da Wolters Kluwer Systems of General Sales Taxation Theory, Policy and Practice Robert F. van Brederode KLUWER LAW INTERNATIONAL Law & Business

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1 KLUWER LAW INTERNATIONAL Systems of General Sales Taxation Theory, Policy and Practice Robert F. van Brederode da Wolters Kluwer Law & Business AUSTIN BOSTON CHICAGO NEW YORK THE NETHERLANDS

2 Preface and Acknowledgments List of Tables and Figures List of Abbreviations List of Cases xvii xix xxiii xxv Chapter 1 General Introduction 1 Chapter 2 Short Overview of the History of General Sales Taxation 5 Chapter 3 Systems of Sales Taxation: General Overview Single Stage Taxes Manufacturer Tax Wholesaler Tax Retail Tax All Stage Taxes Gross Receipt Taxes Value Added Taxes Addition Method Subtraction Method Tax Credit Method Summary and Evaluation 23

3 viii Chapter 4 Characterization of Consumption Taxes Direct Versus Indirect Tax General Coverage Classification on the Basis of the Scope of the Tax Consumption Type Income Type Product Type Tax Incidence Who Bears the Burden of a Consumption Tax? Regressivity of Consumption Taxes Introduction Terminology Progressive Taxes Proportional Taxes Regressive Taxes Philosophical Perspective Regressivity in the Political Debate The Argument for VAT Being Regressive Preliminary Remarks The Effect of Regressivity Is Relative VAT Is Only One Tax in a Tax System Countermeasures Empirical Verification of VAT's Regressivity Level of Expenditure Is Constant Savings Remain Untaxed Individual Income Levels Are Constant The Very Poor and the Very Rich Conclusions Neutrality Economic Efficiency 47 Chapter 5 Gross Receipt Taxes Introduction Overview of Current GRTs in the United States Economic Evaluation Broad Base Low Rate Stable Source of Revenue Tax Cascading Vertical Integration 60

4 ix Disparities in Effective Tax Rates External Neutrality Lack of Transparency Economic Assessment US Legal Issues Nexus Issues Apportionment Issues Path to Collision Conclusions 70 Chapter 6 Retail Sales Taxes General RSTin Federal the United States at the Subnational Level Introduction General Description and Characterization Scope of the Tax Rates Distributional Effects Tax Revenue Cascading Effect Regressivity Tax on Services Interstate Services Interstate Trade in Goods Compliance Coordination of State and Local Sales Taxes Merits and Demerits. 1. Revenue Productivity.2. Revenue Stability.3. Tax Efficiency.4. Operational Cost.5. Resource Allocation.6. Fairness of the Tax.7. Reduced Taxpayer Awareness Self-Supply Rules Conclusions Sales Tax in the United States Introduction ix 86 Outline of the Proposed National Retail Sale General" Abolition of the IRS Collection Costs Reimbursement Low Income Prebate Economic Effects of NRST 92

5 x Effects on Federal/State Relationship Rate for the NRST Tax Avoidance and Evasion Effects Conclusions 98 Chapter 7 Subtraction VAT General The Japanese Consumption Tax Subtraction VAT Proposals in the United States The Michigan Business Tax 104 Chapter 8 Credit Invoice Method VAT Introduction Problem Areas within the Credit Invoice Method VAT Rates and Rates Variation Rationale for Rate Variation Effect of Rate Variation Classification Problems Recouping Effect Administrative and Compliance Complexities Conclusions Optimum Efficient Rate for VAT Agricultural Sector General Background The EU Flat Rate Compensation for the Agricultural Sector Small Enterprises Exemptions Definition of Exemption under a VAT Rationale for Exemptions Economic Effect of Exemptions Recouping Effect within the Distribution Chain Reduced Effective Rate with Exemption at Retail Stage Adverse Incentive of Self-production Self-supply Rules intheeu Classification Problems VAT Adjustments Bad Debts Treatment of Postsale Price Adjustments 134

6 xi Mixed Use Change of Use Financial Services Arguments for Exempting Financial Services Arguments for Taxing Financial Services Practical Problems with the Exemption Regime for Financial Services General Mixed Transactions Change of Use Sale of Used Business Assets Sale of Repossessed Goods Exported Services Definition of Financial Services Input Tax Allocation Analysis of Value Added of Financial Services Methods of Taxing Financial Services Taxation under a Separate Regime Addition Method Subtraction Method Cash Flow Method Taxation within the Credit Invoice Method Option for Taxation Zero Rating Modified Reverse Charge Limited Credit to Financial Institutions Proxy Credit on Financial Services Procurement Evaluation and Conclusions Treatment of Capital Goods Introduction and Scope Moveable Tangible Property Resale of Goods during Economic Life Cycle Business-to-Business (B2B) and Businessto-Consumer (B2C) Sales Consumer-to- Consumer (C2C) Sales (Casual Sales) 169

7 xii Treatment of Secondhand Goods (Sale to Dealer with No Trade-In) VAT Treatment Sales Tax Treatment Conclusions Treatment of Trade-ins VAT Treatment Sales Tax Treatment Conclusions Pro Rata Temporis Credit for Capital Goods Immoveable Tangible Property (Real Property) Outline of the Theoretical Problems The Current Treatment in the EU A Practical Solution for Incorporating Immoveable Property in a VAT System Sales of Commercial Property Sales of Residential Property Commercial Rentals Residential Rentals Conclusions Composite Supplies Public Sector Theory and Background The EU Treatment of the Public Sector Conclusions 201 Chapter 9 Cross-Border Transactions Origin Versus Destination Principle Origin Principle Destination Principle WTO Rules for Border Tax Adjustments and Their Economic Effects US Tax Proposals to Mitigate Cross-Border Disadvantage Replacement of Income Tax by a Federal Indirect Tax General The Economic Effects of Substituting an Indirect Tax for a Corporate Income Tax The Border Tax Equity Act The Alternative: Change the Character of the Corporate Income Tax 214

8 xiii Feasibility of the Value-Added-Based Corporate Income Tax WTO Arguments against FSC and ETI Evaluation of a Value-Added-Based Income Tax against WTO Rules Conclusions Importation and Exportation of Goods Importation Exportation Tax Jurisdiction Rules Place of Supply of Goods Under EU-VAT Place of Supply of Services Under EU-VAT Current Rules Future Rules ( ) Distance (Mail-Order) Sales and E-Commerce The American Debate Introduction Scope of the Debate Legal Environment Economic and Competitive Distortions Complexity and Costs of Withholding Use Tax The Role of Congress Possible Solutions Taxation of Internet Access and Other Online Services International Aspects Conclusions European Practice The Challenge of Fraud Schemes Introduction and Summary Description of Carousel Fraud Countermeasures to Fraud Civil Law Defense Noneconomic Defense Abuse of Law Doctrine Joint and Several Liability Alternative Solutions Conclusions 264 Chapter 10 Harmonization of Indirect Tax in Federal or Common Markets Introduction The Harmonization of Indirect Taxes in the EU The Objectives of the EEC Treaty 267

9 xiv Relationship Between the Objectives and the Tax Provisions of the Treaty The Need for Harmonization and the Choice for VAT Overview of the History of Sales Tax Harmonization in the EU Scope and Present State of the Harmonization The Harmonization of Sales and Use Taxes in the United States Reasons for Harmonization Legislative Aspects Objective and Methodology of the Streamlining Project Participating and Associate States Decision-Making Process Scope of Harmonization Registration and Administration State and Local Tax Base Change of Rules and Regulations Uniform Jurisdiction (Sourcing) Rules Uniform Definitions Uniform Tax Return Forms Certification and Compliance Models Certification Compliance Models Financial Compensation for Businesses Amnesty Consumer Privacy Protection The Voluntary Compliance Assumption Political Feasibility Conclusions 297 Chapter 11 Revenue Allocation within Federal and Common Markets Introduction RST Versus VAT Cooperation Models Separate Federal and Subnational Taxes Federal Surcharge State Surcharge Aggregate Level of Revenue Sharing EU Clearing House System Viable Integrated VAT Compensating VAT Dual VAT System Digital VAT Combined Federal and Subnational Sales Tax Brief Description of the Combined Tax System 317

10 xv Calculation of the Single National Tax Rate Macroeconomic Method of Revenue Allocation Final Remarks and Conclusions 329 Conclusions 330 Chapter 12 Tax Policy Lessons Bibliography Index