Value added tax, part 2
CFAL Economic View
Nassau, The Bahamas
Last week we examined the need for a new tax system in The Bahamas and gave an example of how value added tax, or VAT, would be calculated in practice. In this article we examine the experience of Barbados in its transition to VAT and look at how we can apply those lessons to The Bahamas. Finally, we present an argument for why the tax discussion should ultimately be extended to include modest corporate taxes.
In an excellent article recently published in The Tribune titled “Barbados’s Lessons for The Bahamas over VAT”, Dr. Nikolaos Karagiannis of Winston-Salem State University presented a detailed overview of the process that took our southern Caribbean neighbor to its new tax system.
VAT was introduced in Barbados at the beginning of 1997 at a standard rate of 15 percent (it has since been raised to 17.5 percent). Among the reasons cited for its choosing to implement VAT was to reduce the complexity of the country’s indirect tax system and to reduce the high level of duties and taxes on imported goods.
Serious discussions on tax reform began in earnest when Barbados underwent stabilization and structural adjustment under the International Monetary Fund (IMF) in 1991. In order to coordinate the extensive work of implementing a VAT, Barbados established a VAT Implementation Unit (VIU) in 1993. In January 1994, it entered a technical cooperation agreement with the Inter-American Development Bank (IDB). Under the agreement, loans were allocated for the design of the VAT system and to bolster the Customs and Excise Department.
When the Owen Arthur administration came to office in 1994, the implementation of VAT was postponed to mid-1996 while research continued on estimating the impact of the tax on revenues, prices and the productive sectors.
The VIU started public relations outreach programs in May 1995, including the release of pamphlets and booklets, targeting four main target audiences: the private sector (retailers, manufacturers, importers and managers); the government sector agencies involved in the administration of the system; members of the general public (consumers) and finally the school system. The VIU presented at workshops, seminars, as well as via television and radio to further educate the public and business community. The major features of the new act were passed by the Barbados House of Assembly in September 1996 with effect on January 1, 1997.
The Bahamian context
Will Bahamians comply with a new and seemingly complicated tax? Many are skeptical that we can effectively get companies and individuals to forward the correct amount of tax to the government when we struggle to collect existing property taxes. As reported numerous times before, our government is owed some $400 million in past due property taxes according to the auditor general; much of that amount will probably never be recovered.
However, the reality may prove to be less problematic: only persons/businesses of the size and capability to adhere to good record-keeping (as measured by annual gross sales) will be included in the VAT system. Around the Caribbean region, this minimum threshold is TT$200,000 in Trinidad and Tobago (approx. US$30,000), JM$144,000 in Jamaica (approx. US$2,000) and BD$80,000 in Barbados (US$40,000). Given the higher average per capital GDP of The Bahamas, one can reasonably anticipate that our exemption threshold will be much higher than the rest of the Caribbean.
The Barbadian government was equally concerned with tax avoidance and evasion. Only those traders who were registered, and who displayed a certificate of registration, were legally authorized to charge VAT on the taxable goods and services they were selling. On the other hand, those traders who were not registered were paying VAT on the goods they were buying, but were not legally authorized to charge VAT on the goods they were selling, thereby squeezing their profits.
No doubt Bahamian business culture will need to be transformed. Compared to Barbados, which already had a strong tax framework and a history of paying taxes, this nation is starting from the opposite spectrum in terms of tax familiarity and compliance. The principle challenge for the business community will be record keeping; many companies will need to hire book-keepers or accountants while upgrading their point of sales or POS systems. Ultimately we will need to force compliance by tying it to the renewal of business licenses, alongside rigorous and impartial execution of the law by the newly created tax authority.
The move forward
As the Bahamian economy is a predominantly services-driven one, the real challenge for our policymakers is to introduce a VAT system that can achieve economic, fiscal, social and developmental objectives, while avoiding any adverse effects on tourism and financial services. As one example, VAT in Barbados was applied at a concessionary rate of 7.5 percent (now 8.75 percent) on accommodation in hotels, inns and guest houses. The government will need to decide very carefully which goods and services would be zero-rated and therefore exempted to make sure that VAT is neither regressive, nor penalizing those who are at the lowest levels of income.
Beyond VAT, how do we get the greatest mileage out of the many tax information exchange agreements, or TIEAs, that our jurisdiction has signed? One of the stated goals of the Bahamian financial services industry is to see companies locate their head and subsidiary offices within our shores.
Would that be an easier sell if we had a tax regime that allowed foreign companies to offset taxes paid in our jurisdiction when repatriating income? For example, Barbados has a number of double taxation agreements, or DTAs, that are extremely favorable for certain types of investors. These agreements promote cross border trade, avoid double taxation and prevent tax evasion.
As a result of its 2000 DTA treaty with China, Barbados has emerged as the leading jurisdiction for offshore wholly foreign owned enterprise (WFOE) holding companies in China. Under existing law, payments of dividends by a WFOE to its foreign owners are free of Chinese withholding tax. Payments of interest to foreign lenders are subject to withholding at 20 percent, typically reduced to 10 percent under applicable tax treaties. However, where a taxpayer qualifies for benefits under the Barbados-China treaty, the tax rates are reduced to five percent for dividends and 10 percent for interest.
The Bahamas should be able to compete in this space with the proper tax structure. The current tax debate is an ideal time to examine the merits of corporate tax as a boost to our competitive advantage in an era where being a zero-tax country is now a liability. This would allow the Bahamas to obtain tax income from foreign companies operating here at modest rates of 1.5 percent to 2.5 percent without increasing their overall tax burden since, by the DTA, the tax would be shared by our treasury and that of the home country.
Even as we move to a new tax system, we stress that the government will still need to be vigilant in controlling its spending and getting its fiscal house in order. This is one reason why the so-called Tea Party in the United States is so adamantly against any form of tax increases, including any overhaul of the tax code which increases efficiency and as a consequence increases collection. Instead, it feels the need to “starve the beast”, as governments’ natural inclination is to spend more than whatever revenue it takes in.
Referring to Barbados one last time, that country has a 17.5 percent VAT, 20 percent to 35 percent personal income taxes, 12.5 percent withholding on income and dividends, 15 percent to 25 percent local corporate taxes and import taxes on vehicles, spirits, tobacco and petroleum products. Nevertheless, they still had a 2010/2011 central government deficit of 8.5 percent of GDP and total government debt over 110 percent of GDP. Clearly, getting the tax policy right is still only one side of the government’s fiscal equation.
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Jul 11, 2012