1
Contribution to Liber Amicorum for Sven-Olof Lodin
This is the final manuscript contributed to the editor. Minor amendments may have been done in the printed version.
Who is a taxable person to VAT?
1 Introduction
1. Taxes are levied on income, consumption or other resources that create ability to pay tax. However, taxes are by definition paid by persons. For an income tax it is obvious that when income is the basis for taxation it must be the person in control of the income that should pay the tax.[1]
When consumption forms the basis for taxation the taxpayer could either be a consumer or persons supplying him with goods and services for consumption. Sven-Olof Lodin is probably the scholar that has made the most extensive contribution to the analysis of practical problems and in proposing solutions for a consumption tax where the consumer is the taxpayer.[2] His analysis brought much new insight and demonstrated that practical methods exist for such taxation. Nevertheless, the traditional system for taxation of consumption prevails, and will probably continue to do so in the foreseeable future.
This article deals with the existing general consumption taxes and their rules to determine which persons should pay such tax. The European system of Value Added Tax is the consumption tax system with the widest jurisdiction in the world. It is therefore natural to use the terminology minted in the EEC VAT Directives and when rules will be discussed the examples used will be limited to the articles of the Directives and the case law from the European Court of Justice (ECJ).
2. Persons supplying goods or services purchased by consumers should pay VAT. The taxpayers are thus the suppliers and not the consumers. Although the consumers are supposed to bear the tax finally, it is nevertheless the producers/distributors that are the actual payers of VAT.
As implied above it is not only the final distributor who acts as a taxpayer, but all persons participating in the production/distribution process. This makes necessary a reciprocal system where, until the final stage VAT, paid on sales at one stage should be deductible at the next stage. The fact that a person participating in this chain is a taxable person or not could create effects that are special to the VAT system.
The next section of this article deals with the structure of the VAT system and the effects of it. These are questions which are of general interest for tax systems of the VAT type.[3] Special attention will be paid to the effects that deviate from what would be income tax effects in a similar situation.
In the third section the rules of the EEC Directives which are the foundation of the European VAT-laws are analyzed. Practical problems that must be solved by the rules of delimitation are also discussed.
2 Effects of treating a person as a taxable or non-taxable person
1. In every VAT system the category of persons who should pay tax are defined in some way. These persons should charge VAT on supplies of goods and services (output VAT) and are entitled to deduct VAT that has been charged on their purchases (input VAT). These persons are called taxable persons in the EEC Directive and will so be referred to as such here as well.
As a rule all producers and distributors are taxable persons and under normal circumstances their taxable activities will result in a net payment of VAT. In some activities deductible input VAT exceeds regularly or occasionally the VAT charged on sales. This will result in refunds. The right to a refund is a necessary component of the system in order to uphold the reciprocity. It should be noted that with very few exceptions the right to refund does not exist in income tax systems.[4]
2. In order to make the tax as general as possible and to make the reciprocity of the VAT system function as well as possible, the category of taxable persons should be wide. Ultimately, that would mean that only persons acting in their capacity as consumers should be excluded. However, in practice a number of persons acting as producers or distributors are excluded as well. The effects of this exclusion from the VAT system are a bit special and differ from the effects of exemption arising in the income tax system.
If a person is a non-taxable person the primary effect will be that no VAT will be paid on the value added produced by him. Whether this will be the final effect or not depends, however, on the character of the purchaser. If the purchaser is a consumer the final effect will be that this value will escape VAT, but if the purchaser is a taxable person, it will not.
For a taxable person this will be the effect since there is no input VAT for him to deduct, but when he later sells the product VAT will be charged on the full price. Thus, the value produced by a non-taxable person does not escape VAT, although the tax will not be paid by that person but by the taxable person at the next stage of the production/distribution. This effect will be referred to below as the catching effect.
It should be noted that this effect does not normally arise in the income tax system. This is because normally the right to deduct the costs of purchases exists irrespective of the tax status of the seller.
3. The catching effect described above may be considered desirable or undesirable depending on the situation in which it occurs. Usually, the effect is intended and it is then desirable.
For practical reasons not all persons taking part in the production and distribution of goods and services are treated as taxable persons. Normally under VAT laws persons such as employees, lenders, shareholders and similar are not treated as taxable persons. This delimitation may be discussed, and that will be done to some extent later.
When employees are not treated as taxable persons the VAT system must function in the way described above in paragraph 2. This function means that the value added produced by them will be taxed when their employers charge VAT on the sales of goods and services produced by them. The advantages of the system clearly outweigh the disadvantages, since millions of employees can be kept outside the administrative burden of the VAT system. The disadvantage is only that they are not allowed to deduct VAT on the purchases used in their employment; see further below paragraph 4. However, such purchases are probably normally of limited value.
Taxation of the value added produced by capital employed functions in a similar way. The yield on capital – loans or equity – will be taxed as part of the valued added in the business carried on by the taxable person. This as way of a taxation could also be deemed desirable. Charging VAT on financial services has so far been considered too complicated. Treating the owner of a business – the shareholders or individuals carrying out business - as separate taxable persons would be even more complicated and unjustifiable. Again the disadvantage of such an approach is that the shareholder, lender etc. cannot deduct the VAT connected with the funding. The VAT amount is probably not of considerable value, however.
4. In the situations above the catching effect is considered desirable since the administrative advantages vastly outweigh the disadvantages of lost deductions. However, in many other situations the loss of deductions is deemed to be a considerable and serious problem. When the negative aspects of the effect are emphasized the effect is called the cumulative effect.
The negative result of the cumulative effect is that the total amount of VAT levied on a product will exceed the intended amount of VAT on the product:
A producer purchases rawmaterial for 100 including 20 of VAT. He is not a taxable person. After his work he sells the product for a price equal to his cost and a profit of 30, that is for 130, to a distributor.
The distributor sells the product for 200, including 40 of VAT, to a consumer.
The total correct amount of VAT levied on this product should be 40. Whereas 60 of VAT are actually paid.
This effect is caused by the fact that a non-taxable person occupies a place in the production/distribution line located between two taxable persons, which interrupts the reciprocity of VAT deductions.
A cumulative effect is undesirable in a number of ways:
If the extra amount of VAT will result in an increase of the consumer prices, the consumers will have to carry the burden. There is no reason for heavier taxation on this type of consumption than on other types of consumption.
If the producer carries the extra VAT it could create a distortion of competition, since his costs will e rise by the amount of his input VAT.
If a product is exported or sold in competition with imported products, a cumulative effect may cause a competitive disadvantage in cases where cumulative effects affect products from other countries to a lesser degree.
Cumulative effects are taken seriously. However, sometimes the size of the effect does not justify undertaking measures to eliminate the effect. In my opinion this is for instance the case in the situations described in the previous paragraph. But in most other situations the effect is serious enough to motivate measures in order to eliminate the effect.
5. Discussed above are situations in which a non-taxable person sells his products to a taxable person. If a non-taxable person acts as a seller to a consumer the VAT effects will differ from the effects described above.
In this situation VAT has been levied in the preceding stages of the production chain, but it will not be levied on the value added at the last stage, either by the non taxable person or by any other person. The total amount of VAT levied on this product will therefor be certainly smaller it would have been, had VAT been levied on the consumer price.
This effect would also arise in an income tax system if the seller was exempt from income tax. However, the scope of the effect would differ very much between the two taxes. The construction of the VAT normally means that it is not only the value added produced by the non taxable person that will escape VAT, but also the value added produced by non-taxable person’s employees, lenders and other suppliers of his production, who are not taxable themselves. An exemption from income tax will only include the income of the non taxable person, but not of his employees etc., since they are normally all taxable persons themselves.
This effect should be observed for instance when considering exemptions from VAT for non-profit-making organizations. Such organizations is sometimes competeing with other persons and extensive exemption from VAT might constitute a far more important disadvantage to their competitors than exemption from income tax.
6. To summarize what has been said above it can be stated that the effects described and discussed above provice arguments for a wide scope of taxation and therefore for a broad definition of a "taxable person". It is especially avoding the cumulative effects of the VAT-system that makes it important to have a wide scope of taxation. Further, exemption from taxation of persons selling to consumers may create a distortion of competition, which is aggravated by the fact that the value added subject to exemption includes also the value added by their employees, etc.
However, for practical reasons, it is reasonable not to treat employees as taxable persons. In most cases such an exemption does not create any of the undesirable effects just mentioned, since it is rare that purchases of employees for their employment amount to any considerable amount.[5]
3 Defining taxable persons in VAT-laws
The previous section dealt mainly with problems caused by choosing either a narrow or a wide definition of “taxable person”. The conclusion was that in general a wide definition should be applied in order to avoid the cumulative effect. However, it was also emphasized that for practical reasons a number of categories should be excluded from the concept of a taxable person.
In this section the definition of the concept of a taxable person will be dealt with. The necessary limitations on the scope of the concept of a taxable person and the construction of rules governing it are discussed with the objective to make the discussion interesting in a general international context. However, in order to provide the discussion with a more practical basis the presentation of rules will be based on the EEC Sixth Directive 77/388[6] (hence the Sixth Directive) and case law of ECJ.[7]
3.1 General
1. The Sixth Directive contains in Article 4 (1) a general definition of a taxable person:
"Taxable person" shall mean any person who independently carries out in any place any economic activity specified in paragraph 2, whatever the purpose or results of that activity.
In the previous sections reasons for a wide scope of taxation were explained. The concept of "taxable person" in Article 4 is widely interpreted and the ECJ has stated that "Article 4 of the Sixth Directive confers a very wide scope on value added tax, comprising all stages of production, distribution and the provision of services".[8]
The concept of taxable persons should basically include all persons selling goods and services. Nevertheless, as shown in the previous section, there are reasons to exclude some categories of persons even though they do sell goods or services.
2. First of all consumers should be excluded in order to deny them deduction for VAT on all purchases for consumption. Whenever the primary and dominant purpose for a purchase is consumption, there are reasons not to treat this as a taxable activity. There are reasons not only to exclude purchases but also sales of used goods because they would be hard to control and costly to administer. Further, in these cases there are usually no value added.[9]
The concept of economic activity could be deemed to exclude consumer activities, at least when the explanations in the following paragraphs are considered. The concept ”economic activity” could be interpreted to include a requirement that it does not include activities carried out on an occasional basis.[10] That excludes most sales of used goods by consumers.
However, consumers could often supply services on a continuing basis although the value of the service is limited. An example is given in the ECJ case C-230/94 (Enkler):
Mrs Enkler bought 1984 a motor caravan for DEM 46 249 plus VAT of DEM 6474. During three years allegedly the caravan was used for her private use 79 days, hired to her husband 40 days and to third parties 13 days.
The court held that hiring out of tangible property was an economic ‘activity’, within the meaning of Article 4(2) if it was done for the purpose of obtaining income therefrom on a continuing basis; para. 22. However, the court made no judgment whether that was fulfilled in this case, but discussed some criteria to be used for such a judgment.
My impression is that the court at least did not find it impossible than Mrs Enkler could be deemed to be a taxable person.
A conclusion of the Enkler-case is that the threshold for taxability probably is fairly low concerning services carried out on a continuing basis.
In my opinion there are good practical reasons to exclude this type of activities from taxation. The reasons are the same as stated above for sales of used goods by consumers. The taxation of service-activities are also hard to control and costly to administer. On the other hand there is probably more value added in a service - like renting out an asset - than in the sale of used goods.[11] The conclusion is that also in this case the practical problems normally outweigh the reasons to tax the transactions. It would therefore be desirable if a higher threshold could be applied to these cases. That would require an amendment of the Directive.
3. The reason for exclusion from taxation in the case discussed above – sale of used goods and hiring out - are practical problems with taxation and the limited amount of value added. As discussed in section 2 there are also exclusions that involve persons adding a considerable value to the production/distribution of taxable products. The value added by such persons as employees, lenders etc. will, as was described in section 2, anyhow normally be taxed.
In the Sixth Directive is the exclusion achieved by treating financial services as exempt services according to Article 13 (B)(d). Employees are excluded in Article 4(1) by the statement that an economic activity should be carried out independently. The concept independently is explained in Article 4(4) as excluding "employed and other persons from the tax in so far as they are bound to an employer by a contract of employment or by any other legal ties creating the relationship of employer and employee as regards working conditions, remuneration and the employer's liability."
4. In general, apart from the exclusions mentioned above, the taxation should be wide, for reasons discussed in section 2. As mentioned in para. 1 above the concept of "taxable person" in Article 4 is also wide which has been stressed in case law.