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'Struck By Abuse' Of 15% Vat's Exemptions

By NEIL HARTNELL

Tribune Business Editor

nhartnell@tribunemedia.net

The New Zealand tax consultants were “struck by the potential for abuse” created by the “substantial list of exemptions” under the Government’s initial 15 per cent Value-Added Tax (VAT) model.

The May 6 report by Dr Don Brash and John Shewan, which played a critical role in pushing the Christie administration to radically revise its VAT plan at the last minute, warned that ‘exempting’ so many goods and services from the tax “hugely increases” compliance and enforcement costs.

Pursuing so many exemptions, they added, meant the Bahamas risked “undermining the efficiency and effectiveness of its VAT system from the start” simply to mitigate the new tax’s impact on lower income Bahamians.

The New Zealanders’ report, released yesterday, said: “As currently drafted, the legislation provides that a very long list of goods and services will be exempt from the VAT.

“This structure...... hugely increases the compliance costs involved in implementing the tax and opens the way to considerable abuse.”

Much of what the New Zealand duo had to say during their 10-day stay in the Bahamas, and in their report, echoes many of the concerns expressed by the Bahamian private sector over the initial 15 per cent VAT model.

Many businesses, particularly the food retail and wholesale industry, had objected vehemently to the proposed VAT ‘exempt’ treatment they were initially being subjected to, arguing that it would increase costs for both themselves and consumers because they would be unable to ‘net off’ their VAT input payments.

The New Zealanders noted that most Bahamian retailers would have, under the initial 15 per cent model, ended up selling both VAT-able and ‘exempt’ items.

That, they added, would have greatly complicated companies’ VAT liability calculations and, more so, working out how much of their ‘input’ VAT could be claimed back.

“For some inputs that will be relatively straightforward, but for others - like electricity for lighting and commercial rent - apportioning the inputs will be extremely difficult and time-consuming,” the New Zealand duo warned.

“As the mix of sales varies, perhaps depending on the season, the proportion of VAT paid on inputs which can be recovered will vary. Compliance costs for the retailer, and indeed enforcement costs for the revenue authority, will rise exponentially.”

Messrs Brash and Shewan also warned that applying different VAT treatment to products in the same category increased the potential for fraud, and would drive consumers to the ones enjoying ‘exempt’ treatment.

Explaining, they said: “The Mission was also struck by the potential for abuse in having such a substantial list of exemptions.

“To take one example: At the moment, it is proposed to exempt vegetables, jams, jellies and fruit juices when ‘packaged for infant use’, and similarly ‘mineral waters ‘packaged for infant use’.

“It is not hard to imagine a large increase in the sale of such items, appropriately packaged of course, and a reduction in the sale of items not so packaged.”

While it was not unusual for VAT systems to provide numerous exemptions, Messrs Brash and Shewan warned that this rendered these tax structures “seriously sub-optimal”.

Apart from narrowing the tax base and requiring a higher VAT rate, exemption-heavy systems also created a greater drag on economic growth and jobs. And the greatest beneficiaries were high income earners.

“Countries that have mechanisms to deliver social assistance (and the mission was encouraged at the reforms the Bahamas is introducing in this area) are therefore much better advised to use targeted mechanisms rather than exemptions to provide appropriate relief,” the New Zealanders said.

“It would be very unfortunate if the Bahamas undermined the efficiency and effectiveness of its VAT system from the start, on the basis of social safety net considerations that are more relevant to countries with non-existent or weak social safety net systems.”

Messrs Brash and Shewan noted in their report that there was “widespread confusion” in both the Bahamian private sector, and society at large, over how VAT would operate. And the initial extensive ‘exemptions’ list had more than played its part in this.

“One person in the manufacturing sector expressed serious concern about how the VAT would affect the price of the electricity bought by his business, appearing not to appreciate the fact that the VAT charged on the electricity purchased by his business would be fully refundable through his regular VAT return,” the New Zealanders’ report said.

“A number of others seemed to believe that being exempt from the tax would in some way be to their advantage. As Mr Shewan pointed out at several meetings, VAT is perhaps the single tax which businesses should not want to be exempt from, since it removes their ability to claim back the VAT paid on their inputs and reduces the willingness of businesses which are included in the VAT net to buy from them.”

Messrs Brash and Shewan said it was “a fallacy” to believe that goods and services sold by a VAT ‘exempt’ industry or business would not increase in price.

They added: “There also seemed to be some misunderstanding about the effect on consumers of exempting particular products and services from the VAT net. For example, we met people who seemed under the impression that exempting electricity from the VAT would mean there would be no increase in the retail price of electricity.

“But, of course, because the company supplying electricity would be incurring VAT on its inputs of fuel, generators, transformers, cables and so on, and would be unable as a company providing an exempt supply to claim a refund of that tax paid. The price of electricity would inevitably rise even if it were to be exempt, albeit not quite to the extent of the VAT itself.

“It is very important for the public and the business sector to understand that exemption does not equate to zero price impact from VAT.”

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