VAT Neutrality E-Book

Charlène Adline Herbain

• Herausgeber: Éditions Larcier
• Kategorie: Fachliteratur
• Sprache: Englisch

Seitenzahl: 661

Veröffentlichungsjahr: 2015

Beschreibung

Most major economies use a value added tax (VAT) which is a derivation of the French 1954 taxe sur la valeur ajoutée. The initial imposition of VAT in France and its spread around the world have been driven by economic reasons. This book focuses on one of these economic triggers: the neutrality of VAT as regards the functioning of the economy. It demonstrates that the reason VAT was chosen in France and why thereafter it spread around the world was because it offered the possibility to collect governmental revenue while allowing the economic forces of the market to interplay without being adversely affected.
The prerequisite conditions for the existence of VAT neutrality are therefore identified herein along with an overview of the VAT mechanism, demonstrating that the concept of neutrality is built into the VAT system in a manner that allows for the preservation of the natural functioning of the market. After the definition of VAT neutrality is set forth, the elements that comprise VAT neutrality are tested against the realities on the ground and the issues that infringe the neutrality of VAT are identified and analysed. In conclusion, remedies for these issues are being sought by a review of the causes of infringement of VAT neutrality in the perspective of selected proposals for modified VAT systems. These proposals include redesignating the place where VAT is levied and improving VAT collection. Ultimately, the proposed solution has recourse to the roots of VAT together with the most advanced technological tools available to give back to VAT the power to levy revenue while letting the economic forces of the market interplay without instigating any adverse influence.

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Acknowledgements

It is a pleasure to convey my gratitude to the persons from whom I have received inspiration, help and support and who made this book possible.

I would like to express my sincere gratitude to both my promotor and co-promotor. I am very grateful to Professor Alexander Rust for allowing me to conduct my doctoral research under his auspices and for providing me with skilled guidance. I am truly thankful for his flawless confidence and selfless dedication to my academic development. I am also deeply grateful to Professor Daniel Gutmann for accepting to supervise my research in an international setting. Despite the geographical distance, he gave me constant support and advice. The support, patience and guidance of Professor Alexander Rust and Professor Daniel Gutmann, have been an immense part of the completion of this research.

I extend my appreciation to the members of the defense committee, Me Jean-Claude Bouchard, Professor Joachim Englisch, Professor Werner Haslehner and Professor Oskar Henkow for their time, dedication and for their thoughts and genuine interest. To Professor Joachim Englisch and Professor Oskar Henkow, for adapting to French University rules and traditions. To Me Jean-Claude Bouchard, for generously offering me valuable ideas and recommendations and for his unflagging support and mentorship.

My sincere thanks to all those who contributed directly, or indirectly to my dissertation. In particular, I wish to thank Professor Werner Haslehner and Professor André Prüm for their support and guidance in my academic career, and Professor Rita de la Feria and Professor Edoardo Traversa for offering thorough and excellent feedback on an earlier version of this thesis. I am also indebted to Karine Bellony, Daphné and Arnaud Bon, Clémentine Boulanger, Heleen de Geest, Anne Gérard, Matthieu Heitz, Dr Katarina Koszeghy, Me Dirk Leermakers, Roseline Loutsch, Professor Xavier Prevost, Me Elisabeth Relave-Svendsen, Florine Richter, Nadja Risch, Loic Roussel, Dr Jean Schaffner, Paloma Schwarz, and Professor Laurence Usunier. Also I want to thank with all my heart my family, BeCo in particular for their encouragement and patience. Without their support, I would never have finished this thesis and I would never have found the courage to overcome the difficulties during this work.

Words are inadequate to express my heartfelt thanks to Ayzo van Eysinga to whom this book is dedicated. You have been a solid rock of support for me over the years. I couldn’t have done it without you and Forever. This book is dedicated to you.

A very special thanks to Nathalie Flohimont, Rui Henriques and generally to Promoculture-Larcier for publishing this book and to the Fonds National de la Recherche Luxembourg for its support.

Charlène Adline Herbain

Supported by the Fonds National de la Recherche, Luxembourg

Foreword

In times where State budgets are increasingly under pressure, levying of taxes becomes paramount. Invented by the French after World War I, VAT has rapidly spread throughout the world as an effective way of taxing consumption. For many Member States of the European Union, it has become a major if not the biggest source of tax revenue with a trend of steady increase of its share.

While adding a tax on prices appears at first sight as a simple solution, the design of an efficient yet fair VAT system entails in reality quite some complexities. VAT neutrality in business-to-business situations is a key feature of any such system and in particular of the European VAT regime.

Mrs. Charlène Herbain has dedicated her PhD in tax law at the Universities of Luxembourg and Paris 1 Panthéon-Sorbonne to this challenging topic. The publication through the present book of her work offers the broader public an access to the enlightening results of her in-depth research and innovative proposals.

After a historical introduction to the VAT system, the author sketches the defining features of the neutrality principle and its implications. She shows how this principle entails that VAT must not constitute a charge on businesses, that is must no result in any distortions of competition and that the burden borne by the final consumers should be equal in all circumstances, regardless the Member state of production.

In practice, these imperatives raise in fact many questions and concerns as neutrality is restricted in many ways, notably through imperfections or limitations of the European regime, compliance costs, divergences between Member States, for instance regarding VAT rates and the scope of reduced rates, special treatments like the flat rate schemes existing in the UK or Belgium, and derogations, exemptions and various options tolerated by an incompletely harmonized system.

Notwithstanding that neutrality is a clear policy guideline in the design of VAT for the EU, the principle is far from being always guaranteed in business-to-business situations and gives thus rise to numerous court cases. Indeed, the imperative of neutrality is most frequently referred to by the Court of Justice of the European Union in its purposive approach towards the construction of the EU VAT system.

Mrs. Herbain explores the various limitations and flaws of the regime both at EU level and in various domestic laws of the Member states, mostly in Luxembourg, France and Belgium. Her systematic and subtle analysis leads her to shape an innovative alternative to the current design based mainly on a redefinition of the origin principle and a way of levying the tax directly on the end-consumer, which would, as a side effect, allow to reduce tax fraud. Her proposal constitutes a precious contribution to the current debate on a reform of EU VAT.

Comprehensible and readable even for non-VAT experts, Mrs Herbain’s work, while rich in details, always tend to assess technicalities against fundamental features of the VAT regime.

Practitioners will find in this book a precious source of detailed information. Students and non-VAT experts will be guided through the presentation of many cases and the conceptualization of the defining features of the neutrality principle. Scholars and legislatures will gain from the inspiring proposals for a simplified and possibly even more effective VAT regime assuring full neutrality in business-to-business relationships. For all Mrs Herbain’s work offers definitively a way toward a finer understanding of EU VAT and its underlying imperative of tax neutrality.

Professor André PrümUniversity of Luxembourg

List of abbreviations,acronyms and references

AG

Advocate General

Approximation of VAT Rates Directive

Council Directive 92/77/EEC

Belgian VAT Code

Code du 3 juillet 1969 de la taxe sur la valeur ajoutée (BE)

B2B

Business-to-business

B2C

Business-to-consumer

CGI

Code général des impôts (FR)

CJEU

Court of Justice of the European Union

CVAT

Compensating VAT

Digital Services Directive

Council Directive 2002/38/EC

ECOFIN Council

Economic and Financial Affairs Council

EEC

European Economic Community

ECR

European Court Reports

Eighth VAT Directive

Eighth Council Directive 79/1072/EEC

ERP

Marshall Plan or the European Recovery Program

EU

European Union

Excess VAT

Input VAT in excess of output VAT

First VAT Directive

First Council Directive 67/227/EEC

GATT

General Agreement on Tariffs and Trade

Green Paper

COM (2010) 695 final

GST

Goods and Services Tax (NZ)

HMRC

Her Majesty’s Revenue and Customs

ICM

Imposto sobre circulacao de mercadorias (BR)

ICMS

Imposto sobre operações relativas à circulação de mercadorias e sobre serviços de transporte interestadual e intermunicipal e de comunicação, ainda que as operações se iniciem no exterior (BR)

IPI

Imposto sobre Produtos industrializados (BR)

Law of 10 April 1954

loi no 54-404 du 10 avril 1954 1966 Portant réforme fiscale (FR)

Luxembourg VAT Act

loi du 12 février 1979 concernant la taxe sur la valeur ajoutée (LU)

Member State of request

Member State in which cross-border refund claimant is established

Member State of reimbursement

Member State in which cross-border VAT costs have been incurred

MOSS

Mini one-stop-shop scheme

Neumark Report

Report of the Fiscal and Financial Committee of the European Economic Community

OECD

Organisation for Economic Co-operation and Development

OJ

Official Journal of the European Communities

Polish VAT Act

Ustawa z dnia 11 marca 2004 r. o podatku od towarów i usług (PL)

Production Agents

Goods that are physically consumed but economically resold through another product to which they are combined

Refund Directive

Council Directive 2008/9/EC

Reg on Community statistics

Regulation (EC) No 638/2004 as updated by Regulation (EC) No 222/2009

RTvat

Real-Time VAT

Second VAT Directive

Second Council Directive 67/228/EEC

Sixth VAT Directive

Sixth Council Directive 77/388/EEC

SLIM

Simpler Legislation for the Internal Market

Thirteenth VAT Directive

Council Directive 86/560/EEC

UCITS Directive

Council Directive 85/611/EEC as amended by Directive 2001/108/EC

VAT

Value added tax

VAT Directive

Council Directive 2006/112/EEC

VAT/GST Guidelines

Guidelines on VAT neutrality approved by the Committee on Fiscal Affairs of the OECD

VIES

VAT information exchange system

VIVAT

Viable integrated VAT

WST

Wholesale Sales Tax (NZ)

WTO

World Trade Organization

Introduction

Nearly every major economy around the world has in its tax portfolio a tax on consumption. Most use a Value Added Tax (hereafter referred to as VAT) which is an offspring of the French 1954 taxe sur la valeur ajoutée.1 Intriguing worldwide dominance of VAT; what had caused so many governments to be devoted to it? This question undoubtedly requires some economical background analysis. After 1945 and until 1973, world trading growth increased by almost 8% annually and the volume of international trade increased sevenfold.2 These developments led to profound changes in the economic relationships between Member States. Protectionism and economic nationalism proved self-defeating, while free trade on the other hand appeared to be conducive to national development. In this context, the ideal scenario appeared to be letting the economic forces of the market, based on objective elements such as quality of economic infrastructures or availability of qualified workforce, determine the location of investment and factors of production where they would be most efficient. In order to realise this objective, any intervention that could modify the market allocation of investments, means of production or, as a necessary consequence, flows of trade, had to be banished. However, non-intervention by state governments was particularly complex. In fact the need to raise revenue for their overall functioning has led for a long time already to a levy on the wealth created in their territory. This levy, commonly know as tax, was prone to generating distortions in the aforementioned market allocation and flow of trade. This is in this context of wake of market liberalisation that the concept of VAT neutrality was created and VAT spread throughout the world.

The current importance of VAT neutrality for businesses, and the related and underlying problems associated with it, are underlined by the various references to neutrality made over the years by the Court of Justice of the European Union (hereafter referred to as CJEU or Court) in its judgments. In many instances, the CJEU has referred to the wording of the EU law which formulates the framework definition of VAT neutrality:

The principle of the common system of VAT entails the application to goods and services of a general tax on consumption exactly proportional to the price of the goods and services, however many transactions take place in the production and distribution process before the stage at which the tax is charged. On each transaction, VAT, calculated on the price of the goods or services at the rate applicable to such goods or services, shall be chargeable after deduction of the amount of VAT borne directly by the various cost components.3

Perusing further through the judgments of the CJEU is revealing and informative but also to a certain extent disconcerting, as VAT neutrality is given other meanings than initially set out in the legislation. In that respect it can be noted that the Court held on occasion that VAT neutrality reflects in secondary EU law the constitutional principle of equal treatment and that it extended the equal treatment feature of VAT neutrality as far as to apply it to lawful and unlawful transactions. The Court also mentioned VAT neutrality in relation to goods, services and economic operators and other times, it associated neutrality with the avoidance of double taxation and with the elimination of distortion of competition. The central aim of this work finds its roots on the basis of these observations; it is to delineate this concept of neutrality in VAT matters and to evaluate its efficiency in fulfilling its objective – to leave the market free to function as it sees fit. This objective itself is not evaluated.

The tripartite structure of this work starts with the historical bias towards VAT and its link with the concept of neutrality. It shows that VAT is the result of a progressive construction which is aimed at permitting the levy of governmental revenue while maximising economic efficiency by avoiding the impediment of the natural functioning of the market. This demonstration is undertaken in Part 1 and starts in the birthplace of VAT, France, where the implementation of VAT in 1954 was the culmination of empirical fiscal experiences started after the First World War. Afterwards, the demonstration highlights how neutrality, by promising the elimination of distortion in cross-border competition, played a role in the spread of VAT in the European Community and around the whole world while carrying on its own conceptualization and notably so through its processing into a general tax applied across the entire economic sector, and to the entire taxable substance.

After having identified in Part 1 the role of the concept of neutrality in the establishment of VAT, Part 2 analyses and systematises the content of that concept. The conditions for the existence of VAT neutrality are therefore identified along an overview of the VAT mechanism, and these data are classified into three categories to create a systematic definition of VAT neutrality. It is shown that the concept of neutrality is built into VAT in a very complete manner which allows the fulfillment of the aim of preserving the natural functioning of the market. Such discussion requires an in depth analysis of the mechanism of VAT.

In Part 3 the definition of VAT neutrality that has been construed further to the analysis of the concept is tested against the practicalities of the Common VAT system. It is shown that despite a very well built principle, VAT neutrality is compromised by the realities on the ground in each of the three categories previously identified. The identification of the issues is accompanied and supported by their related causes. As such there is the fact that the principle of VAT neutrality is not a rule of primary law but a principle of interpretation applying concurrently to other principles, the fact that because of politics essentially, imperfect solutions have been progressively implemented by way of legislation or via jurisprudence as permanent-temporary measures, and last but not least, the freedom of interpretation of Member States derived from the VAT legislation. This third part demonstrates that VAT is like nature; on its own the mechanism works like a well-oiled machine but as soon as humanity gets involved, it falls apart.

In conclusion, remedies for the issues identified are being sought through a review of the identified causes.

On another note, the below exclusions from the scope of the work should be pinpointed. First and while acknowledging that the generalisation of the VAT implies its exclusivity and is consequently a guarantee of neutrality as it avoids the imposition of other turnover taxes susceptible to generate tax cascading or other non-neutral elements, it should be noted that no in-depth study is carried on in regard of this aspect of neutrality. In fact the topic of this work does not extend to the neutrality of VAT in the perspective of other taxes. Following, no in-depth review of the VAT concepts of economic activities or of taxable person is performed either.4 It should also be noted that the analysis performed in the context of this work is set within a limited framework which mostly revolves around the European Union. In that context, the first limitation relates to the kind of VAT under review which exclusively concerns the VAT as designed by the European rules. This VAT type known as the invoice-credit materialises as a levy on the value a business adds with its machinery, workforce and capital to goods and services created or previously acquired. The levy is collected by the so-called invoice-credit method (also known as the staged-collection process with deduction of input VAT) through which each business participating in the life-cycle of a taxable supply applies VAT to its output and, as a balance, credit the VAT paid on its input acquired for business purposes against the output VAT. Therefore, at each stage of the life-cycle of a supply the only VAT to be remitted to the treasury is that on the value added between the input and the output. The second limitation concerns the geographical scope of the analysis which also stops, except for few exceptions, at the European borders, therefore focusing only on intra-Community transactions.

1. It is interesting to note that the international spread of VAT has been accompanied by the French language has its language of choice. See Pasquale Pistone, “Soft Tax Coordination: A Suitable Path for the OECD and the European Union to Address the Challenges of International Double (Non-)Taxation in VAT/GST Systems” in Michael Lang, Peter Melz et al (eds), Value Added Tax and Direct Taxation, similarities and differences (IBFD 2009) 1161 and 1162 (1161-1170).

2. Serge d’Agostino, Marc Montoussé, Alain Chaffel, Jean-Marc Huart, 100 fiches pour comprendre la mondialisation (Editions Bréal 2006) 12; Emmanuel Combe, Précis d’économie (Presses Universitaires de France 2011) 370.

3. Article 2 First Council Directive 67/227/EEC of 11 April 1967 on the harmonisation of legislation of Member States concerning turnover taxes [1967] OJ 71/1301; transposed in article 1(2) Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax [2006] OJ L347/1.

4. See the thesis of Michel Roques which focuses in its first part on the generalisation of VAT in the perspective of its neutrality. Michel Roques, “La Cour de Justice des Communautés Européennes et le principe de neutralité de la TVA” (Doctoral thesis, Université de Nice-Sophia Antipolis, Faculté de Droit, de Sciences Politiques, Economiques et de Gestion 2002) 23 et sqq.

PART 1

THE INITIAL IMPETUS FOR NEUTRALITY

He’s building another wolf machine.

He must be crazy in the beans.1

I. Introduction

Governmental raising of taxes funds the operation of government itself and also welfare and public services such as education and healthcare. However, in some cases, the levying of taxes can cause overall welfare to decline. When the levying of 1€ of tax incurs a cost to society above that of the 1€ collected the levying of tax creates a burden, a deadweight loss. This burden may arise for various reasons, such as an inefficient system of collection coupled with too low a return on the tax. Depending on the elasticity of supply and/or the elasticity of demand, it can also be the case that because the imposition of a tax – in most cases – increases the price paid by a purchaser and/or reduces the amount received by the seller, the levying of tax triggers a change in the purchaser’s behaviour or in that of the seller. Such change modifies the overall equilibrium between supply and demand and thus hinders the optimal allocation of resources, eventually creating a burden on society.

At the time of the implementation of VAT in France and Europe, these implications were particularly evident. It had become clear that a good tax would be economically efficient, produce a high return and create the fewest distorting effects and would thus be the least burdensome. In short, that a good tax would have the most neutral effect on society.

The first part of the present work considers how the search for neutrality played a role in the implementation of VAT in France, Europe and in other specific countries. VAT, in its contemporary European form, appeared for the first time in France on 10 April 1954. Its mechanism had, though, already emerged in 1948 and it was only in 1964, with the repeal of restrictions on deductions, that the necessary conclusions were drawn from the doctrine of neutrality. Leaving aside the doctrinal arguments about the origins of the tax, the grounds for and the process of its adoption in France are of great interest when it comes to an understanding of the role of the concept of neutrality in the implementation of VAT (chapter II below). Seemingly, the stages of implementation of VAT within the Common Market, in Brazil and in New Zealand reveal a great deal about the function played by the concept of neutrality in the choice of VAT (chapter III below).

II. France

Alain Frenkel was one of the first to point out that VAT is a means of providing a technique, the deduction mechanism, to a doctrine, tax neutrality.2 He also interestingly noted, though this point was raised first by Marcel Pellenc in the report of the bill generalising VAT in France, that the VAT mechanism, and consequently its inherent neutrality, is the product of historical development. He stated that VAT was the result of practical research, that is the various and continuous evolution of the tax system conducted in France.3 In fact, between 1917 and 1954, five legal texts marked out the history of tax in France. Various turnover and purchase taxes were tried until 1936 (section 1) below) and it was then that the direct forerunner of VAT appeared (section 2) below). The final part of the puzzle fell into place in 1954 with the intervention of Maurice Lauré (section 3) below). This chapter, while respecting the continuum of events, shows how the concept of neutrality contributed to the introduction of VAT in France. It will be demonstrated that the concept of neutrality was however not the initial goal of the successive reforms.

1) TRY-OUTS

France took the path that would lead to the worldwide VAT when it implemented a tax on payments (subsection a. below) followed by a gross turnover tax (subsection b. below) and one-off taxes (subsection c. below) after the First World War.

a. Taxe sur les paiements4

With the First World War getting bogged down, the French financial needs grew and spurred to comprehensive tax reform. In 1917 the tax on payments made a “timide apparition”.5 If the appearance of the tax can be so qualified, it is because the administration had insufficient means of control and as a consequence the tax was almost fruitless: “sur le plan budgétaire, cet impôt avait un rendement très faible, nettement inférieur aux prévisions … et en tout état de cause, hors de proportion avec les nécessités budgétaires de l’époque”.6 This shy attempt nevertheless opened the path to consumption tax that was destined to end with VAT.

Created by the law dated 31 December 1917, the tax on payments was levied on payments that were set out in writing and made to non-merchants (like rent or private lessons) or to merchants but outside the scope of their commercial activity.7 The tax was levied through stamps and, with an option for merchants, in monthly payments.8 In case of payments to merchants in the scope of their commercial activity, the levy was performed at the time of the final sale to the consumer on payments above Fr.150.9 The regular rate was fixed at 0.20% and the rate for luxury goods at 10%.

As noted above, the success of the tax was limited by fault of lack of governments’ means of control. There are two additional main shortcomings that explain this lack of success. First, the tax created accounting complexity for merchants who had to organise their sales so as to ensure that the tax was applied correctly – on the one hand that the correct rate was applied (0.20% or 10%) and, on the other hand, that only sales to consumers were being taxed. Second, merchants had a strong interest in circumventing the tax as it both decreased the taxable basis of the tax on revenue by under-declaring the profit realised and rendered their products economically more competitive.10

b. Taxe sur le chiffre d’affaires11

In 1920, drawing its inspiration from the Umsatzsteuer instituted four years earlier in Germany,12 France introduced a low rated gross turnover tax on businesses.

…il est institué un impôt sur le chiffre des affaires faites en France par les personnes qui, habituellement ou occasionnellement, achètent pour revendre, ou accomplissent des actes relevant des professions assujetties à l’impôt sur les bénéfices industriels et commerciaux…, ainsi-que par les exploitants d’entreprises assujetties à la redevance proportionnelle ….13

The purpose of the tax was to terminate the state budget deficit generated by the increased spending on reconstruction after the First World War without triggering distortion.14 The picture drawn by the general rapporteur for the 1921 budget was gloomy:

Un budget en déficit de 2 milliards 800 millions en 1921; une trésorerie qui réclame pour l’exercice en cours 36 milliards de ressources d’emprunt; la perspective de 6 à 8 milliards de ressources annuelles et permanentes à créer pour assurer l’équilibre du budget ordinaire dans les années qui viennent; la question des pensions et dommages non résolue pour l’avenir.15

In respect of the aim to avoid distortion, we can quote Pierre Mendès France who, together with Gabriel Ardant, explained that it was impossible to avail old taxes to raise new resources without distorting both production and consumption: “il parut impossible de [demander de nouvelles ressources] aux impôts classiques … parce qu’ils désorienteraient, déformeraient à la fois la production et la consummation”.16 Despite this noble aim, the new tax distorted both production and consumption.

In practice, gross turnover tax was a tax on gross income based on all the amounts collected by businesses against their sales whether a profit was realised or not. The tax which was levied at 1% initially (plus 0.10% for departments and municipalities) went up in 1926 to 2%.17 It was remitted on a monthly basis.18 Levied on all transactions, it was leading to higher taxation of longer economic cycles as compared to the taxation of shorter ones. The tax consequently encouraged producers to shorten the circuit of production and favoured vertical trusts (namely businesses that perform all the operations necessary for the manufacturing of products on their own). In reaction, businesses organised themselves in tax efficient manner that is: “vertical and horizontal integration of production and distribution”.19 The aim being to eliminate as many intermediaries as possible to reach “a reduction of taxes under the cumulative cascade system”.20 In certain circumstances these reorganisations may have been economically favorable. But in most situations it was not the case, especially as the nature of the production often required the simultaneous action of different branches of industry whose integration into one business was economically unviable.

These characteristics were well known but in that post-war period they were accepted if not embraced21 mainly because public opinion was strongly opposed to the merchants who were blamed for having exploited the misery of the war to enrich themselves. The tax was also supported politically despite its imperfection in terms of its impact on business organisation. Edgard Allix notably said: “[la taxe sur le chiffre d’affaire est] loin sans doute d’être un impôt idéal, … mais [elle est] un merveilleux pourvoyeur des budgets en détresse”.22 We find the same state of mind in the report of Charles Dumont, then general budget rapporteur for the Chamber of Deputies: “cet impôt comporte des inconvénients certains et graves, mais c’est le seul qui puisse nous donner aujourd’hui, immédiatement [le rendement nécessaire]”.23 All in all, whether motivated by demagoguism, group selfishness or even pragmatism, the flaws of the tax were not at first condemned. However, as underlined by the Directorate-General for Research of the European Parliament as the years passed, the rate of the tax increased24 and its side effects became problematic:

As long as the rates were at a very low level the economic effects were small. As rates rose, however, it became clear that the system created certain undesirable distortion.25

As it happens, by its very nature, this tax was both cascading and compounding and thus the amount of tax levied on the final product varied with the length of the economic cycle being taken by the merchandise. In relation to businesses in the economic cycle, on the one hand, they were differentiated depending on the production cycle they were part of. Integrated businesses could realise bigger margins or increase their sales by being competitive in prices and in any event could make more profit. Products sold via non-integrated businesses had to bear a heavier tax burden and thus the non-integrated businesses had to reduce their margins to align their prices with those of integrated businesses to remain competitive.

On the other hand, the distortion was causing the same products to be taxed differently and consequently the amount of tax payable differed for the consumer depending on the level of integration of the whole production cycle rather than on the intrinsic value of the product. The figure below schematically represents a case where the amount of tax is fixed and businesses impose an overall margin of 20.

Figure 1: the operation of gross turnover tax

This view on the distorting effect has recently been upheld in a VAT guide in the following terms:

In cumulative cascade tax systems legal neutrality can never be guaranteed. … At each stage the tax is cumulated or “pyramided”. … The tax burden on a given product cannot be determined exactly because a product may have different producers with varying levels of integration and therefore carries different tax burdens. As a result cumulative cascade systems do not offer legal neutrality.26

In addition, because of its characteristics the tax was a restraint on foreign trade.27 The then applicable principle in international taxation was that of destination. As such, the tax was being levied by the country where the product was being sold. It meant that taxes were collected on imports and rebated on exports. However, in France the gross turnover tax could not be rebated completely since only the exporter could sell his merchandise without tax. It was not sufficient to not tax the final step of production to completely relieve the merchandise from the burden of the tax, as the tax that had been borne in the previous transactions remained integrated into the selling price at the time of the export, rendering the local merchandise less competitive abroad. Also, in the case where no such tax existed in the country of origin of the merchandise, merchandise imported in France was more competitive than local merchandise as the imported merchandise would be taxed upon import, thus reaching France having been taxed only once, where local merchandise at the same stage of the production cycle could have already been taxed many times. These impediments revealed that the taxation system was a restraint on foreign trade. The only solution under this regime would have been to reimburse the exporting businesses with the amounts of tax paid by their suppliers but this would have been seen as a dumping measure that could have hindered the commercial relationship of France:

Pour assurer la neutralité de l’imposition il était nécessaire … de rembourser l’exportateur des sommes payées par ses fournisseurs au tire de l’impôt sur le chiffre d’affaires. Or pareille mesure risquait d’être considérée à l’étranger, comme une mesure de dumping justifiant des mesures de rétorsions.28

A tax protest movement29 brandished those distortion effects and the inquisitorial administrative controls as arguments to have the tax removed.30 As a result taxpayers with an annual turnover below 120.000 francs for products or 30.000 francs for services were authorised to conclude lump-sum contracts with the Administration which would exonerate them from any control. In parallel, an exemption for artisan was voted. All in all, the scope of the gross turnover tax decreased considerably.31

The legislative election was held on 11 and 25 May 1924 and the “Cartel des Gauches” was elected, notably on the promise to repeal the tax. However, for budgetary requirements, the promise was not ratified by the Finance Minister32 in the 1925 budget.33 Instead, to partly satisfy the claim of the protesters, one-off taxes were created to replace the gross turnover tax on some products.

c. Taxes uniques34

With the one-off taxes, the levy was performed at only one stage (the production stage). The determination of the rate was of utmost importance since it was necessary to establish the tax at a rate where, in one levy, the same amount of tax would be levied as with the gross turnover tax. In order to find out the rate, the number of stages that each kind of product was going through had to be calculated. With this number, an estimation of the yield of the cascading gross turnover tax could be obtained and a rate for the one-off tax could be determined:

…il était nécessaire pour chaque variété de produits, de prendre en considération le nombre de transactions auxquelles ce produit donnait normalement lieu dans le circuit économique et qui allaient échapper à la taxe à cascade.35

The one-off taxes succeeded in suppressing most of the fiscal distortions caused by the gross turnover tax. Essentially, the one-off taxes were not privileging vertical trusts and were more neutral towards exports. Between 1925 and 1936, more than 30 one-off taxes were created, the first two were for coal and meat.36 However, the lack of coordination of the gross turnover tax with the one-off taxes led to numerous cases of double taxation. It happened that ingredients subject to the gross turnover tax were part of a product that would itself be subject to a one-off tax, so there was an overlapping of the gross turnover tax with the one-off tax. Reform was again necessary but progress had been made. The notions raised in the 1920s with the experience of gross turnover tax37 and one-off taxes are that a consumption tax should neither impede the market by confusing or distorting production or consumption, nor should it deter businesses from the territory by hindering trade at both national and cross-border levels. These principles would at a later stage be included into the neutrality concept of VAT.

2) FORERUNNER

The April-May 1936 legislative election brought the “Front populaire”38 to power and then the taxation system was reformed. The law of 31 December 1936 abolished the gross turnover tax and most of the one-off taxes. The “taxe unique à la production”39 was implemented as a replacement with the aim to tax the products and services at only one point of their life cycle so that a great number of businesses would be freed from any tax liability.40 Three years later, in 193941 a “taxe d’armement”42 – in reality a gross turnover tax similar to that of 1920 – was created. In 1940 it was renamed “taxe sur les transactions”43 and, in 1941, an additional local tax was added to the tax structure.

In this context, the focus is brought to the single production tax (subsection a. below) together with its fractioned payment scheme (subsection b. below) for these are the precursor elements of VAT neutrality.

a. Taxe unique à la production

In 1936, the Popular Front government abolished the gross turnover tax and most of the one-off taxes to introduce the single production tax.44 The single production tax was a combination of two taxes: the so-called “taxe unique globaleThree years late45 and a tax on the supply of services which was the perpetuation of the 1920 tax regime. The change to a single global tax was intended to remedy the previously mentioned flaws existing under the 1920s system.

The purpose of the tax was clearly revealed in a report preceding the application decree of the 1936 reform where the reporter explained that the new tax was meant to restore tax equality between small and big businesses: “l’institution de la taxe unique … a visé à rétablir l’égalité des conditions fiscales entre la grande et la petite entreprise”.46

Levied at the end of the production cycle of the merchandise, the tax was a one-off tax and as such all but one of the stages of the production and commercial cycles were suspended from tax.47 The tax was imposed upon so-called sales-for-sales-for-use and on transactions performed by producers deemed similar to sales-for-sales-for-use, like self-delivery.48 Schematically, this means that if the sale to the consumer was the final sale, the tax was imposed upon the penultimate sale. Thus the sales made between merchants prior to the sales-for-sales-for-use were not subject to tax which means that producers active in those prior stages were allowed to receive the materials needed for the fabrication of the products tax free. The suspension was granted upon presentation to the vendor of a certificate attesting to the buyer’s registration with the administration. The attestation was to be renewed every year.49

Figure 2: the operation of the single production tax (suspension)

As a consequence of this suspension system, and as opposed to gross turnover tax, the single global tax was neither of a cascading nature nor of a compounding nature. The distortions existing under the 1920 system could no longer impede the equality of taxation of similar products or the equality of businesses notably in terms of margin capacity. As underlined by the Parliament in the preparatory discussions to the vote of the single production tax, the restraint on foreign trade seemed sidestepped as it was sufficient to not tax the final step of production to avoid the imposition of the tax upon the merchandise or the service:

Tout d’abord, en ce qui concerne les exportations, l’article 10 du projet de loi exonère les produits exportés de la nouvelle taxe de 6 p. 100: mesure excellente, qui aura d’heureux effets sur nos ventes a l’extérieur. Sous l’empire de la législation actuelle, l’article 15 du décret de codification de la taxe sur le chiffre d’affaires exonère de la taxe de 2 p. 100 les opérations de vente portant sur les marchandises exportées. Mais dans le prix de vente de ces marchandises restent incluses les diverses taxes de 2 p. 100 perçues en cascade à chaque stade antérieur de vente ou de transformation de la matière première. Le projet de loi qui vous est soumis donne satisfaction aux anciennes revendications de l’exportation française, désormais exonérée, non plus, de 2, mais de 6 p. 100. Notre production se trouvera donc en meilleure posture pour exporter, dans l’avenir, puisque chaque stade de fabrication se trouvera exonéré de charges fiscales notables.50

However, it was only a question of time before a new undesirable effect causing businesses to alter their structures was discovered. The initial rate of the tax was 6% and was raised in stages to 15.35%. The law implementing the tax had foreseen a decrease of 2% for small merchants but this was abolished in 1938 in order to place all merchants in a similar position. A reduced rate of 2% was instituted and progressively raised to 5.80% on certain services51 and to 6.35% on specific products (including coal, meat and electricity).52 This general increase in the rates participated to highlight a particular drawback of the tax.

As stated by the Council of State in a case that heralds the emergence of the neutrality principle,53 the aim of the single production tax was to create a tax that would not be levied more than once on a piece of merchandise.54 However, since the tax was levied on many business inputs a risk of cascading remained and a protective measure which took the form of “a régime suspensif …, exempting businesses from taxation of their physical inputs”55 was implemented. It took some years after the implementation of the tax for the determination of which inputs were materials needed for the fabrication of the products and which were not. Five categories were eventually distinguished, out of which the first two could benefit from the suspension of tax:56

raw materials and products used in the composition of products that would subsequently be subject to the tax;

products or materials that are being destroyed or rendered useless after their use in the fabrication process;

products that are not being destroyed upon initial usage but that are being rendered useless after a couple of uses in the fabrication process and that are referred to as “fast consumption” products. A 50% reduced rate of was allowed for these fast consumption products;

special tools made for a single use; and

tools in general.

Despite all the efforts, the suspension mechanism described above concealed an overtaxation of those goods that were physically consumed but economically resold through another product to which they were combined (hereafter referred to as the Production Agents). The overtaxation occurred by way of a superimposition of taxes in the sense that after the tax was levied on the Production Agents, the costs of these Production Agents, including the tax, were integrated to the selling price of the merchandise realised with the Production Agents. When the tax was levied on that merchandise, it was thus levied on an amount already comprising tax. The tax was consequently still accumulating from one stage to another. In respect of the rebate upon export, it could necessarily only be partial, thus hindering cross-border sales.

This being said, the then pervasiveness of the Malthusian model – which asserts that machinery is the cause of unemployment – alongside the fresh memory of the Great Depression, discouraged investment in Production Agents as Production Agents were often, although wrongfully, associated only with machinery. Thus, the government was, at best, indifferent to the overtaxation of Production Agents, and traders who did not necessarily have the tools to realise the existence of such overtaxation believed it was a matter of common interest to invest in labour rather than in potentially innovative machinery. In a nutshell, businesses were not willing to invest in machinery and were not equipped to realise the overtaxation imposed upon them on the rest of Production Agents and government was more preoccupied by the unemployment situation.

In 1939, despite the increase of the production tax rate by 3%, increased armament expenses and the budget deficit compelled the government to seek new resources. A new tax, initially called “armament tax”57 and later “transaction tax”,58 having the same cascading and compounding nature as the gross turnover tax was introduced. The system was completed in 1941 with a so-called “local turnover tax”, a one-off tax on retail sales.59 As a result, four turnover taxes co-existed and were sometimes applicable simultaneously to a single tax.

This system had its flaws and if this was most certainly not the cause of its collapse, lessons were again learnt from that experience. Mainly, the concept which would at a later stage be included into the neutrality concept of VAT would be that a situation of tax accumulation should be avoided.

b. Fractional payment

The deduction mechanism, also referred to as the subtractive procedure, appeared in 1948 with the implementation of fractional payments to the single production tax.60 Instead of transactions being performed tax-free further to the suspension mechanism, businesses paid tax on their expenditures and were allowed to offset that amount of tax against the tax they collected on their output that was meant to be remitted to the state.61 The analysis of this specific collection procedure (together with the before mentioned rate increase) underlines the issues of the single production tax that made businesses altering their organisation.

In September 1948, the Ministry of Finance introduced a major change in the collection procedure of the single production tax: each manufacturer “all along the line from raw material to finished commodity would pay a part of the tax”.62

Figure 3: the operation of the single production tax (fractional levy)

This functioning through fractional levies was not expected to create cascading as businesses would be entitled to a credit right for the tax paid on their expenditure. In line with the aim to tax only once each merchandise,63 the Council of State enshrined the principle of neutrality in a landmark case referring to the deduction mechanism:

…malgré son mode de paiement fractionné, [la taxe] n’a pas un caractère cumulatif et [permet] aux producteurs de se rembourser de la taxe qu’ils ont supportée lors de l’achat, tandis que la taxe supportée par eux lors de la vente leur sera remboursée par leur propre acheteur sur la facture duquel elle doit normalement figurer à raison de l’intégralité de son montant…64

The idea of functioning through fractional levies of tax from the successive economic actors appeared for a variety of reasons including the desire to put an end to the fraud widely practiced by retailers under the previous system.65 Under that system, fraud could not be avoided efficiently since the receipt of merchandise could be done in suspension of tax for businesses that were not at the end of the production cycle but that fraudulently subscribed to an option evidencing their entitlement to benefit from the suspension. Such fraud was not easily detected since the retailers’ claims against the 1920 restrictive tax regime had undermined the Ministry of Finance’s confidence in implementing a strong regulating system. However under the new mechanism, the risk of fraud was reduced as, instead of the option for suspension of tax, businesses would have a deduction claim at their disposal, but only after the payment of tax. The tax would thus be levied on all business purchases and the deduction of that tax would be linked to two elements. First, the prohibition of the reimbursement of the balance of tax deductible whenever it would exceed the amount of tax collected on sales, which practically meant that “la taxe déductible au titre d’une opération ne pouvait excéder la taxe due au titre de cette même opération”.66 This prohibition was known by the name “butoir”.67 Second, the use of the expenditures for which the tax deduction was requested, for business purposes. This change of levy method enabled the administration to cross-control information, that is to put in parallel the declared turnover of a business with the request for deduction of tax on costs from another business.

The second motivation for implementing the fractional levy mechanism was that the government saw an opportunity to quickly levy a significant amount of tax, “to increase [the tax] immediate yield”,68 at a time when the need for new resources was pressing. As a matter of fact, to receive US financial aid69 the French financial situation needed to be rationalised. The cabinet of the Ministry of Finance expected that the withdrawing of the tax suspension would derive 20 billion francs per month for three months. The reasoning behind the measure was that the tax would be levied on products from the start of their life cycle and thus the levy of the tax would be tightened.70 In reality, this mechanism placed the tax burden upon all the producers and the total tax collected remained the same as under the suspension regime. Since the new mechanism applied simultaneously to all producers, at the start and middle of the life cycle they would suffer a levy that they had not suffered under the previous mechanism, while producers at the end of the life cycle suffered a lower tax levy compared to the previous regime since the difference was levied at previous stages of the products’ life cycles. To (partly) remedy this unanticipated hurdle, the decree of application applied a difference of one month between the payment date and the authorization to deduct: the producers were given the right to deduct from the tax they collected on their sales on m+1 the tax paid on their purchases on m+0.71 In the first month, this mismatching provided additional tax revenue on the producers’ purchases to the state. The measure entered into force in September 1948.72

With the implementation of the deduction mechanism and of the fractional payments to production tax and with the increase of rate, the overtaxation of investments came to attention.73 Because the mechanism linked the deduction right of input tax with the realisation of sales, it directed the focus to the tax borne by and not deductible on Production Agents. André Muller in 1965 analysed the mechanism through which businesses became aware of a residual tax that was not deductible:

…le régime suspensif en dissociant l’imposition de l’acquisition des éléments… (achats bénéficiant ou non de la suspension de taxe), pouvait être générateur d’un  « éblouissement mental » empêchant de prendre clairement conscience du phénomène.

Le régime des paiements fractionnés, au contraire, en liant par la déduction de taxes les deux aspects de la question (l’imposition et la franchise), les mettait pour ainsi dire en corrélation et donnait donc un relief accru au phénomène de double imposition. Même un redevable modérément rationnel pouvait désormais devenir conscient du poids de l’impôt sur les investissements. Bref, la pression fiscale psychologique se trouvait augmentée.74

In fact, single production tax was hitting certain Production Agents such as investments as if they were the objects of final consumption: no refund of the tax paid upon the investments was granted to businesses. In a 2013 VAT guide, the authors indicate that the perception of the economic effect of Production Agents’ taxation has recently changed:

Not too long ago it was thought that a tax on consumption should cover not only consumption of goods in a literal sense, e.g. the ingestion and in general the “using-up” of products, but also the mere usage or application. The character of the tax should therefore result … in taxation of the use of machines, means of transportation and other means of production.75

Then, according to these authors, only in recent times has it become natural not to assume Production Agents are objects of final consumption for tax purposes. This analysis is, however, debatable. The idea of including Production Agents in the subtractive procedure notably existed (ie not letting Production Agents bear a tax burden like objects of final consumption) under a limited form around 1920 in the United States. While reconsidering businesses income tax, Thomas Sewall Adams launched the idea of a new tax which he entitled the “approximate net income” and that would be “a sales tax with a credit or refund for the taxes paid by the producer or dealer (as purchaser) on goods bought for resale or for necessary use in the production of goods for sale”.76 However under Adams’ proposal the subtractive procedure was limited to raw materials only. Later it was enlarged to include all investments with Carl Summer Shoup’s proposal.77 In the meantime in Canada, manufacturer’s sales tax was realising a detaxation of some Production Agents via the application of a tax exemption on some commodities purchased for use in production.78 Those examples show that considering the Production Agents as businesses’ final consumption has not just been called into question in recent times.

In France, the visibility of the overtaxation of Production Agents increased with the implementation of fractional payments for single production tax in 1948. However, no real care had been given to the matter before Maurice Lauré’s intervention in 1951. Maurice Lauré showed that to be worth turning away from immediate gain or additional production, investments must necessarily allow the producer to save a huge amount of time or to gain a huge amount of money to compensate for the time or gain lost on it. Indeed, businesses have to take risks (when investments are being made with debts), to turn away from immediate gain (when investments use the financial capacity of the company) and from additional production (when investments are being built by the business itself, and made with the company’s productive capacity) to favour investments. To the extent the investments are realised by businesses to save time and money, the systematic burden imposed by single production tax on Production Agents was an inhibiting influence on productivity: adding a tax burden to the investments encourages businesses to turn away from investments and thus productivity is affected. On the other hand, by giving tax relief to businesses on their investments, businesses are able to elect to invest in machinery or in staff without being influenced by the question of taxation. Frances M.B. Lynch summarises those thoughts by stating that the single production tax “impeded the investment necessary to raise labour productivity.”79

By altering, essentially for budgetary reasons, the structure of the production tax the legislator had, unknowingly made a major step towards the establishment of VAT.80 Next to the mere discovery of the hindrance on economic neutrality of the taxation of Production Agent, the double taxation which became increasingly heavy with the constant tax rate increase made emerged the idea to create a single tax with fractioned payment and full deduction of the tax paid. It was in fact inevitable that voices speak up to summon deductions of the tax paid on investments and overheads in addition to the existing deductions on Production Agents. A suspensive mechanism could have avoided the double taxation issue. However, the way back was blocked as the Treasury would have been forced to give back the resources which it had collected with the institution of the fractionated system. The first step of the reform was attained in 1953.81 The credit of this reform goes to the Minister of Finance, which, according to the Cahiers Fiscaux du Patronat Français considered that a bill had to be drawn on the future.82 The reform authorised the Minister of Finance to reduce temporarily the amount of tax levied on the Production Agents. This was realised by allowing the deduction of half the production tax charged on depreciable equipment excluding non-industrial buildings, vehicles and items of furniture or office.83 However, the detaxation of Production Agents was only partial in its scope and it was also limited in its period of application as the measure was limited to six months, from 1 October 1953 to 31 March 1954. Only one solution remained to eliminate the disadvantages of the system of fractionated payment and it was to headlong rush towards a new type of tax.

3) TAXESURLAVALEURAJOUTÉE84

The choice of VAT was aiming at promoting investment and the efficiency of the economy. Those were of the utmost importance in the 1950s as the country had to come to terms with the end of ERP while rebuilding itself following the devastating Second World War. Also, facing high military expenditure with the war in Indochina,85 the French industry needed to modernise and investment was the key to the future. That quest for economic efficiency is highlighted in the proposal that preceded the implementation of VAT (subsection a. below) as well as the early stages of existence of VAT (subsection b. below).

a. The proposal

In April 1952, with the academic support of Henry Laufenburger86 and under the leadership of Maurice Lauré who believed that VAT only could bring economic neutrality and thus efficiency, the Commission on Productivity and Taxation published an official report in favour of the adoption of VAT.87 Despite the fact that the report noted that VAT would raise labour productivity and that consequently tax receipts would rise too while the overall fiscal burden would fall, the publication of the report which overlapped with a change of government, remained confidential and achieved nothing.88

The leader of the new government, Antoine Pinay,89 set up a new commission which he named after its vice-chairman, Louis Loriot.90 The Loriot commission was tasked with searching for a tax system that would promote productivity and cross-border trade. It is of interest to note that the Loriot commission was working in an environment in which the question of fiscal neutrality of international trade was of the essence notably because of a tax dispute between France and West Germany that jeopardised the entry into force in 1953 of the common market for steel.91 Further to the dispute, the qualification as an indirect tax of the then in-place French single production tax was not absolutely secured. Should the qualification be denied, the tax borne by French exports would not have benefited from the right to be refunded at the border92 and thus French exports would have become more expensive than equivalent foreign products.

Maurice Lauré presented his findings to the Loriot commission. In his testimony he relates how he obtained the support of the Directorate-General for Taxation and eventually of the Loriot commission:

Le président Loriot, qui savait que j’appartenais à la Direction générale des impôts, se tourna vers le directeur général, Pierre Allix, qui, par fonction, assistait à toutes les auditions, et lui dit: « Voyons, Monsieur le directeur général, je ne comprends pas: voici M. Lauré, qui appartient à votre direction générale et qui est pour la TVA; or j’ai entendu tout à l’heure votre chef du Service de la législation, qui est intervenu contre la TVA. Quelle est donc la position de la Direction générale des impôts? » Pierre Allix prit une bonne minute de réflexion, et il dit finalement: « La Direction générale des impôts est pour la TVA ». Je n’avais qu’un soutien, à la DGI, mais il était de taille...93

At the same period, a VAT proposal limiting the deduction of investments to 50% and proposing a rate of 18.50% was introduced by the Government but it is the proposal of Maurice Lauré that won the favour of the commission. It succeeded in persuading rhe commission with its simplicity – VAT is levied on each transaction realised by all companies – and neutrality – VAT avoids the cascading effect of earlier turnover taxes.

Raymond Aron was so impressed by VAT proposal of Maurice Lauré that he called him a “prince de l’esprit…l’un des hommes les plus intelligents de France”.94 This is then that the Finance Minister promised to authorise, whether VAT would be voted in or not, the deduction of all the tax born on the investments without increasing the rate of the production tax. This promise was a decisive step towards the introduction of VAT as it curbed the proposed VAT rate to go sky-high in comparison with the production tax and that the issue of the rate was important for the vote of the law (beyond a certain limit, the reform would have caused too much resistance among the businesses for the Parliament to vote it).95

The proposal of Maurice Lauré had its critics. The socialist party notably is worth mentioning as it disagreed on the ground of the neutrality of the VAT. The socialists were of the opinion that the deduction should not be the principle but the exception so that only the investments in line with the public interest would not be overtaxed. Their justification was that the elimination of the overtaxation of investments would not permit an optimal allocation of production capacity but, a contrario, the overtaxation could be used in the framework of a command economy.96

b. The law

The Commission which had to decide on the arrangements for exercising the deduction rights adopted the principle of immediate97 and non-selective deduction of the tax paid on investments goods. Thus regardless of the critics, the VAT proposal of Maurice Lauré became law on 10 April 195498 and as stated by Denis Brunel, the resulting mechanism of VAT greatly promoted economic efficiency:

… en imposant à l’Etat de reverser immédiatement et à 100% la TVA que le producteur a payée sur l’achat de sa machine, le nouvel impôt favorise grandement l’investissement.99

However, it is worth noting that the reform was somewhat different from what Maurice Lauré was considering. He himself considered that his proposal was implemented in an impure form:

…je dus consentir bien des concessions, qui apparurent ensuite comme des verrues du système. Dans la plupart des débats, ce n’était pas la logique qui était à l’honneur.100

At first VAT was rather similar to the production tax. Some even commented that VAT was merely changing the name of production tax and allowing the deduction of the tax on investments.101 Nevertheless