|  26.06.2014

Considerations upon taxation and competition in Europe

Last year, at the Economic Forum held in Krynica, one of the most important in Europe, most discussions regarding taxation and competitiveness in Europe began and ended with the acute need to reduce labor cost.

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When it comes to problems regarding taxation and competitiveness, Romania is one of the ‘champions’, but there are problems everywhere – larger or smaller.


Europe has concerns with regards to the ‘common taxation base’ for multinationals, but also with respect to the implementation of anti-BEPS (‘Base Erosion and Profit Shifting’) regulations. VAT is another big issue that may be considered, without hesitation, an invitation to fraud.


VAT – in need of reform
The value added tax – VAT is, in the end, a tax on consumption borne by the end consumer, either households or companies or public institutions with no deduction right. VAT is charged only to the end consumer, as tax on consumption in USA. This European invention, afterwards exported across all continents, is based on the split payment of the VAT by companies concurring in the manufacture of such good or the provision of such service. Each company pays VAT for the purchased goods and services and charges VAT for the sold goods and services. The paid VAT is deductible, so the taxpayer pays to the state budget only the difference for the value added by such company. If the paid VAT is bigger than the output VAT, the taxpayer may request a repayment, so – at least in theory – the VAT should be neutral for the business.


If the taxpayer exports such good or product, things get more complicated: the VAT rate for exportation is zero. The taxpayer should request the VAT repayment – repayment which in certain countries is not easy to make. The chain of split payments does not break however, being rebuilt by the purchaser through the VAT customs payment, in its own country. Nevertheless, this is not the case in the European Union, where there are no customs. Here is where issues begin, but here is also where the solutions are.


The problem is very simple: without customs, the chain of split payments breaks. Europe had two options: (i) to allow the chain to break and to implement a reverse taxation system in which the purchaser owes the VAT in the country where the purchase is made or (ii) not to allow the VAT chain to break, with the seller to collect the VAT from the purchaser, as if it were in the same country.

The second option was quickly abandoned because it could not have been implemented: the VAT rates are different in EU countries and the latter should have relied upon each other for collecting their own income, as well as for setting up VAT clearing houses between the European countries.


The first option was the winner, but it creates two different VAT regimes: (i) intra-community acquisitions for which reverse taxation is usually applicable (the VAT is not paid to the supplier, but directly to the state). If the buyer has a deduction right, the VAT is no longer actually paid, but set off with the deductible VAT) and (ii) intra-country acquisitions, for which the system of split payments subsists (the effective VAT payment to the supplier).


The solution would have been very good if another issue had not occurred: the fraud. Shortly, two huge gaps were discovered in the system: (i) the possibility to benefit from illegal VAT repayments by purchasing goods for overrated prices, followed by exportation and (ii) the possibility to steal the entire VAT from the chain at a given time, by simply interposing a company between the purchaser and the seller, in an intra- community acquisition.


If the first gap has always been possible, but was harder to use because it involved the existence of corrupt or slightly skilled tax inspectors, the second one was a true blessing for the offenders: they could steal without depending on corrupt inspectors. This way, approximately EUR 110.8bn were stolen each year, i.e. more than half of approximately EUR 193bn missing each year from the treasuries of the budgets of EU countries, only from VAT. If another thousand illegal repayments adds up, it results that most VAT fraud comes simply from a faulty design of this tax, which is extremely important for all budgets of the European countries.


Europe took action for fraud reduction: new reporting, declarations, controls, restrictions upon giving the VAT code, but they all involved additional management costs, both for the European companies and for the European countries.


The obligation of the European companies to cross-check providers was also introduced, because, this way, there is the (real) risk that the tax authorities will refuse the deduction right for the VAT paid to providers which turn out to have committed fraud. This measure also resulted in other additional costs for European companies, but also in inevitably undertaking the risk of not being able to deduct a part of the paid VAT, because someone stole it.


Therefore, the management costs for European companies increase, the risks for correct taxpayer grow bigger, but fraud still does not decrease.


Is it possible for the VAT to be the best example of self-impairment of its own competition? In the current form, the VAT became an issue threatening to erase many substantial benefits of the European common market.



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