main issues for a good vat system

8/11/2019 Main Issues for a Good VAT System

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Policy Research Institute, Ministry of Finance, Japan, Public Policy Review, Vol.8, No5, November 2012 683

Main Issues for a Good Value Added Tax System

Yumi Nishiyama

Professor, School of Law, Tokai University

Abstract

This article focuses on the main issues of VAT ( tax rate structure, exemptions andenforcement and compliance ) discussed in the Mirrlees Review (2010 and 2011). At present,especially after the Great Earthquake in Tohoku, a raise in the tax rate of Consumption Tax (theJapanese VAT) has been highlighted for the financial reasons. However, this paper argues thatwe should aim instead, and as well, to achieve a good VAT system from a long-term standpoint.

The important factors for a good VAT system include a single tax rate, a broad tax base withfew exemptions, and modernization of procedures for enforcement and compliance. The

Mirrlees Review points out that the present VAT system in the EU is old and imperfectlyadapted to the changed international circumstances, and that this serious situation has beencaused by a multiple tax rate structure and a wide range of exemptions. According to the

Review, applying reduced tax rate is just a moderately pro-poor policy and less effective or less persuasive. The effective measures to remove or mitigate regressive effects caused by theVAT will be income tax credits or social benefit system. Once reduced rate has beenintroduced, it is definitely hard to show the political will that this rate structure is meaningless.

Additional to lots of experiences of the EU, we can gain some clues for a modern VAT byoverviewing the VAT system in New Zealand, which is highly regarded by the Review. Apartfrom its simple system (with a single tax rate and few exemptions), wide-ranged surveys on theVAT impact to the society were carried out by the government before introducing a new tax,which will be a key element for a social acceptance.

I. Introduction

The purpose of this article is to survey main issues relating to Value Added Tax (hereafterVAT) discussed in two seminal reviews which are generally called The Mirrlees Review 1.

1 The Mirrlees Review was edited by an expert commission chaired by the Sir James Mirrlees (NobelLaureate in 1996) in order to take a hard look at the UK tax system and its characteristics for a good taxsystem in an open economy in the twenty-first century. The first draft of the Review 1 was released in


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684 Y. Nishiyama / Public Policy Review

The Mirrlees Review consists of two volumes: the first one is Dimensions of Tax Design (2010, hereafter the Review 1) and the second one is Tax by Design (2011, hereafter theReview 2) 2. Three main issues of the VAT in the UK are discussed in the Mirrlees Review :they are a tax rate structure, exemptions and enforcement, which are also of relevance to theJapanese Consumption Tax (hereafter JCT). The Mirrlees Review points out several

problems of the VAT system in the UK, by comparing it with that of other OECD countries.We have to keep it in mind that VAT problems in the UK are at the same time those of the EU,since the common VAT system has been already integrated into the EU. From the over 90years of history and tradition of the European VAT 3, we can learn not only good suggestions

but also hints from a lot of failures.The Mirrlees Review aims at identifying the characteristics that would make a good VAT

system in the twenty-first century4 and considers the strategic design that could shape the

future course of the UK policy on VAT 5. The Review, in analysing the VAT systemsthroughout the OECD countries, recommends a tax system with single tax rate and broad tax

base for a good tax system. Apart from this suggestion, the Review also presents some possible measures against VAT fraud (such as the so-called carousel scheme).

The proposal of the VAT system with a single tax rate structure and less exemptions can bemeaningful for a discussion of the JCT reform. The anti-fraud measures are also suggestive:although this kind of scheme is caused solely by the abuse of an important EU principle,

namely the free movement of goods. However, as long as these schemes cannot be achievedMarch 2008. See http://www.ifs.org.uk/mirrleesReview. The Review 1 consists of 13 chaptersoverviewing wide-ranging dimensions of the present UK tax system. The 4 th chapter is Value Added Taxand Excises and written by Ian Crawford (reader in economics at University of Oxford), MichaelKeen(assistant director of fiscal affairs department of the IMF) and Stephen Smith (professor ofeconomics Fiscal Affairs. The Review 1 contains four commentaries by Richard M. Bird(Canada),Sijbren Cnosse (Netherlands), Ian Dickson / David White (New Zealand) and Jonathan Gruber (USA).The Review 2 consists of 20 chapters and was jointly written by Sir Mirrlees and other 9 authors.2 This article is mainly based on another article of mine published in Financial Review no.102 (PolicyResearch Institute, 2011), in which I analyse the Review 1. Half a year after publishing the article of

Financial Review , the Review 2 was released in the Web-site of IFS and later officially published. Undersuch a circumstance, the Review 2 is also referred in this article. Addition to these Reviews, thefollowing reports from the European Commission and OECD are also important on this issue: GreenPaper on the Future of VAT (the European Commission, 1.12.2010, hereafter the Green Paper) ,Communication on the Future of VAT (the European Commission, 6.12.2011, hereafter theCommunication), OECD International VAT/GST Guidelines (OECD, 28.6.2011, hereafter theGuidelines) and Draft Commentary on the International VAT Neutrality Guideline (OECD, June 2012,hereafter the Commentary ). The latest study on the Green Paper and the Communication, s. SatoshiWatanbe, Zeimu-Koho vol.60 no.7 (2012).3 The sales tax as an original form of VAT was introduced during the First World War in order to managethe finance for the war. See Johannes Popitz, Kommentar zum Umsatzsteuergesetz (1918). Popitz wasone of the members who drafted the first law for the sales tax (=Umsatzsteuer).4 See Preface of the Review 1.5 See Executive Summary of the Review 1.


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without abuse of invoices, this issue is also worth considering in Japan, where introduction ofinput tax deduction based on invoices 6 has been discussed.

II. Overview of the Report

In the thirty years since the Meade Report (1978) the balance of taxation has shifted towardthe VAT. The Review 1 points out that the appropriate balance between direct and indirecttaxation is one of the oldest issues in public finance. However the differences between them areless sharp than before, as the two taxes should have a broadly equivalent effect on the labourmarket. Shifting toward the VAT doesnt mean having a great impact on work incentive orincreasing levels of employment. The appropriate balance between direct and indirect

taxation is just a matter of administration and compliance, as running a broad-based VAT, in parallel with taxes on income, reduces the risk of revenue loss 7.

The Review 1 focuses mainly on three issues: The tax rate structure, exemptions and theVAT enforcement 8. The Review 2 also focuses on the issues of the tax rate structure and thetax base 9.

Indirect taxes can tax different type of consumption at different rates. This different rate

structure is justified by the so-called extra-costs-theory : Goods causing pollution or otherexternal costs should be taxed more heavily. Or it is justified by the so-called useful-tag-effect base on the egalitarianism: A reduced tax rate might be a useful tag for the tax system toachieve the good distribution of wealth 10. However the multiple tax rate system cannot benecessarily an effective tool for distribution of wealth. Other instruments, such as measures

by income tax or social benefits, can be more effective. No one can explain why the reducedrate (or zero-rating in the UK) removes a regressive impact: it is just a signal of a moderately

pro-poor policy 11. The rationale for the reduced rate is far from clear: for example, why givezero-rating to childrens clothes, but 5% to childrens car seats? Who can explain such adifferentiation persuasively?

6 In Japan a prerequisite for application of input tax deduction is keeping of books and bills ( 30 ,JCT Law). These bills are different from invoices in the European VAT system: the address of thetaxable person and of the customer, VAT amount payable, and the VAT identification number are notrequired to be issued, which means that contents of bills are less detailed than those of invoices in EU.7 The Review 1, p.276.8 See Chapter 4 of the Review 1.9 See Chapter 6, Chapter 7 and Chapter 9 of the Review 2. In Chapter 8, VAT on financial services isdiscussed.10 The Review 2, p.159.11 The Review 1, p.300.


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The average of standard rate of the OECD countries is 17.7% 12. According to the data ofHM Revenue & Customs the revenue cost is 29 billion for domestic zero rate and 3 billionfor the reduced rate, and C-efficiency 13 for the UK is 49% (in 2005) 14 or the ratio of VATrevenue for the UK is 46% (in 2008). These indexes are much lower than that of the OECDaverage 15.

Apart from the rate system, extensive exemptions under the VAT system should be

considered. Any exemption is anathema to the logic of the VAT, since it inherently breaks thechain of credit and refund, leading this tax to an element of production taxation 16. We shouldalso recognise that public sectors are protected from competition with private ones by the

exemption system of old VAT.The threshold for small enterprises, namely the subjective exemption, cannot find any

perfect justification, just with an explanation that this system saves administration cost ofauthorities and compliance costs of taxpayers. The threshold distorts competition between thecountries, whose threshold is different.

The Review 2 has illustrated the VAT with a broad tax base and single tax rate as a possibletax reform package, because this would increase consumers welfare by distorting theirspending choice less 17. This VAT system would inevitably raise the cost of living. However,

this harmful effect can be compensated by the changes to income taxes and benefitmechanisms, which will avoid worsening work incentives and keep distributional neutrality 18.

VAT is evaded by under-report sales or misclassifying sales of commodities into the

category subject to lower rate. The other types of VAT evasion or fraud are caused by abuseof credit and refund mechanisms. In the UK it is reported that the VAT gap 19 was 11.5

billion in 2009-2010, which is estimated to be 14% of the potential VAT revenue yield.Since the establishment of a common market and the removal of fiscal frontiers in the EU

12 Table 4.2 of the report, p.299.13 C-efficiency 100 means that VAT revenue to the product from all consumption, if it would becompletely levied at uniform rate and without exemptions.14 The Review 1, p.299.15 C-efficiency for OECD 58%, for Japan 72%, for New Zealand 105%. The efficiency cannot be

precisely measured by C-efficiency, therefore since several years the ratio of VAT revenue has been used.16 The Review 1, p.305.17 The Review 2, p.229.18 According to the Review 2, distributional neutrality is achieved by ensuring that gains and losses ofhouseholds with a different level of income and spending would be relatively modest. See p.230.19 The VAT gap means the difference between tax actually collected and the tax that would have been

paid if all tax payers (individuals and companies) complied with law. See the Review 2, p.180.


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(1993), the fraud scheme named carousel fraud has been widespread all over the EU 20. Thefollowing figure shows one of examples of carousel fraud.

Figure 1 Example of Carousel Fraud

United Kingdom

FranceSTART

Source: The Review 1, p.312.

Under the present legal system, administrative measures against this fraud are limited: just frequent visit for tighter checks on firms, or payment of VAT refunds after collecting VATdue and so on. However, these measures have some side-effects as well: bureaucratic

procedures may harm business in general 21.The Review 1 suggests other radical measures against the fraud as follows:

A reverse- charge system for B2B transactions, under which the liability shifts fromthe seller to the buyer. In the UK this system has already applied to supplies ofmobile phones and/or computer chips.

A withholding system for B2B transactions, by which the seller is given credit for

20 The revenue loss is not certainly calculated, but it is reported that this fraud costs between 1.12 billion and 1.9 billion in 2004-2005 FY of the UK.21 The Review 1, p.313.

Company C: The Buffer

Buys goods from B , pays VAT, and sells toCompany D, charging VAT. Company C may

be wholly unaware of the fraud. Remits theVAT and reclaims the VAT with the invoicefrom Company B.

Company B: The missing trader

Purchases goods from Company A in memberstate 2 (France). Charges VAT on sale toCompany C. Immediately after reclaiming theVAT with an inauthentic (e.g. forged) invoice,disappear without remitting the VAT to therevenue authorities

Company D

Pays VAT on purchase from Company C.Exports goods to Company A in France atzero-rated. Claims a refund for VAT onexported goods. Company D is usuallyunaware of the fraud. In effect, the VAT is not paid by Company B.

Company AExports goods to Company B in anothermember state (United Kingdom). Export saleis VAT zero-rated. Claims a refund onexported goods.


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further into each issue using concrete cases. This chapter will considers the tax rate structure,the next chapter will focus on exemptions, and the final chapter will focuson enforcement andcompliance issues.

III.1. The tax rate rule of the Directive

The Recast VAT Directive (hereafter the Directive) 26 provides the common rule of VATin the EU.

Article 97 of the Directive1. From 1 January until 31 December 2010 27, the standard rate may not be less than 15%.

Article 98 of the Directive1. Member states may apply either one or two reduced rates.

Article 991. The reduced rates shall be fixed as a percentage of the taxable amount, which may not be

less than 5%.

According to Annex

of the Directive, the list of supplies of goods and services to whichreduced rates are applied is as follows:

(1) Foodstuffs (including beverages but excluding alcoholic beverages) for human andanimal consumption; live animals, seeds, plants and ingredients normally intended foruse in the preparation of foodstuffs; products normally used to supplement foodstuffsor as a substitute for foodstuffs;

(2) supply of water;(3) pharmaceutical products of a kind normally used for health care, prevention of

illnesses and as treatment for medical and veterinary purposes, including productsused for contraception and sanitary protection;

(4) medical equipment, aids and other appliances normally intended to alleviate or treatdisability, for the exclusive personal use of the disabled, including the repair of suchgoods, and supply of children's car seats;

(5) transport of passengers and their accompanying luggage;(6) supply, including on loan by libraries, of books (including brochures, leaflets and

26 Council directive 2006/112/EC of 28 November 2006 on the common system of value added tax, OJ L347 of 11 December 2006.27 This term has been extended automatically.


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similar printed matter, children's picture, drawing or colouring books, music printed orin manuscript form, maps and hydrographic or similar charts),newspapers and

periodicals, other than material wholly or predominantly devoted to advertising;(7) admission to shows, theatres, circuses, fairs, amusement parks, concerts, museums,

zoos, cinemas, exhibitions and similar cultural events and facilities;(8) reception of radio and television broadcasting services;(9) supply of services by writers, composers and performing artists, or of the royalties due

to them;(10) provision, construction, renovation and alteration of housing, as part of a social policy;(10a) renovation and repairing of private dwellings, excluding materials which account for a

significant part of the value of the service supplied;

(10b) window-cleaning and cleaning in private households;(11) supply of goods and services of a kind normally intended for use in agricultural

production but excluding capital goods such as machinery or buildings;(12) accommodation provided in hotels and similar establishments, including the provision

of holiday accommodation and the letting of places on camping or caravan sites;(12a) restaurant and catering services, it being possible to exclude the supply of (alcoholic

and/or non-alcoholic) beverages.(13) admission to sporting events;

(14) use of sporting facilities;(15) supply of goods and services by organisations recognised as being devoted to socialwellbeing by Member States and engaged in welfare or social security work, in so faras those transactions are not exempt pursuant to Articles 132, 135 and 136;

(16) supply of services by undertakers and cremation services, and the supply of goodsrelated thereto;

(17) provision of medical and dental care and thermal treatment in so far as those servicesare not exempt pursuant to points (b) to (e) of Article 132(1);

(18) supply of services provided in connection with street cleaning, refuse collection andwaste treatment, other than the supply of such services by bodies referred to in Article13.

(19) minor repairing of bicycles, shoes and leather goods, clothing and household linen(including mending and alternation);

(20) domestic care services such as home help and care of young, elderly, sick or disabled;(21) hairdressing.

According to the so-called inverse elasticity rule, commodities for which demand is more

elastic should be taxed at a lower rate and those for which demand is less elastic should be at a


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higher rate 28. However, generally speaking, the demand for the necessities is less elastic. Itseems to be a paradox that necessities of life should be taxed at a higher rate, or to be aninequity from the final consumers point of view. It is necessary to take this argument intoaccount from other consideration: for example, commodities associated with leisure should betaxed more heavily than those associated with paid work in order to mitigate the distortion ofworkers decisions.

The multiple tax rates system is often criticised for some reasons. Firstly, decisions to selectgoods to which reduced rates are applied can be presumably influenced by lobbyists.Secondly, lots of arguments and disputes about which rate to apply can be caused betweentaxpayers and authorities. Thirdly, the tax structures with reduced rates are maintained at thecost of the fiscal loss. Fourthly, the scope of goods and services to which reduced rates are

applied would be endlessly expanded, if taxpayers convenience (not final consumersregressiveness) were considered.

III.2. Some Cases of Problems Caused by Reduced Tax Rates

III.2.1. The Marks & Spencers Teacake Case

Is chocolate teacake sold by Marks & Spencers (hereafter M&S) biscuit or cake?

If it is the former, it is taxed at standard rate. If the latter, it is taxed at zero rate.This teacake had been taxed as biscuit at standard rate since 1973 (the year of introductionof VAT in the UK). However in1994 the authorities recognised that this product should beclassified as a cake. M&S launched a legal battle to have the wrongly-paid VAT returned(3.5 million), while the UK argued that paying back the total sum would unjustly enrich M&S.This legal battle continued for 13 years before M& S won the suit at House of Lords 29.

This case shows that criteria for distinction of similar items with different rate are not foundeasily. Nevertheless both taxpayers and the authority have to spend a lot of time and money insuch legal battles. This is definitely inefficient for both.

III.2.2. Set-Sale

When seeds (taxed at the reduced rate in Germany) and sowing-services (at the standardrate) are supplied at the same time, which rate should be applied?

According to the judgment of the German Federal Tax Court, the tax rate depends on therelation between them. When sale of seeds is more important than sowing-services and the

28 About this rule, see Liam Ebrill et al., The Modern VAT (2001), p.70.29 Marks and Spencer plc v. Her Majestys Commissioners of Customs and Excise, [2009] UKHL8.


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former is a main purpose of the transaction, the rate of sowing-service is adapted to that ofseeds 30.

Another type of set-sale (e.g. pasta and pasta-sauce set) needs a ruling from the Ministry ofFinance in order to decide the tax rate applied. These rulings can make the VAT rules andtheir enforcement complicated and confused.

Apart from this issue, the relation between contents and their container is to be considered.For example, can the same tax rate be applied to mustard (taxed at the reduced rate inGermany) and their costly glass container, which can be used as a wine-glass afterwards?According to the German theory, the container is taxed at its own rate (namely at the standardrate) when it has its own independent utility value 31.

III.2.3. Works of Art

According to the German law, works of art belong to goods taxed at reduced rate(Umsatzteuergesetz 12, Nr.53 of List 2.). However what is art? In Germany, whether acertain item is art or not is depending on the customs duty rules 32. However the judgementcan be influenced by personal tastes or feelings.

III.2.4. Labour Intensive Service

According to the Directive, so-called labour intensive services can be taxed at thereduced rate (Annex ,10a, 10b, 19, 20 and 21). Applying reduced rate to such services runscounter to the aim of the multiple tax rate structure, as the reduced rates should basically servefinal consumers, not taxable persons who run a small business such as hairdressing orwindow-cleaning.

IV. Exemptions

IV.1. The exemption rule of the Directive

According to the Directive, activities in the public interests and other activities prescribed inArticle 135 of the Directive 33 are exempted. The Directive provides the rule of exemptions

30 Umsatzsteuerrundschau 2003, 143. The court said, The fate of sub-supply should follow that ofmain-supply.31 Johann Bunjes/Reinhold Geist, Umsatzsteuergesetz Kommentar 10.Aufl. , 12, Rz.39.32 Umsatzsteuerrundschau 3/97, p.97.33 Article 135 of the Directive provides that the followings transactions are exempted: (a) insurance andreinsurance transactions, (b) the granting and the negotiation of credit and the management of credit by


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for certain activities in the public interests, as follows:

Article 132 of the Directive1. Member States shall exempt the following transactions:

(a) the supply by the public postal services of services other than passenger transport andtelecommunications services, and the supply of goods incidental thereto;

(b) hospital and medical care and closely related activities undertaken by bodiesgoverned by public law or, under social conditions comparable with those applicableto bodies governed by public law, by hospitals, centres for medical treatment ordiagnosis and other duly recognized establishments of a similar nature;

(c) the provision of medical care in the exercise of the medical and paramedical

professions as defined by the Member State concerned;(d) the supply of human organs, blood and milk;(e) the supply of services by dental technicians in their professional capacity and the

supply of dental prostheses by dentists and dental technicians;(f) the supply of services by independent groups of persons, who are carrying on an

activity which is exempt from VAT or in relation to which they are not taxable persons, for the purpose of rendering their members the services directly necessaryfor the exercise of that activity, where those groups merely claim from their members

exact reimbursement of their share of the joint expenses, provided that suchexemption is not likely to cause distortion of competition;(g) the supply of services and of goods closely linked to welfare and social security work,

including those supplied by old people's homes, by bodies governed by public law or by other bodies recognised by the Member State concerned as being devoted tosocial wellbeing;

(h) the supply of services and of goods closely linked to the protection of children andyoung persons by bodies governed by public law or by other organizationsrecognised by the Member State concerned as being devoted to social wellbeing;

the person granting it, (c) the negotiation of or any dealings in credit guarantees or any other security formoney and the management of credit guarantees by the person who is granting the credit, (d) transactions,including negotiation, concerning deposit and current accounts, payments, transfers, debts, cheques andother negotiable instruments, but excluding debt collection, (e) transactions, including negotiation,concerning currency, bank notes and coins used as legal tender, (f) transactions, including negotiation butnot management or safekeeping, in shares, interests in companies or associations, debentures and othersecurities, (g) the management of special investment funds as defined by Member States, (h) the supply atface value of postage stamps valid for use for postal services within their respective territory, fiscalstamps and other similar stamps, (i) betting, lotteries and other forms of gambling, subject to theconditions and limitations laid down by each Member State, (j) the supply of a building or parts thereof,and of the land on which it stands, (k) the supply of land which has not been built on other than thesupply of building land, (l) the leasing or letting of immovable property.


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(i) the provision of children's or young people's education, school or universityeducation, vocational training or retraining, including the supply of services and ofgoods closely related thereto, by bodies governed by public law having such as theiraim or by other organizations recognised by the Member State concerned as havingsimilar objects;

(j) tuition given privately by teachers and covering school or university education;11.12.2006 EN Official Journal of the European Union L 347/27

(k) the supply of staff by religious or philosophical institutions for the purpose of theactivities referred to in points (b), (g),(h) and (i) and with a view to spiritual welfare;

(l) the supply of services, and the supply of goods closely linked thereto, to theirmembers in their common interest in return for a subscription fixed in accordance

with their rules by non-profit-making organisations with aims of a political,trade-union, religious, patriotic, philosophical, philanthropic or civic nature, providedthat this exemption is not likely to cause distortion of competition;

(m) the supply of certain services closely linked to sport or physical education bynon-profit-making organisations to persons taking part in sport or physical education;

(n) the supply of certain cultural services, and the supply of goods closely linked thereto, by bodies governed by public law or by other cultural bodies recognised by theMember State concerned;

(o) the supply of services and goods, by organisations whose activities are exempt pursuant to points (b), (g), (h), (i), (l), (m) and (n), in connection with fund-raisingevents organised exclusively for their own benefit, provided that exemption is notlikely to cause distortion of competition;

(p) the supply of transport services for sick or injured persons in vehicles speciallydesigned for the purpose, by duly authorised bodies;

(q) the activities, other than those of a commercial nature, carried out by public radio andtelevision bodies.

IV.2. Erosion of the Tax Base by Exemptions

Several cases given bellow show that wide-ranging exemption of VAT erode its tax base.

IV.2.1. Cost Factors for Taxable Persons

It is often pointed out that exemptions without the right of deduction could increase the burden of final consumers. When taxable persons cannot deduct their input taxes because of

the exemption, the taxes become a cost factor for them. In order to avoid it, they must shiftthe amount of the taxes to the price implicitly.


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In a field where the prices for the service are strictly controlled for some reasons (e.g. themedical treatment fee in Japan), the taxable persons cannot shift the amount of input taxes totheir customers. It means that the input taxes become their cost completely 34.

IV.2.2. Exemptions for Activities of Public Interests

Are exemptions for activities of public interests justified for promoting these activities?In Germany, for example, such activities are exempted under certain conditions, as follows:

(a) public, charitable or religious purposes are exclusively and directly performed, (b) theirservices are supplied directly only to the persons, who are given beneficiary by articles ofcorporation or the other rule, and (c)the price doesnt exceed the average kept in a private

sector 35

.Exemptions for public interests can be effective in promoting such activities. However, how

can we maintain a strict interpretation of the words exclusively and directly? Exclusivelymeans that a corporation performs its activity only for the purposes described in its articles ofcorporation (56 of Abgabenordnung=General Tax Law), and directly means that acorporation attains its purpose described in articles of corporation by itself (57 ofAbgabenordnung). Both words are defined by law, but still unclear.

The German ruling from the Ministry of Finance prescribes that driving-services for

patients supplied by public corporations are not exempted, presumably because such servicescan be competitive to those in the private sector (e.g. taxi business). However, thisexplanation is not persuasive.

IV.2.3. Services Provided by Bodies Governed by Public Law

Should services provided by bodies governed by public law be exempted from a public point of view? States, local government authorities and other bodies governed by public laware generally excluded from taxable persons, even where they collect dues, fees, contributionsor payments in connection with their activities. However, they are regarded as taxable

persons in respect of their activities or transactions where their position as non-taxable personswould lead to significant distortions of competition (Article 13 of the Directive).

How can we define significant distortions of competition with business persons in a private sector? Does the area, where distortions exist, mean a certain market or markets ingeneral? Should existence of competition be real competition, or can the hypothetical

34 The Japanese Medial Association often emphasises that exemptions with the right to deduction concerning medical fee should be introduced. See http://dl.med.or.jp/dl-med/teireikaiken/20101006_2.pdf(in Japanese).35 4 Nr.18 UStG (=German VAT Law).


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possibility of the existence of competition be considered enough? How can we evaluatewhether or not distortions are significant?

According to the judgment of the European Court of Justice (hereafter ECJ) 36, theexistence of distortion should be evaluated in the local market in which a body governed by

public law carries on the same activities as a private operator does.The expression would lead to in Article 13 of the Directive is to be interpreted as

encompassing not only actual competition, but also potential competition, provided that the possibility of a private operator entering the relevant market is real, at least not purelyhypothetical. And the word significant is to be interpreted as meaning that the actual or

potential distortions of competition are more than negligible.

V. Emforcement and Compliance

V.1. Characteristics of the VAT System in the EU

Compared with a JCT system, the VAT of the EU has some characteristics.Firstly, the taxable period is shorter in the EU: this means that tax returns are submitted

more frequently.

Article 252 of the Directive1. The VAT return shall be submitted by deadline to be determined by Member States.That deadline may not more than two months after the end of each tax period.

2. The tax period shall be set by each Member State at one month, two months or threemonths.

This frequent payment is said to be effective for avoiding non-payment of taxes. In Japan,the taxable year is usually a calendar year for individual enterprises or a business year forcorporation (Law 19 (1)(2)). And non-payment of JCT amounts 339,842 million JPY,which is the highest of all taxes (2010 FY) 37.

Secondly, the full and immediate deduction principle based on invoices is strictly adheredin the EU. It is often said in the EU that input tax deduction is heart of VAT 38. In Japan, onthe other hand, input taxes are not deducted on invoices but on books and bills (Law 30 ).Whether prerequisite of input tax deduction is satisfied or not is often strictly judged in thecourts, since a legal character of input tax deduction as claim right is not written clearly in thelaw.

36 So-called Isle of Wight case (16 th September 2008, C-288/07).37 Japanese Tax Agencys Annual Report of 2012FY.38 Tipke/Lang, Steuerrecht 20.Aufl ., 14-150.


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As stated above, full and immediate deduction based on invoices is, as it were, asophisticated masterpiece of the EU VAT system, but nevertheless it is abused by the evasionscheme, such as carrousel fraud . In this scheme, illegally acquired invoices are used andso-called missing traders disappear immediately after deducting input taxes without payingoutput taxes. This shows that the invoice-based system has still some vulnerability.

Thirdly, taxable persons in the EU are identified by means of an individual number (theso-called VAT- ID-number, Article 214 of the Directive). In Japan there is no such ID-numbernor taxpayers number in general 39. These ID-numbers link to the EU-wide network system(VIES ; VAT-Information-Exchange-Service 40 ). VIES is a new control system after theintroduction of the single market on 1 January 1993. This new system is helpful not only formonitoring by VAT administrators and control of intra-community trade, but also for taxable

persons, who need to confirm their trade partners identity or VAT-ID-numbers. The CentralLiaison Office has a direct access to the VAT database of Member States 41.

The VIES system is working relatively well in the EU. However, there is a great technicaldifferences between Member States. For this reason the EU commission is not responsible forits security, saying It is our goal to minimise disruption caused by technical errors. However

some data or information on our site may have been created or structured in files or formatswhich are not error-free and we cannot guarantee that our service will not be interrupted orotherwise affected by such problems. The Commission accepts no responsibility with regard to

such problems incurred as a result of using this site or any linked external sites.42

Thismeans that each Member State itself should be responsible to it.

V.2. Electronic Tax Return System in Germany

The VIES described above has been working in Germany very systematically since the newlaw (so-called Tax-data Transmission Law 2003) was put in force in 2003. Based on theGerman E-Government policy and Tax-Compliance strategy, a free program named ELSTER (Elektronische Steuererklrung) 43 was developed by the government in corporation withBayern Ministry of Finance. The data transmitted from taxable persons with this program arecollected and utilised by the Federal Central Tax Agent 44. This network system links to all

39 Introduction of the so-called my-number-system has been discussing in Japan.40 See http://ec.europa.eu/taxation_customs/taxation/vat/traders/vat_number/index_en.htm41 VIES works as follows: traders, who for example need to confirm whether a VAT number iscorrectly associated with their partners name or address, access to this system through their nationalCentral Liaison Office. Replies are given by Yes-No system for security and data protection reasons.42 See EU Commissions information of VIES, http://ec.europa.eu/taxation_customs/taxation/vat/traders/vat_number/index_en.htm.43 About ELSTER, see Tipke/Lang, Steuerrecht 20.Aufl., 21-183.44 After 1.1.2006 the operation of Federal Agency of Finance (Bundesamt fr Fianzen) was shifted to


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states (16 states) and it is very easy for users to download its software. This program(ELSTERBasis) is a basically free, and another pay programs (ELSTERSpezial /ELSTERPlus)with the higher security are available (See Table 1, shown below).

Table 1: Three types of ELSTER

ELSTERBasis ELSTERSpezial ELSTERPlus

security high very high very high

price free 41 Euro 50 - 150 Euro

operation Simple simple relatively complicated

valuatuin

Source: https://www.elsteronline.de/eportal/eop/auth/RegistrierungPlus.tax

In Germany, a taxable person has to submit his/her provisional VAT tax return every monthor ever three months by electronic means ( 18 German VAT Law).

V.3 VAT ID-numbers in Germany

A VAT ID-number 45 is indispensable tool for collecting tax data with ELSTER system.

This number of a taxable person is distributed from the Federal Central Tax Agency by his/herfiling of an application ( 27a German VAT Law). The general Tax-number, which isdistributed from his/her competent tax office, is an alternative.

The Federal Central Tax Agency can store and process the data, which are collectedthrough the number-distribution procedure, and if necessary can offer them to another MemberState in order to make identification of persons or authentication of trades cross-checked. Thedata are used solely for the administration of VAT and statistics and strictly prohibited fromusing for other purpose.

This number is useful not only for the tax authority but also for taxable persons, who forexample want to know an identity of their business partner in another Member State. Theycan check it by YES-NO system, as follows:

Federal Central Tax Agency (Bundeszentralamt fr Steuern, located in Bon) in order to make the taxadministration effective and modernised.45 The VAT ID-number is required on VAT invoices (226 of the Directive).


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VI.6. Towards a modern VAT: New Zealand GST

The European VAT is usually or generally regarded as a highly developed one. However,the Review 1 evaluates it as follows: New at the time of Mead, the VAT is now starting old andimperfectly adapted to the changed international circumstances in which the UK finds itself. 48 On the other hand, the New Zealands VAT (=goods and services tax, hereafter GST) 49 ishighly regarded in the Review 1. In a word, the GST systems merit is its simplicity.

Firstly, it has kept a single rate structure (now 15%) since the tax was introduced in1986.Secondly, it has a wide tax base with few exemptions. Strictly limited goods and services areexempted, e.g. letting or renting a dwelling for use as a private home, interest received, donatedgoods and services sold by a non-profit body, as well as certain financial services 50 (14 GST

Act) .The New Zealand GST is well known for its smooth take-off. Roger Douglas, the

Minister of Finance at the time of its introduction, pointed out, Traders who would becollecting GST had to be assured they could cope with the new tax. Simplicity for them was, in

fact, one of the key reasons for setting the tax at a single rate and without exemptions. Ibelieve now this was one of the principal reasons why the tax reform package was so wellaccepted when it was introduced .51

One of the commentaries to the Review 1 is written by two experts of New Zealand 52 and

their commentary suggests three important points for a modern VAT system, namely,campaigns for acceptance, costs for administration and compliance and social securityand tax 53.

VI.1. Campaigns for Acceptance

New Zealand policymakers started a campaign two years before the introduction of theGST. Along with this campaign, they researched the most difficult issue, namely sensitiverelation to food and other necessities. The research conceded that while the bottom 20% of

48 The Review 1, p.351.49 See Clinton Alley et al., New Zealand Taxation: Principles, Cases and Questions (2010).50 About its definition, see 3 GSTA. Financial services, which are exempted, include thefollowing: (a)paying or collecting any amount of interest, (b)mortgages and other loans,(3)bank fees,(4)securities such as stocks and shares, (5)providing credit under a credit contract, (6)exchangingcurrency, (7)arranging or agreeing to do any of the above, (8)financial options, (9)future contracts,(10)non-deliverable contracts. According to the information from the Inland Revenue Department(http://www.ird.govt.nz/gst/additional-calcs/calc-spec-supplies/calc-exempt/#fs) Services relating tofinancial planning fees, monitoring fees, evaluation fees and replanning fees are subject to GST.51 Cited from: Alan A. Tait, Value Added Tax: International Practice and Problems (1988), p.44.52 Commentary by Ian Dickson and David White, the Review 1, pp.387-406.53 The New Zealand system is not a brand-new but same wine and new bottle. Id . at 388.


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households allocated between 23-29% of their budgets on food the top tow deciles spent between 7-10% of their budgets on food. This shows that taxing food is regressive.However, upper-income households spend twice as much as low-income households. Thisshows that taxing all food at a single rate makes revenue available to redistribute the income tothe poor.

The campaign based on the research was broadly accepted and promoted the introductionof a simple system.

VI.2. Costs for Administration and Compliance

The New Zealand GST with a single tax rate does not require hundreds of pages of

classifications of goods and services and rulings54

. The Inland Revenue Department has thetime of around 1 1 professional policy staff dedicated to GST out of total policy complementof 45. It is clear that the GST is a low maintenance tax 55.

On the other hand the compliance costs are regressive. According to the survey in1991-1992, compliance costs amounted 1.6% of turnover for firms with NZ$ 30,000-100,000turnover, but 0.005% of turnover for firms with more than NZ$ 50 million turnover. Thesurvey in 2004 showed that compliance costs amounted NZ$ 1,285 for firms with NZ$ 40,000-99,000 turnover, but NZ$ 2,646 for firms with more than NZ$ 1.3 million turnover. The

survey revealed that level of stress for GST were higher (3.8%) than for pay-as-you-earnincome tax (3.2%), as they had to be conscious of compliance and to find the money to pay thetax56.

These survey definitely shows that compliance costs are regressive and give taxable persons, especially SMEs (=Small-Medium-Entrepreneurs) lots of stress. However, we find itimportant to keep on conduct this kind of surveys for public acceptance.

VI.3. Social Security and Tax

New Zealand is a small-sized nation 57 with the relatively well-designed social securitysystem, whose situation is much different from Japans. However, we can gain somesuggestions from the New Zealand system. For example, its simplicity and comparativecampaigns are so suggestive.

In New Zealand, the following two groups are taken in to account when examining theregressive impacts in taxation of necessities of life: pensioners (hereafter Group A) and

54 The Review 1, p.393.55 Id . at 394.56 Id . at 395.57 The population of New Zealand is about 4.4 million ( 2011).


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low-paid-workers and social security beneficiaries (hereafter Group B).Group A participates in the higher after-tax incomes of working age individuals as far as

their state-funded pensions are concerned. This security system is supported under theuniversal New Zealand Superannuation scheme (a pay-as-you-go scheme).

Group B was given one-off adjustments at the time of GSTs introduction and low-paidworkers were relieved thorough income tax credits 58.

These measures were the results of official studies based on data gathered from householdincome and expenditure surveys 59. The results of the study also point out that indirect taxesare clearly regressive for low-income households and families with more children. However,

pensioners have less regressive impact than a typical household, presumably because theyconsume not so much food 60.

As stated above, the New Zealands VAT system has been well-designed by variouscareful surveys and studies beforehand. The VAT is definitely regressive especially forlow-income households, therefore it is necessary to redistribute income to these group in aneffective and pin-pointed way.

VII. Conclusions

In Japan, issues of JCT are focused mainly on a raise of tax rate for the financial reason 61.

Another topic such as VAT fraud is not so active, however, it is very important to design amodern VAT system from a long-term prospect. A modern VAT system should be simple,robust to fraud and fiscally efficient 62. The Mirrlees Review shows that a system with a

broad tax base and a single rate and a careful auditing and enforcement with a moderntechnique can be a way to a modern VAT system. In this sense, gathering VAT data throughVAT-ID-numbers is so effective not only for tax authorities but also for tax payers, who canalso get some information about their business partner though the numbers. Its introductionshould be considered in Japan irrespective of the tax rate structure.

As for preparation procedures, detailed and continuing surveys are required These surveysshould target not only at consumers situations but also at influences on labour markets. It isnecessary to make both positive and negative data available to the public, although taxation ofVAT could presumably show regressive effects especially for low-paid households. Thesesurveys have been well achieved in New Zealand, where a good VAT (GST) system has been

58 These tax credits were confined to families with dependent children.59 The Review 1, p.399.60 Id . at 400.61 The Diet approved the bill on August 2012, which raises the tax rate of JCT to 8% from April 2014and 10% from October 2015.62 The Green Paper and the Communication (fn.2)by the European Commission uses the followingsub-title: On the future of VAT towards a simpler, more robust and efficient VAT system.


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maintained 63.The Review clearly recognises that tax reform shifting towards indirect taxation is

regressive when household welfare is measured by income 64. On the other hand, if wemeasure household welfare by expenditure, indirect taxation is progressive. Shifting fromdirect taxation towards indirect one can be one of possible tax reforms, as income usuallyequals expenditure from a life-time point of view. Of course, such a reform seems to be tooradical, therefore feasible measures should be taken in order avoid regressive effects caused bythe VAT. As such measures, the income credit method or social benefit system will beeffective, while the introduction of reduced tax rate is just a moderately pro-poor policy 65.

The VAT is itself very reasonable tax, since the ability to consume and external expensesare fairly considered, and every generation pays the burden all through his/her life. Such a

wide-ranging tax should be simple and easy to manage for both tax payers and tax authorities.In Japan, where there are no special courts for taxation, legal battles concerning classificationof tax rate should be avoided as much as possible.

We have to keep it in mind that modernisation or digitalisation of enforcement procedurecan serve compliance of taxpayers, as well. Something like the VIES system, which gathersVAT data though the ID-numbers of taxable persons, can promote a modern and effectiveVAT system. Use of these data should be open to the persons offering the data as well,

provided its security is well protected.

In Japan, we have learned lots about the VAT from the EU. However, we should keep it inmind that the European VAT is getting old, remaining serious problems such as complicatedsystem or carousel fraud. The European VAT is now struggling against these problems andtries to be modernised. In June 2012, the European Commission set up a group of experts onVAT called VAT Expert Group . This group is responsible to advise the Commission on

preparation of legislative acts and other policy initiative concerning VAT and to provide insighton the practical implementation of legislative acts and other policy initiatives concerning VAT.It has not been evaluated yet whether it works well or not, however, the group is expected toachieve both theoretical and practical analysis of VAT any further.

63 More about GST of New Zealand, see Ecker/Lang/Lejeune ed., The Future of Indirect Taxation (2012), pp.355-397.64 The Review 2, p.230.65 The Review 1, p.300.


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main issues for a good vat system

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