20. Example of a Reverse Charge System (VAT = 19%) Company A Sells goods to Company B for €100. No VAT is charged. Submits to VAT office Reverse Charge Sales List (RCSL) of customers to whom sales without VAT have been made. Company B Reverse charges itself VAT on purchase price of €100, declaring €19 payable to VAT authorities on the VAT return. Reclaims input VAT of €19 on the same VAT return. No net VAT is due. Sells to Company C for €150. No VAT is charged. Submits RCSL to VAT office. Company C Reverse charges itself VAT on purchase price of €150, declaring €28.50 payable to VAT authorities on the VAT return. Reclaims input VAT of €28.50 on the same VAT return. Sells to final consumer for €200 plus €38 VAT. Output VAT of €38 declared on VAT return and paid to VAT authorities. VAT OFFICE Rather than receiving a proportion of the VAT due at each point in the supply chain (fractional payment system), the VAT authorities receive the amount due of €38 in one sum from Company C, once the goods are sold to the final consumer

21. Own observations  Exporter rating proposals designed for BTAs on goods (in EU after 1992), but BTAs for services already on reverse charge basis (and goods also in Benelux)  Focus on break in the VAT-collection chain instead of the VAT-audit trail  System change is not solution to criminal fraud

22. Lessons for India  Dual VAT good system, but administrative coordination between Centre and States essential for interstate transactions  VAT should have broadest possible base and should be levied at a uniform rate (separate for Centre and individual states) with a sizable registration threshold  Perhaps exemption (not zero rate) for unprocessed foodstuffs (possibly, with zero rate for major agricultural inputs) Warning: if you don’t do it right the first time, you will not get a chance to correct your mistakes later – with deleterious economic and administrative consequences

23. Thank you for letting me share my views with you!