chapter 5 Difficult-to-Tax Goods and Services

Alan Tait
Published Date:
June 1988
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Pas trop de zèle—Not too much zeal.

—Charles Maurice Talleyrand

Apart from exemptions and zero ratings justified on the grounds that the transactions are “meritorious” or that they help equity, there is a final miscellaneous group that is considered just too difficult to tax. The implication is that if a practical way could be seen to apply the vat, it would be levied. Some of the categories are among the most important in the economy, for example, financial services or renting and leasing movable and immovable property; others are less important but can stir strong emotions, such as gambling and secondhand goods. In theory, all such goods and services should be liable to vat; in practice, messy solutions are found. Eight such goods and services are examined in this chapter to illustrate the problems. These are construction, leasing, financial services, services performed abroad, secondhand goods, the trade of craftsmen, betting, and racing.

The Construction Industry

Land and Buildings

The vat is supposed to be a tax on flows. Land is a stock and transfer of that stock should not be liable to vat. Such transfers frequently are liable to other taxes such as capital transfer taxes or stamp duties. The purchase of land is not a consumption expenditure in the usual sense since nothing is taken out of gross national product.

This broad statement is generally acceptable; however, some stocks are taxed under vat (for example, the sale of used automobiles) and land values can involve value added. It would be quite practical to levy vat on the change in land value between purchase and sale, although there would be some transitional problems with the initial valuation at the introduction of vat. Moreover, as in any land taxation, the requirement that land ownership must be registered to be legally recognized makes the property transfer easily established as a point of supply, though the price at which the transaction takes place may be more difficult to ascertain. However, despite its attraction, vat is never applied to agricultural land, and even the EC’s Sixth Directive leaves it open to states whether or not to tax persons selling building land.1

The problem is that the treatment of land is bound up with appropriate vat liability of the entire sector, including the development of land, building, leasing land and buildings, and rental property. Four examples illustrate the interlocked nature of the problem. First, if land were liable to vat, the farmer could offset any vat liability on his purchase as a credit against his output; but in many countries, farmers are exempt from vat and could not use such an offset and, therefore, vat could not be charged on agricultural land without creating a cascade. Second, builders who bought land and sold a house standing on that land could credit the vat paid on any input, including the land, against the vat liability on the house. If building is made exempt from vat, the vat on inputs could create a cascade. Third, unless leasing and rental were liable to vat, the vat on, say, land would be unfair between those who sold land and those who rented it. Finally, if land is not taxed and new building is, then values and inputs have to be assigned separately to both land and building. The complexity of the relationships suggests that either land and building should be fully liable to the vat (as in New Zealand) or should be prorated.

In practice, no such neat alternatives are adopted. As discussed in Chapter 7, few countries tax farmers as fully taxable persons (the notable exceptions are Denmark, New Zealand, Sweden, and the United Kingdom) and even these countries do not make agricultural land liable to vat. Most developing countries exclude farmers from the system and frequently exempt agricultural inputs from VAT; agricultural land is never liable to vat. For buildings and the development of land, the practice is best examined through the treatment of the construction industry.


The construction industry presents some peculiarities that must be analyzed to select a treatment under the vat that is as rational and feasible as possible. In the first place, the construction industry produces goods that, from an economic point of view, can be considered either for production, such as business premises, or for consumption, such as housing. Second, construction work usually involves numerous subcontractors, who operate firms of entirely different sizes and organizational characteristics. Third, some of the activities of the construction industry, for example, low-cost housing, are frequently the target for favorable treatment by governments to accomplish certain social objectives (see Chapters 3 and 4). Fourth, there are difficulties in defining what is meant by “construction,” “alterations,” “repairs and maintenance,” and “civil engineering.”

Ideally, a vat should be neutral. If special treatment is to be given to particular forms of expenditure, for example, low-cost housing, it is better (as mentioned in the discussion on housing in Chapter 3) to accomplish it by subsidies. The vat should not be burdened by such devices. Equally, if the authorities wish to ensure that certain forms of construction are tax free, they would have to register traders involved in these construction categories so that they can claim credit or be zero rated. Yet, it is in the nature of the construction industry that the same builder can undertake to build both low-cost and high-cost housing. It is difficult, therefore, to enforce any provision requiring a distinction between these activities because common inputs and work forces would have to be carefully allocated among projects, based not on business efficiency but on political and social definitions.

It is best to subject the construction industry to the same treatment as other industries. The purchase of new business premises should, of course, be liable to vat as any other purchase of capital goods, that is, should entitle the buyer to claim full credit for tax paid against his current liability. On the other hand, sales of new properties that are not business premises are sales to final consumers, and this means the purchaser has to pay the entire tax.

This is broadly what the EC’s Sixth Directive tries to accomplish2 but, as Table 5-1 shows, some countries supplement the vat on new buildings by fees and taxes on the transfer of existing property.

Table 5-1.Application of Article 13C (a) of the EC’s Sixth VAT Directive: Summary Table of the Right of Option for Taxation of the Leasing of Immovable Property
Exercise of

the Right

of Option
Status of

the Lessee



DenmarkIn respect of each premiseNot to be taken into considerationYesFor at least two years
FranceIn respect of each premise or set of premisesTaxable person (even if exempt)YesValid up to the end of the fourth year; subsequently renewable by five-year periods
Germany, Fed. Rep. ofFor each transaction, at the discretion of the optant; not applicable to small traders exempt from the tax or flat rate farmersTaxable person who will use the immovable properly for his undertaking (even for exempt transactions)NoNo limit
IrelandGeneralNot taken into considerationYesUntil termination
LuxembourgIn respect of any building or part of a building representing a separate unit which is used entirely or, in the case of mixed use, mainly by a lessee entitled to deduct input tax; the schemes for small traders and flat rate farmers are not applicable to the transactions in questionTaxable person entitled to deduct taxYesNo limit
NetherlandsIn respect of each item of immovable property; not applicable to small traders exempt from the tax or flat rate farmersNot taken into consideration, lessee must agreeYesNo limit
Source: Derived from European Community, “First Report from the Commission to the Council on the Application of the Common System of Value Added Tax,” Annex II, Table 1 (COM(83)426 final, Brussels, September 14, 1983); reproduced in Intertax (Deventer, Netherlands), March 1984, p. 120.
Source: Derived from European Community, “First Report from the Commission to the Council on the Application of the Common System of Value Added Tax,” Annex II, Table 1 (COM(83)426 final, Brussels, September 14, 1983); reproduced in Intertax (Deventer, Netherlands), March 1984, p. 120.

The actual treatment under various national vat regimes is somewhat different. Some levy the full standard rate, while others exempt or even zero rate construction work, with the result that such indulgent treatment may itself create more problems than it solves.

An example is that of the U.K. authorities who wish to distinguish between actual construction including alterations (which are zero rated) and repair or maintenance work (which is liable to the normal vat). This leads the authorities into lists of examples of each set of work,3 which they themselves admit are “not exhaustive”; to take one example, the installation of central heating was zero rated but the replacement of existing radiators was not. Difficulties with these distinctions persuaded the British Government to change the rules in 1984, so that all construction other than the creation of a new building became liable to VAT4 which, of course, led to further disagreements.5 Further definitions are needed when work may include alterations, new building, and repair and maintenance (“mixed work”); some “civil” engineering is zero rated, such as outdoor recreation grounds but not the construction of a swimming pool at a private residence. Builders’ hardware, such as fitted cupboards in kitchens, is zero rated but built-in units in bedrooms are liable to vat. Such fine definitional problems, which make the job of both authorities and traders extremely difficult, are not confined to the British example.

Basically (as mentioned in Chapter 4 in the discussion of exemptions on grounds of merit), the problem arises because of the desire to treat housing or goods considered desirable on social considerations (for example, swimming pools and recreation halls) indulgently. For instance, Sweden and Ireland have dealt with this perceived need by retaining a positive rate of vat but adjusting the value on which it is levied. In Sweden, the effective rate on a valuation of 50 percent is half the nominal rate and, originally in Ireland, a low rate of vat was applied to only 30 percent of the contract price. This distinctive treatment for housing, of course, makes the activity attractive and creates the need for lists of definitions similar to those in the British legislation. In some developing countries (for example, Colombia) new low-income housing is exempt, which, as mentioned above, requires a definition of what constitutes housing for lower-income individuals.

Theoretically, these reductions or exemptions from vat are available in the EC for the transitional period only. Eventually the problem should be solved when all construction work becomes liable to the full vat, as this is the only way to levy the tax efficiently. However, given the social priorities involved, the transitional period may be long. The European Court decision of June 21, 1988 that the United Kingdom could not zero rate industrial or commercial buildings has already been partly vitiated. Landlords will be allowed to charge vat on rents (so that approximately three quarters of those using new offices can claim it as a credit); in addition, the new liability to vat will only be introduced gradually.

It is not only the social priority accorded to housing that is the problem. The construction industry itself is difficult to tax. Belgium found that small building companies were likely to dissolve and disappear without paying their vat. The authorities met this problem by making the purchaser of the house liable for the vat should the builder not pay, thereby ensuring that the purchaser would not connive with the builder to avoid vat liability.

The speculative nature of the building trade, the frequently undercapitalized character of many builders, and the small scale of many building enterprises means that this sector is a problem in most countries and especially in developing countries. The difficulty is compounded in most countries by a perceived need of the authorities to encourage self-help in construction to help relieve the housing shortage. However, if a private citizen buys the materials and hires workmen to build his own house, he cannot claim back the vat paid on materials since he is not registered for the vat. It might be possible to allow a system of temporary registration for such builders, but rather than get involved in the cumbersome business of issuing temporary registration certificates (which could easily be abused), it might be better to allow private house builders to submit their invoices to their local tax office, together with an official claim form on which the invoices would be listed. Such private noncommercial “do-it-yourself” construction typically takes much longer to complete a building than usual. The private person, short of capital, may find he has considerable vat paid on inputs and yet cannot claim credit until the house is complete. It might be sensible to allow several claims during the construction of the house to relieve the builder from tying up too much capital.

Problems of the Definition of “Supply” Leasing

Typically, construction work is paid for by installments as materials are delivered on site, cladding completed, roofs finished, and so on; where such payments are made within a contract, specifying such payments, then the time of supply is the date when payment is received by the supplier. The receipt issued by the supplier showing the input vat paid is used to claim the credit.

The liability to vat when renting and leasing immovable property has to be carefully specified. The EC’s Sixth Directive6 permits member states to allow taxpayers to opt for vat if they wish when they are renting or leasing immovable property. In most countries, the retail sale of such property is liable to vat, and the vat on the sale of an intermediate good (for example, a factory) is credited against vat liability. Someone who buys, say, an apartment block, and leases or rents out the accommodations, is not making a retail sale of the property but can be considered to be more akin to an element in the chain of production; the final retail sale would only come about when the property itself (and not its use) was sold. The argument is that such an entrepreneur should be allowed to opt into the vat and deduct the vat liability from his sales if he sees an advantage to this. Table 5-1 shows the current EC treatment; as the United Kingdom zero rates all buildings, of course, no one (until June 1988—see above) in the United Kingdom could opt for a positive rate of vat.

The rental of business accommodations, including such services as parking, should be taxable, but the vat charged will be allowed as a credit to the tenant, if he is a registered trader. In practice, it is inequitable to include the supply of rental of private accommodation within the vat base. To do so places owner-occupiers of housing at an advantage compared with those who rent. The alternative way to correct this inequity would be to impute rentals to owner-occupiers, and no matter how attractive this may seem in theory, practice has shown it to be administratively difficult, inequitable, and, politically, most unattractive.

Hotels and Catering

Because of their close relationship, it may be convenient to consider the renting and leasing of immovable property and the treatment of hotels and catering together. Among the exemptions, specified for activities within the territory of member states of the EC, is the leasing and letting of immovable property excluding, inter alia, the provision of accommodation, as defined in the national law, in the hotel sector or in sectors with a similar function, including accommodation in holiday camps or in sites developed for use as camping sites. The term “in sectors with a function similar to hotels” is somewhat vague and capable of various interpretations. Does it, for example, cover guest houses, boarding houses, and retirement homes for senior citizens? However, the major difficult decision is where to draw the line between long-term rental accommodation (which is not to be taxed) and short-term rentals (for example, tourist stays in a hotel) that ought to be taxed. A brief review of some practices indicates the possible treatments (and pitfalls) that apply to most countries using a vat.

In Belgium, as a general rule, the leasing and renting of immovable property is exempt from vat. Services supplied by homes for the aged, by nurseries and kindergartens, and by institutions, whose main purpose, according to their bylaws, is the supervision, support, and education of young people, are exempt from vat. The renting of accommodations, furnished lodgings, or camping space by or for the account of an organization or association, recognized by the Secretary for Tourism, is taxable at 6 percent (the low rate), while the supply of meals and drinks to be consumed on the premises is chargeable at the intermediate rate of 17 percent.

In Denmark, rental of immovable property is not usually taxable. However, the rental of rooms in hotels, inns, motels, and so on, the rental of rooms in establishments for periods of less than one month, and the rental of camping, parking, and advertising space, as well as other services by hotels, restaurants, caterers, and so on, are taxable. Rental of a parking space is taxable only if it is not part of the rental of a residence.

In France, vat is not chargeable on leasing unimproved land, rural property, and empty premises. The low rate of 7 percent applies to furnished rentals of rooms, houses, and apartments, and to meals served in canteens. The intermediate rate of 18.6 percent applies to meals in hotels and to accommodations in higher-class hotels, while the top rate of 33⅓ percent applies to five star hotels.

In the Federal Republic of Germany, renting and leasing immovable property is exempt, except for hotels, camping sites, and parking spaces (where the higher rate of 14 percent applies).

In Ireland, renting immovable property is exempt from tax, except where the rental is made in the course of carrying on a hotel business—which includes guest houses, holiday hostels, holiday camps, motels, caravan parks, and camping sites. Hotel accommodation in Ireland is chargeable to vat at 18 percent.

In Italy, the leasing or renting of real property, including appurtenances and movable goods for the furnishing of the property, is exempt. A low rate applies to the provision of food and drink in schools and through vending machines. A higher rate applies to the supply of goods and services to guests in hotels, as well as to the supply of food and drinks in premises open to the public.

In the United Kingdom, leasing immovable property is exempt unless it concerns a hotel, a boarding house, or a holiday flat, or consists of facilities for camping or parking, or falls within a few other exempted categories. Where a supply consists of the provision of accommodation in a hotel or boarding house, tax is payable on the supply for only the first four weeks. Thereafter, tax is payable only on the value of the facilities provided other than accommodation but that value must be at least 20 percent of the total (the same rules apply to vat in New Zealand).

In Sweden, what is, in effect, a reduced rate applies to supplies by caterers. The charge is on 60 percent of the taxable base.

Similarly, hotels and tourist establishments in Morocco pay the reduced rate of 12 percent, but restaurants are liable for the standard rate of 19 percent.

In Korea, exemption applies to leasing houses and the land on which they stand, provided that the area of the land is not more than ten times the floor space of the house. Restaurants and hotels are chargeable to vat on their supplies.

In Norway, the provision of food and drinks in hotels, restaurants, and similar establishments, as well as in trains, ships, and aircraft during inland voyages, is taxable, but the renting of hotel rooms is exempt.

In Latin American countries, the renting or leasing of immovable property is not, as a general rule, chargeable to vat.

As mentioned earlier, Article 13C (a) of the EC’s Sixth Directive provides that member states may allow taxpayers a right of option to be taxed on the renting and leasing of immovable property, and such a provision is, as described above, included in the vat system of the various member states. The purpose of the option is to allow a property owner, who rents property for business purposes to come within the scope of vat, if he so wishes, to be able to pass on to his tenants the advantage of a vat credit for the prior-stage tax borne on the property.

In general, it seems the distinction between renting long-term or short-term accommodation should be restricted to a definition dependent only on time. Definitions that have to define the end use for activities such as nurseries or kindergartens (Belgium), or defining the type of business (Ireland), do not seem as satisfactory as one that uses, say, six weeks as the dividing line between taxable and nontaxable accommodation.

In the same way, renting any property for less than the specified time should be taxable; the type of property should not need to be specified. Nor should the end user (for example, catering) be part of the legislation or regulations. All catering, as a service, should be taxable, and exemptions should not be allowed for hospitals, schools, or nursing homes (as in Ireland), or vending machines (as in Italy).

Applying differential rates to different uses or users of accommodation (as in Belgium and France) or of catering (as in Italy, Morocco, Norway, and Sweden) does not make for an efficient vat system.

It is best to use a straightforward rule that all accommodations and services are liable to vat at the standard rate if the occupation is less than, as suggested above, six weeks. If the stay exceeds this period, only services other than the provision of accommodation (for example, laundry and meals), are subject to the tax.

Leasing Goods and Agents


Leasing or hiring goods, instead of buying them outright, is increasingly popular (often for tax advantages quite independent of the discussions about vat). As far as vat is concerned, the position is clear: leasing is the provision of a service and as such the entire charge (amortization, interest, and leasing administration fee) should be liable to vat. If a registered trader leases an aircraft, a computer, or an earth-moving equipment, say, then the full rental is liable to vat provided the supply and consumption of the service occurs within the territory of the country concerned. Difficulties occur where the lessor and the lessee are in different countries. Many vat acts (including those in the EC) used to focus on where the lessor had his principal fixed establishment. Thus, in the EC, if an Italian company (VAT at 18 percent) decided to sell and lease back its new computer to a leasing company elsewhere in the EC, the vat on the rental could be anything from 12 percent (Luxembourg) to 25 percent (Ireland). This is unreasonable and the EC’s Tenth Directive changed the basis of tax to the lessee’s member state.7 This means the same tax rate applies no matter where the rental company is established or where the lessee uses the equipment. This seems to be a practical solution for most vats.


Most vat acts recognize that, in an arrangement using an agency, the supply is made by or to the principal and not the agent. However, where the agent is registered, he should be required to charge or account for tax on his commission. This can be no trivial matter, particularly in developing countries.

Sometimes traders have tried to siphon off profits by interpolating a main agent between a manufacturer and distributors. However, whether or not the agent is acting in the name of either party, he presumably issues invoices and collects proceeds on behalf of the agency; if he acts on his own behalf, but on the instructions of and for the account of his principal, then the agent should be chargeable on the difference between his output and input tax. The agency agreements between the parties may be written or oral or may be implicit in their general relationship. However, the agent should be required to maintain sufficient records (that is, tax invoices) to enable the authorities to trace the principal on whose behalf the transaction was undertaken.

The essence of any act or regulation should be to ensure that, whatever commercial arrangements may exist, and whatever legal agreements there may be between manufacturers and main agent or main distributor, the vat charge extends to the full selling price by the main agent or distributor. Also, his commission must be included either in the price invoiced by the manufacturer (or the main agent acting on his behalf), or must be charged separately as represented by the difference between output and input tax on the main agent’s or main distributor’s own vat returns. If one party does not wish the other party to know its identity, then the agent can receive and issue invoices between them as though he were the principal and the agency situation need not be disturbed (his input tax will equal his output tax).

Commodities markets (either physical or future) constitute a supply of goods; commodities brokers’ services are chargeable to vat. If the commodity trade is large and is conducted mainly on behalf of offshore dealings, then special arrangements can be made to zero rate such transactions. This is the so-called Black Box arrangement which argues that trades between registered traders in the London commodity markets are zero rated.8

Financial Services

Value added in banking and insurance is no less appropriate for inclusion in the vat base than any other service or provision of goods. Indeed, to exempt financial services from vat excludes from taxation a sector that is often perceived as extraordinarily remunerative, has a high visibility in terms of its physical assets, and is seen as a bastion of traditional orthodoxy. This is especially so in developing countries.

As Edwards and Mayer9 suggest, “Why should the output of banks (and other financial companies)—namely, financial services—be exempt from vat when most other consumption goods are subject to VAT? … It is difficult to find any convincing reasons in tax theory for this exemption. The theory of optimal taxation would suggest that, from the point of view of economic efficiency, exemption … would be justified if it were a particularly close substitute for the consumption of leisure,” or, in equity terms, if financial services were a higher proportion of low-income household budgets than of high-income household budgets—”neither of these conditions seems likely to hold in practice.”

Full Taxation of Value Added in the Financial Sector

At present, in no country are all financial services fully taxed under vat, although Canada and New Zealand debated the problem in detail. A determined effort was made to evaluate all the possible ways in which various forms of financial services could be brought within the vat (referred to as the goods and services tax—GST—in New Zealand). Table 5-2 gives a schematic presentation of one publication on the debate. The basic conclusions seem to have been that while insurance might be brought under the vat, interest is a more complex kind of price, bundling together elements relating to the real cost of capital, the rate of inflation, and the cost of intermediation. Moreover, the great variety of ways in which intermediation can be provided and paid for10 suggest caution before taxing. However, the financial sector in most countries is considered able to bear a tax, and where most services are taxed, to exclude financial services seems both unfair and distortionary. A discussion of a few alternatives gives a flavor of the debate.

Table 5-2.Summary of VAT Options for Taxing Financial Services
Forms of Financial Services

Trading in

financial assets
Fee and

commssion activity

(life or other)
Optional forms of VAT:
Full invoice credit offsetComplex; administratively extensive; lending shiftsComplex; offshore trading encouragedPracticalTax should not be on full premiums; offshore competition
Special tax ratesThe more simple, the more nonneutralTax not related in value of service suppliedLikely to be arbitraryPossible
Zero ratingShould be limited to export of servicesShould be limited to exportsNo reason to zero rateNo reason to zero rate
ExemptionCascade, incentive to self-supply servicesCascade, offshore problemsCascade, offshore problemsCascade, perhaps offshore problems
Direct additive accounts basePossible cascade, low cost, problems for offshore and domestic producersCascade possible, offshore problemsCascade possiblePractical
Source: Adapted from Carl Bakker and Phil Chronican, Financial Service and the GST: A Discussion Paper (Wellington: Institute of Policy Studies, Victoria University Press, 1985), pp. 19–30.
Source: Adapted from Carl Bakker and Phil Chronican, Financial Service and the GST: A Discussion Paper (Wellington: Institute of Policy Studies, Victoria University Press, 1985), pp. 19–30.

One country, Israel, has tried a close approximation to the full taxation of financial services. In theory, this might be the preferred solution where a bold attempt is made to make the vat as comprehensive as possible. Because the price paid by the user of the services (interest rate, policy premium, and so on) embodies both the price of the services and other considerations, it cannot be used as a basis for a vat. Thus, the indirect calculation used in the invoice-method vat, whereby tax is computed on the price of the good or service and tax on inputs is subtracted, cannot be used. Instead, value added has to be calculated directly, by adding wages, salaries, and profits, and applying the tax rate to this base.

Israel used this method to tax the financial sector from 1976 (when the vat was introduced) through 1979. Since 1979, the tax on the financial sector has been designated as a separate and distinct tax and, formally, is no longer part of the vat. Several considerations led to this change. First, since the tax cannot be invoiced to users of financial services, it cannot be taken as a credit, and thus breaks the value-added chain. Second, if financial services were part of the vat, credit would have to be given for financial services exported, a difficult and complicated matter that might seriously erode the base; yet if it is not allowed it could discriminate seriously against the profitable trade of providing financial services overseas. Third, the calculation of the base—wages and salaries plus profits—differs sufficiently from that for the vat itself, that it is, appropriately, considered a separate tax. Profits for purposes of this tax must be computed on a cash flow basis and not in the way they are defined for income tax; capital goods purchased are fully expensed, rather than depreciated. In the Israeli system, no credit was given for vat on inputs, but the tax-inclusive cost of inputs was deductible in computing profits. The rate applicable in the Israeli system is the standard vat rate.

Were other countries to adopt a system similar to the Israeli one, they would have the advantage of imposing a tax on the financial sector, similar to that imposed on other service sectors, thus improving equity, reducing distortions, and gaining revenue. The principal disadvantage is that the tax is not integrated with the regular vat system and does not give rise to vat credits for users of financial services. Cascading is created and the advantages of cross-checking and integrated administration is lost. Also, presumably, the financial sector may be put at a competitive disadvantage compared to overseas financial centers offering identical services.

Selective VAT Application to Some Financial Sector Services

If it is impractical to apply the vat in full to financial services, perhaps selected services can be taxed. The country that most closely approximated such a system is France which, since 1979, taxes banks on the amount of credit outstanding against the private sector on the first working day after the end of each calendar year. The tax is separate from vat and is at a rate of 0.21 percent. However, a bank may opt to be integrated with the vat system, in which case the rate drops to 0.14 percent. In this latter case, the bank may take credit for vat paid on inputs and may issue invoices to customers detailing the tax and allowing them to credit it against vat on their sales. The system applies only to banks; insurance companies and other entities in the financial sector are not covered.

This type of partial integration of the financial sector with the vat has been tried in other francophone countries. There are problems with selecting the bases and setting the rates, but they are not insurmountable. In Morocco, some interest on bank loans and fees are taxed under vat at 12 percent; a similar treatment has been recommended for Tunisia.

The insurance sector could also be integrated through a tax on policy premiums. The advantages of equity would be served, and the tax credit for users of the financial services would be generated. The principal disadvantage is that only certain financial transactions are susceptible to taxation, with a consequent danger of distortion in the financial markets. In addition, the possible need to establish a once-a-year date for valuing the base, as in the French case, could give rise to seasonal manipulation and upsets in markets.

The separate taxation of insurance under vat has also been debated.11 The difference is explored between “pure insurance” (automobile, fire, theft, and casualty) and life or annuity insurances. For pure insurance, taxes on premiums should be accompanied by a gross-up (effectively a tax refund) of claims at the prevailing tax rate.12 Life insurance is more complicated, because of the element of saving involved, but could still be taxed. However, both pure and life insurance vats would involve bringing households into the vat system as claims by households would have to be grossed-up by the current vat rate. Taxing insurance under a separate direct-subtraction or additive method might still be easier, but would involve cascading unless business were given an imputed credit on policies or require policies held by taxable businesses to be excluded from the tax base; this involves classifying policyholders (exempt and nonexempt) and the separation of claims.

After long debate, New Zealand decided to tax only fire and general insurance premiums. The vat at 10 percent is due on insurance company premiums, commissions, and other income (such as proceeds from the sale of damaged goods) and on the sale of fixed assets; deductions are allowed on outward reinsurance, on vat paid on purchases (including goods purchased to settle claims), and as one eleventh of payments made in satisfaction of insurance claims.13 Registered persons can claim as a deduction from their own vat liability the vat included in their invoice for payment of premiums.

The importance of allowing the vat content of claims is exemplified in Table 5-3, which shows why the domestic insurer is not placed at a disadvantage compared with the direct placement of the business with an overseas insurer (despite the obvious belief that premiums paid offshore, not subject to vat, will give overseas insurers an advantage). The total claim is increased by the amount of vat from $NZ 100,000 to $NZ 110,000, and the local insurer can increase the level of cover to cater for vat without increasing premiums because he claims a net refund from the tax authorities. The overseas insurer must pay the claim, including vat, and will have to increase his premiums accordingly. Nonresident reinsurers will also, effectively, be placed on the same footing as their resident counterparts.14

Table 5-3.New Zealand: Position of Resident and Nonresident Insurer Before and After Introduction of VAT1(In New Zealand dollars)
Before vatAfter vat
Nonresident insurer
Plus VAT
Total premium30,00030,000
Total claim (approximately)100,000100,000
VAT refunded
Resident insurer
Plus VAT3,000
Total premium30,00033,000
Total claim (approximately)100,000100,000
Net vat refund from Inland
Revenue Department7,000
Net loss70,00070,000
Source: Adapted from New Zealand, GST Coordinating Office, The Fire and General Insurance Industry & GST (Wellington: Government Printer, April 1986), p. 22.

Known in New Zealand as the goods and services tax (GST).

Source: Adapted from New Zealand, GST Coordinating Office, The Fire and General Insurance Industry & GST (Wellington: Government Printer, April 1986), p. 22.

Known in New Zealand as the goods and services tax (GST).

Even this limited taxation of financial services runs into difficulties. For instance, under personal accident policies, vat is charged only on the portion of the premium for accident cover (and not on the life cover); vat on travel insurance relates only to the policies for accident (and not life) and only for the portion of travel within New Zealand. Where brokers, reinsurers, and underwriters have income from different financial transactions, as well as insurance (and nearly all have), some apportionment scheme must be used, such as floor area occupied, time spent, or gross revenues.

The basic problem remains that financial transactions such as insurance can bundle together so many flexible instruments, payments, liabilities, and claims over long periods of time that it is difficult to assign the “risk pool” to particular taxable entities and to ensure that distortions do not arise from cross-financing.

An Alternative Tax to Exclude the Financial Sector from VAT?

The option most commonly chosen regarding financial services is to exclude them from taxation under the vat, and sometimes to apply an alternative tax or taxes. In the EC, the Sixth Directive explicitly exempts most insurance and banking transactions from vat, although it allows systems in which banking institutions can opt to join the vat, as in France. Many EC countries apply alternative taxes, often derived from taxes predating the vat. Thus, Italy applies a stamp tax to various banking transactions. Insurance transactions are usually subject to taxes on premiums paid. In the Federal Republic of Germany, the tax on premiums is basically 5 percent. In Greece, the tax is 3, 8, or 18 percent, according to the kind of insurance. In addition, Greece has a 3 percent tax on the principal of all bank loans and advances and an 8 percent tax on all bank revenues. In Italy, insurance premiums are liable to taxes of 1 percent to 15 percent, and in France from 2.4 percent to 30 percent.

Outside the EC, the range of taxes applied to financial transactions is even greater. In Korea, a tax of 0.5 percent is applied to gross receipts from interest, dividends, insurance premiums, commissions, profits accruing from foreign exchange transactions, and many other transactions.

In Argentina and Uruguay, annual taxes on the net worth of financial institutions are imposed. In most countries with the civil law tradition, including Spain, Portugal, and most of Latin America and francophone Africa, stamp taxes at varying rates apply to a wide range of transactions conducted by financial institutions (including a tax on outstanding credit). In Colombia, leasing is taxed at the standard vat rate (10 percent) and insurance premiums are taxed at 15 percent, but life insurance is not taxed. In all the countries mentioned above that have a vat, the financial sector is exempt from the vat itself.

Côte d’Ivoire is a good example of a country that taxes interest charges on bank credit at an effective rate of 20 percent. Borrowers subject to vat may offer the tax paid on interest against their vat liability. The tax probably discriminates against unregistered importers of consumer goods and real estate investors, but as neither of these is a category necessarily to be encouraged in a developing country, this might not be a great disadvantage. A more valid criticism is that if refunds of the tax on interest against vat charged were tardy, then entrepreneurs, especially exporters, could be harmed; however, this is an administrative problem rather than one inherent in the arrangement.

The advantages of imposing a separate tax on the financial sector may be strong. As pointed out above, there is no fully satisfactory way to impose the vat on the sector and allow a credit for users of financial services. An exact calculation of value added in the sector, even on an annual basis, is extremely difficult. In view of these problems, little seems to be lost and much gained in terms of simplicity if the sector is exempted from vat and a separate tax is imposed that produces a yield approximately equal to that which would be produced by application of the vat. If the separate tax resembles a stamp tax, that is, it applies to each transaction individually, it will have the advantage of reacting rapidly to changes in the tax base. If the tax has an annual base—as in France, Israel, Korea, and Uruguay—it will not react to intra-annual changes in economic conditions, but may be able more closely to approximate the value-added base. Any substitute tax will at least increase the equity of the overall tax system by extracting from the financial sector an appropriate contribution to the treasury.

There are, however, several disadvantages to separate taxes. First, since all would tax proxy bases rather than value added itself, they may introduce distortions in financial transactions as taxpayers attempt to shift transactions to formats that avoid the tax. This sort of manipulation, where the legal format of a transaction is artificially changed to avoid taxes while the underlying economic effect is unchanged, is especially possible in the financial sector, where there are a wealth of possible ways to structure a transaction and an abundance of accountants and lawyers to arrange to do so. Second, there is the loss of cross-checking and the need for separate administration. And third, there is the need to ensure that the substitute tax be seen as causing the financial sector to bear a fair share of the fiscal burden, and to ensure that future changes in the vat be appropriately reflected, if necessary, in the substitute tax.

Financial Sector Exclusion from the VAT

Some countries that exclude the financial sector from the vat (for instance, the EC) do not apply any explicit alternative tax. This solution has, of course, the advantage of simplicity. It also liberates the government from the considerable political pressure that the financial sector can bring to bear, and this in practice seems to have been a major factor for many countries choosing this option. However, it can be noted that in several countries that failed to create a specific tax on the financial sector to substitute for the vat, the reason given was often that a pre-existing tax, usually a stamp or registry tax, already imposed a burden on the sector.

General Comment on Financial Services

The disadvantages of failure to tax the financial sector are clear: loss of revenue, loss of information that would be generated by a tax, distortions in the economy, and loss of both real and perceived equity. As the Central Bank of Ireland pointed out, “banks should be subject to the same taxation regime—no more and no less favourable—as other non-manufacturing enterprises.”15

However, the problems of disentangling the costs of intermediation, the sensitivity of the financial sector to fine margins, the likelihood of encouraging (untaxed) offshore provision of financial services (through international arbitrage and “laundering”), and the important role finance plays in the efficient operation of a modern economy, all argue against experimental sales tax techniques or rough and ready solutions. Trying to get to grips with banking, as one central banker (in a different context) has put it, is akin “to trying to get your hands around a piece of jelly.”16 While unsatisfactory, the exemption of financial services from vat, and the consequent cascade effect, looks to be the best solution for the time being.

Services Performed Abroad

The practice in the EC and most other European countries with a vat is to zero rate the following services when they are performed abroad:

  • Services relating to land and buildings overseas.

  • The hire of transport for use overseas.

  • Services relating to goods and activities overseas.

  • Work on temporarily imported goods.

  • Services for procuring exports of goods.

In addition, there is generally a zero-rating facility for a group of services that are defined as “reverse charge” services. This means that a customer in, say, the United Kingdom who receives a reverse charge service from France must charge himself vat as if he had supplied the services. The object of this complicated arrangement is to avoid a possible distortion of trade. If the reverse charge did not exist there would be an incentive for exempt and partially exempt persons to order services from abroad and not in their own country thus avoiding vat and discriminating against home industries.

Reverse charge services are in fact services that are deemed to be supplied where they are received. They generally include the following:

  • Transfers and assignments of copyrights, patents, licenses, trademarks, and similar rights.

  • Advertising services.

  • Services of consultants, engineers, consultancy bureaus, lawyers and other similar services, data processing, and a provision of information (but excluding any services) relating to land.

  • Acceptance of any obligation to refrain from pursuing any business activity.

  • Banking, financial, and insurance services.

  • Supply of staff.

  • Services rendered by one person to another in procuring for another any of the above services.

The aim of the EC and associated countries is to ensure as far as possible that vat does not produce distortions in trade. Reverse charge services are an example of this.

Another example is the arrangement under the EC’s Eighth Directive,17 where a businessman can reclaim any vat he incurs in another country which would have given rise to an input tax deduction had he incurred it in his own country. For instance, a German businessman visiting France on business is entitled to reclaim from the French Government the vat he incurs on such items as hotel accommodation and rental of cars. He has to prove that he is a taxable person in Germany and produce the invoices concerned to the French authorities. This puts the German on the same footing as his French competitors.

Of course, unless such arrangements are specifically covered by a customs or a tax treaty on a reciprocal basis, businessmen will simply have to bear the costs.

Auctioneers and Secondhand Goods

There is general agreement that used goods sold privately cannot possibly be made subject to vat. The position is not so clear regarding registered business to unregistered person trade in secondhand goods. Excluding these goods from coverage forces vendors who sell both new and used goods to distinguish between these two categories, and this may create increased compliance costs. In addition, these vendors will be able to evade tax by reporting sales of new goods as sales of used goods. On the other hand, making business sales of secondhand goods taxable introduces discrimination against dealers vis-à-vis direct, unregistered, person-to-person sales.

It has been reported that this disadvantage has become particularly severe in some countries for goods such as automobiles, cameras, and television sets.18 It would not be difficult for sellers, who see this as discrimination against them, to evade tax by operating through (untaxed) individuals. One possible solution, recommended by an EC Commission, would be to tax only the dealers’ margins.19

This is the effect of the British scheme for secondhand works of art and antiques. “A registered dealer must keep a stock book … of all articles which he buys and intends to sell under the scheme, showing their purchase and selling prices or details of other methods of disposal. . . . When the sale takes place the amount by which the selling price exceeds the buying price is treated as a tax-inclusive margin. . . . The tax due must be entered in the dealer’s stock book and record of output tax and included in his tax return to Customs and Excise.”20

Should it happen, peradventure, that the dealer is obliged to sell the item for less than he paid, there is no vat liability.

The same procedure could be used for the secondhand sale of other items such as automobiles, scrap, electronic equipment, and jewelry. However, such transactions are frequently made for cash and no records are kept. Perhaps simply requiring the dealers to register for vat pulls them into the monitoring mechanism and helps reduce evasion.

The proposed harmonized EC Directive on secondhand goods21 suggests that the taxable amount shall be either 30 percent of the selling price or the difference between the selling and buying prices; the trader must opt for one or the other system for at least a year. Secondhand automobiles, motorcycles, and boats are supposed to be treated somewhat differently; the trader who has bought a used automobile from a nontaxable person is allowed to deduct an amount of vat calculated on the basis of the acquisition price, but the amount deductible may not exceed four fifths of the vat due on resale.22 This proposal was made in 1978, but has not been adopted. It has been commented, “The EEC proposals show no sympathy for the way the antiques business is run. . . . It is not uncommon to see an article sold several times in a day in open markets.”23 It is the casual, semibarter nature of such trade that makes it difficult to tax. Indeed the EC has had to withdraw this proposal “after it had been amended beyond recognition by the EC member states.”24 It is understood that a new proposal is likely to be “closely modelled on the U.K.’s current scheme.”25

In Korea and, as a general rule, in Latin America, secondhand goods sold in the course of trade by registered traders are taxable where such goods would be taxable if new. The treatment is, however, not the same for all categories of goods.

In Uruguay, for example, sales of secondhand furniture are chargeable on the full price, while sales of secondhand automobiles are charged on 10 percent of the selling price. In the case of a trade-in, vat is chargeable on the full selling price.

In Colombia, the only secondhand sales taxed under vat are those of automobiles and, even then, only if sold through a dealer; the vat is levied on the intermediaries’ markup.

New Zealand, in its vat Act, defines secondhand goods as “goods that have previously been used, or acquired for use, or held for use, by any other person.”26 This definition includes houses and buildings. Registered traders account for vat on their sales in the usual way; however, they can claim a national input tax credit on the purchase price of the goods (at the rate appropriate to the goods when sold new). This allowance means that, in effect, only the value added by the dealer (including the real estate broker) is subject to vat.

Apart from the sale of secondhand automobiles in Luxembourg and of a limited range of items in France, sales of secondhand goods by private individuals are not normally chargeable to vat. Automobiles are probably the only form of movable property where collection of the tax on secondhand private sales could be enforced by requiring the purchaser to produce evidence of payment of vat before he is allowed to register the car in his name. To protect dealers in secondhand automobiles, works of art, antiques, and collectors’ items, as well as dealers in secondhand caravans and boats, from being eliminated and the secondhand market limited to private transactions, the provision of relief on the lines adopted by the United Kingdom is probably the most realistic solution. To operate it effectively, however, taxable persons must keep adequate and detailed records of their sales and purchases so that the system can be properly controlled and supervised by the tax authorities. To extend such a system to goods such as secondhand clothing or secondhand furniture would, however, entail the risk of traders’ classifying as secondhand goods items of slow-moving inventory that have been on hand for an unduly long time.

Of course, many secondhand dealers may fall under the exclusion rule for small traders, but in some countries, including many developing countries, secondhand dealers are an important element in the trading community. Therefore, although the provision on the vat liability of dealers in secondhand goods may appear trivial, it can be important. Indeed, in the EC, “the Member States are deeply divided on this point… some … wish to see a special scheme only for certain categories of goods, and not even the same categories.”27 Basically, it seems desirable to pull these dealers into the vat registration and require them to keep stock books that can be adequately audited. The New Zealand treatment should be followed, allowing a credit to be claimed for the vat content on the goods purchased. Such full registration allows credit to be claimed for vat on large capital inputs (in such businesses as large secondhand bookshops or automobile dealerships).

In developing countries, including some countries where the secondhand trade is sufficiently important for government-owned shops to conduct it, governments find it impossible to levy a tax on secondhand traders, although frequently the trade is valuable and should be taxed. In any case, the revenue yield is likely to be small and the administrative costs could be large. Therefore, such activities have a low priority in the overall assessment of the vat base.


Often closely allied to auctioneers and antique traders is the trade of craftsmen. Usually these specialist craftsmen, such as jewelers, bookbinders, potters, restorers of antique furniture, engravers, and carvers are exempt under the small trader’s rule. They should always have the right to opt for inclusion in the full vat. It should be noted that the rates to which these traders are liable vary greatly:

  • Federal Republic of Germany:

    • 14% in principle;

    • 7% for transactions in which artistic creativity predominates;

  • Belgium:

    • 33% for jewelry, jewels, goldsmiths’ and silversmiths’ wares of precious metal;

    • 25% for articles referred to above of rolled precious metal, imitation jewelry, real pearls and precious or semiprecious stones and articles consisting wholly or partly of such pearls and stones; ornaments and fancy goods used to embellish or decorate dwellings and gardens;

    • 19% for other goods and services;

  • Denmark: 22%;

  • France:

    • 33% for articles wholly or partly of platinum, gold or silver, pearls, precious stones and cut stones;

    • 18.6% for the transactions referred to above, other than resales of articles in an unaltered state, carried out by craftsmen who are registered in the directory of trades and are eligible for special relief or have opted for the simplified vat scheme; other goods and services supplied;

  • United Kingdom: 15%;

  • Ireland:

    • 25% for goods and services;

  • Italy:

    • 2% for services supplied by firms engaged in restoring old buildings;

    • 9% for articles of stone and certain building materials such as tiles;

    • 38% for precious stones and related work, pearls and related work, nonindustrial work in platinum, hand-painted porcelain articles and “Kilim” rugs;

    • 18% for other sales and services in the craft sphere;

  • Luxembourg: 12%;

  • Netherlands:

    • 20% for supplies of craft products and services;

    • 6% for unmounted precious stones or pearls, cameos (made with materials of vegetable or animal origin).28

Such fine distinctions in definitions of trades and rates are undesirable. Basically, the craftsmen should be exempt as a small trader, taxable under the small trader rules, or fully liable.

Betting, Gaming, and Lotteries

Unless betting, gaming, lotteries, and similar activities are forced into recognizable, easily located, identified premises or locations, they will probably be semi-illegal and untaxable. However, in most countries there are betting shops, licensed bookmakers, and state-registered totalizators, as well as lotteries, casinos, and gaming arcades. Nevertheless, the borderline between legal and illegal can be affected by vat as exemplified by the Irish taxation of gambling. A vat of 25 percent on the betting stake so altered the odds that those placing the bets opened accounts with bookmakers in the United Kingdom—where the vat was half the Irish rate—and improved their odds. Of course, formally the transaction was illegal but it was almost impossible to check and eventually led to a reduction in the rate of tax on betting in Ireland.

Even where the activities are identified, it is only where the state is the organizer that it is possible to levy vat on a reliable basis. When private individuals are running the gaming tables or machines, the monitoring of income and expenses for tax purposes (for vat or income tax for that matter) is almost impossible. The preference has to be for more simple taxes based on clearly identified characteristics, for example, the number of gaming tables or machines, the square footage of the establishment, or a license to trade.

Sometimes, gaming machine takings are liable to vat or special charges are made to participate in a game of chance separate from the stakes risked by players; such charges are liable to vat at the standard rate. Of course, where establishments such as casinos sell meals and drinks as well as organize the gambling, then their activities as restaurants and caterers are liable to vat in the normal way.


Allied to betting in some countries is the whole complex world of racing. Basically, the vat should distinguish between horse breeders and owners who race only as a hobby or who race continuously and regularly (it is not a good idea to include profit to judge whether racing is a business or not). Trainers, jockeys, breeders, and syndicates should all be liable to vat and registered if their turnover exceeds the threshold. Although the arrangements of this particular business can be extraordinarily tangled, involving many intercountry transactions, the basic rule is that the value added, whatever form it takes, is taxable.29

Overall, the rule in applying vat to all these difficult to tax sectors seems to be that quoted from Talleyrand at the beginning of this chapter; by all means try to pull these activities within the vat but beware of the administrative and compliance costs of too much zeal in doing so.

European Community, Sixth Council Directive, Article 4(3).

European Community, Sixth Council Directive, Articles 4, 13, and 28.

United Kingdom, H.M. Customs and Excise, Value Added Tax: Construction Industry (1975, pp. 4—5), and Value Added Tax: Construction Industry: Alterations & Repairs & Maintenance (1975).

The guidance issued by Customs got into details specifying that if an existing building was razed to its foundations, the new building using the old foundations would be zero rated, as would a new building using the wall of the old previous building; however, if more walls were left, constituting a shell “even without floor or roof,” vat at the standard rate would be liable.

So that repairs to ancient monuments and churches were relieved of vat, as were buildings listed as part of the “national heritage.”

European Community, Sixth Council Directive, Article 13C (a).

See European Community, Tenth Council Directive.

See Pink (1985, pp. 85–93).

Edwards and Mayer (pp. 62–63).

Explicit charges can be made for, say, brokers’ services, but if discounted values were used as well, the vat might have to be applied to the asset as well as to the income flow generated. Establishing a margin requires a comparison of sale and purchase prices, so that the vat is associated with the transaction value of the instrument in addition to any explicit charges in connection with the sale.

Barham, Poddar, and Whalley (1987, pp. 172–75).

New Zealand, GST Coordinating Office, The Fire and General Insurance Industry & GST(1986, p. 8).

New Zealand, GST Coordinating Office, The Fire and General Insurance Industry & GST(1986, pp. 20–22).

Ireland, Central Bank (1980, p. 60).

Quoted in David Lascelles, “The Battle to Keep Tabs in the Face of Rapid Change,” Financial Times (London), April 21, 1986, p. 15.

See European Community, Eighth Council Directive.

See the case of Germany in Pohmer (1981).

Pohmer (1981, p. 11).

United Kingdom, H.M. Customs and Excise, Value Added Tax: Second-Hand Works of Art, Antiques and Scientific Collections (1973, p. 5).

European Community, Amended Proposed Seventh Directive, Article 4.

European Community, Amended Proposed Seventh Directive, Article 4(2) and 4(3).

Hicks (1987, p. 29).

“EC: vat,” World Tax Report (1987, p. 12).

“EC: vat,” World Tax Report (1987, p. 13).

New Zealand, An Act to Amend the Goods and Services Tax Act 1985 (1988, p. 7).

European Community, “First Report from the Commission to the Council on the Application of the Common System of Value Added Tax,” reproduced in Intertax (March 1984, p. 102).

European Community, “VAT on Goods and Services Supplied by Craftsmen in the Applied Arts Sector,” reproduced in Intertax (February 1984, pp. 79–80). (Rates updated.)

For a straightforward treatment, see New Zealand, GST Coordinating Office, Bloodstock and Racing Industry & GST.

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