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Lead time planning essential in implementing VAT here
In Michigan, the debate over a sales tax on services appears to be deferred, if not dead, for the time being. We all remember the service tax’s brief life a couple of years back and its quick repeal (death). Its repeal added the surtax on the Michigan Business Tax that businesses are left to deal with today.
Meanwhile, in Washington, D.C., there continues to be some discussion on whether the imposition in the future of a Value Added Tax will be necessary to assist with raising revenue to fund the spending habits of Congress and assist in reducing the amount of the nation’s federal deficit.
As discussed in earlier columns, the VAT is a tax concept that most of our major trading partners have embraced. It is common in Europe and also in place closer to home in both Mexico and in Canada. The day-to-day life of dealing with a VAT tax adds additional costs and compliance issues to businesses in a jurisdiction that has such a tax system.
The U.S. may benefit from being able to learn from the experiences of its NAFTA trading partners in their VAT efforts.
Most of us have had dealings with the Canadian goods and service tax or GST. There has been a change in Canada in recent years to combine the provincial sales tax regime with the federal GST. This combination is commonly referred to as harmonization, and the combined tax is often referred to as the harmonized sales tax or HST. On July 1, the provinces of Ontario and British Columbia harmonized their provincial sales tax regimes with the GST regime and now have a combined regime for the reporting, collection and remittance of the tax.
The use of an HST in Canada is intended to streamline and simplify the process in certain respects. The recent change in Ontario to the HST may give us some insight into what a federal VAT in the U.S. may bring and how it may work with the existing state sales tax regimes.
The current Ontario HST tax rate is 13 percent. This is the result of combining the federal GST rate of 5 percent with the Ontario provincial sales tax rate. Canada has differing rates of provincial sales taxes, just as the U.S. has differing state sales taxes, so determining what rate to apply does cause issues. Under the HST, the rate is based on the rate applied in the province where goods are delivered or made available. Thus, it is a destination-based test.
Any HST assessed on services is based on the recipient’s home or business address in Canada. However, there are exceptions, and that is where businesses can get caught if they don’t have full appreciation for the rules surrounding the application and determination of the HST.
Quebec does not currently participate in the HST and has its own provincial sales tax (QST) as well as the federal GST. This adds additional compliance and systems issues in dealing with the sale of goods and services by U.S. companies into the second largest provincial market in Canada.
Both Ontario and British Columbia have implemented transition rules to implement the harmonized system. A full understanding of the transitional rules as well as the harmonized rules is needed to properly collect, report and remit the proper amount of tax. It is likely there will be confusion in the first months of the operation of the HST. This confusion may apply for both Canadian companies as well as for U.S. companies doing business in Canada in how to properly report transactions under the new HST regime.
Also, the requirement of electronic reporting is included with some of the recent changes: All large businesses (those entities with taxable revenues of at least CAD $10 million) are now required to file their HST returns electronically.
Another issue companies will need to deal with is that of returns and allowances for items purchased prior to July 1, 2010, and that are returned after July 1, 2010. There are transition rules in place in how to work with these types of situations.
The U.S. will need to deal with these types of issues if a federal level VAT tax is considered. The infrastructure, both at the government administration and collection basis and at businesses, is critical in the proper identification of transactions subject to the levies, the determination of any liabilities, and the actual reporting and remitting of the tax revenues to the governmental entity.
Any movement to such a system in the U.S. will require a significant amount of lead time to allow for these types of items and allow businesses to update their systems and purchase the necessary software and hire the appropriate personnel to function in a system where there is a VAT.
The bigger issues will be whether the states can agree to harmonize their systems to a federal VAT, or whether there will be significant differences in state sales and use tax systems and rules, and the rules and requirements under a federal VAT. These types of issues may take a significant amount of time to deal with in an effective way.
It may serve the U.S. well to have a comprehensive dialogue with our neighbors to the north to understand what issues and complications they have experienced over the years in putting into place the GST and now the harmonization of the GST with provincial sales tax systems.
We have already seen the issues that arise with different income tax systems in the states, as well as different sales and use tax systems in the states. All of this creates compliance issues for taxpayers that desire to comply but are faced with no two states having the same rules and definitions in the administration of their specific state tax systems.
If a move to a VAT in the U.S. does occur in the future, there are a number of practical issues that need to be considered. Many businesses deal with VAT systems in Europe, Canada and Mexico, so many businesses already are familiar with the issues that arise in infrastructure requirements, additional employees and other resource needs that come with the territory. However, based on these past experiences, it will take some lead time and planning for both government and businesses to adapt.
William F. Roth III is a tax partner with BDO USA LLP. The views expressed above are those of the author and not necessarily those of BDO. The comments expressed above are general in nature and are not to be considered as specific tax or accounting advice and cannot be relied upon for the purpose of avoiding penalties. Readers are urged to consult with their professional advisers before acting on any items discussed herein.