Canadian Government's review and study of Goods and Services Tax.
Tax Executives Institute is pleased to submit the following comments to the Standing Committee on Finance of the House of Commons in connection with its analysis and review of the Existing Goods and Services Tax (GST) and, further, to make recommendations on proposals to replace, retain, reform, or otherwise improve the administration of, and compliance With, Canada's GST.
Tax Executives Institute, Inc. is an international organization of approximately 4,800 professionals who are responsible--in an executive, administrative, or managerial capacity--for the tax affairs of the corporations and other businesses by which they are employed.
Canadians make up approximately 10 percent of TEI's membership, with our Canadian members belonging to chapters in Calgary, Montreal, Toronto, and Vancouver, which together make up one of our nine geographic regions. In addition, a substantial number of our U.S. members work for companies with significant Canadian operations. In sum, TEI's membership includes representatives from most major industries, including manufacturing, distributing, wholesaling, and retailing; real estate; transportation; financial; and natural resources (including timber and integrated oil companies). The comments set forth in this submission reflect the views of the Institute as a whole, but more particularly those of our Canadian constituency.
TEI has historically been concerned with issues of tax policy and administration and is dedicated to working with government agencies in Ottawa (and Washington), as well as in the provinces (and the states), to reduce the costs and burdens of tax compliance and administration to our common benefit. We are convinced that the administration of the tax laws in accordance with the highest standards of professional competence and integrity, as well as in an atmosphere of mutual trust and confidence between business and government, will promote the efficient and equitable operation of the tax system. In furtherance of this principle, TEI supports efforts to improve the tax laws and their administration at all levels of government.
Among TEI's principal objectives are the gathering and dissemination of information on tax issues of wide concern and the development of responsible positions that reflect not only the diversity and professional training of our members but also an appreciation for the practical aspects of tax administration and business decisions. In addition, we strongly believe that tax legislation should be fully consistent with the goals of economic growth, clarity, and competitiveness.
II. Purpose of Studying Canada's GST
TEI endorses the Committee's comprehensive review and study of the GST. Anecdotal and empirical evidence concerning the levels of compliance with the present GST suggests that there are systemic problems that must be remedied by legislative action. While we concur that the study should proceed, we must acknowledge a diversity of opinion within our membership concerning specific provisions of the GST and its possible alternatives. Notwithstanding our lack of consensus on specific provisions, we believe there are certain principles that should guide the Committee through its review of the complex issues. Moreover, we urge the Committee to proceed with its deliberations.
III. Lessons Gleaned from Experience with GST
Before reviewing alternative tax systems to replace the GST or considering specific GST reform measures, we believe the Committee can profitably review the issues and problems associated with the wholesale substitution of the GST for its predecessor, the Federal Sales Tax (FST).
A. Costs of Implementation and Ongoing Compliance
The cost to changeover from the FST to the GST was enormous for large and small businesses alike. For large manufacturers, the cost of changing accounting and management information changes was likely in excess of $1 million per taxpayer. For financial institutions, the cost was even greater. And for retailers, the cost of implementing GST was astoundingly high, with one retailer's transition costs alone approaching $25 million. These estimates do not include the substantial opportunity cost arising from diversion of
administrative staff from more productive pursuits to study and implement systems to collect, remit, and account for GST inputs and credits. The exorbitant transition costs are attributable to the need for business to sort through the layers of complexity embedded within the GST system.
After incurring the initial transition costs, large businesses have developed routine procedures to administer their GST obligations. This has enabled taxpayers to manage the GST compliance burden and control its attendant costs. As a result, annual costs to comply with GST for most large businesses trended downward and leveled off as experience and familiarity with the new system increased. Administrative costs, however, to comply with GST have begun to rise in line with the inflation rate. Current estimates of annual administrative costs to comply with the GST range from 8;100,000 to $500,000 per large taxpayer, with a total cost to small business of approximately $1.2 billion throughout Canada.
Over a fairly wide range of transactions, the administrative cost of complying with the GST tends to be fixed. Because of their relatively small volume of transactions, smaller businesses--especially those with fewer than five employees--have likely not benefitted from the economies of scale that larger businesses have been able to achieve. As a result, the burden of annual administrative compliance costs for small businesses has not decreased to the same degree as costs have declined for larger companies. The cost of administering the GST and provincial retail sales taxes has impaired small business entrepreneurship and so eroded small business profits that strong incentives may exist to evade the tax. The danger, of course, is that noncompliance tends to feed upon itself as compliant small businesses find that themselves tempted to adopt the practices of noncompliant competitors in order to survive.
In assessing whether to revise or supplant the GST, the Committee should eschew any system that would impose a substantial transition cost upon business or increase the annual cost of compliance above those already incurred. Specific recommendations concerning the treatment of smaller businesses are summarized in section VI.
One favourable aspect of the GST is that it permits Canadian businesses to compete fairly with foreign businesses within Canada, whereas the FST perversely discriminated against Canadian-based producers. In addition, the GST enables Canadian businesses to be more competitive outside Canada than was possible under the FST. Enhancing or, at a minimum, maintaining the competitiveness of Canadian business is vital to preserving the Canadian economy.
C. Visibility of the GST
One factor contributing to public antipathy toward the GST is the perception that GST was an added, rather than a substitute, tax. When GST is added to the pre-existing provincial retail sales taxes, the total invoiced price of goods seems exorbitant. The FST, on the other hand, was generally invisible to all but manufacturers who were compelled to bear its cost and recover it, if at all, by passing the tax through to customers as part of the overall price of goods rather than as a separate item on the invoice.
TEI believes that taxes should, as a general principle, be visible in a democratic society. Taxes are the means of funding the necessary cost of government services and should be disclosed in some fashion that permits identification of the amount of taxes paid and imposes a significant measure of accountability on the government. This statement of principle, however, does not dictate that one form of disclosure be used exclusively. Indeed, the specific means of disclosing the tax paid requires balance and care to prevent confusion in the marketplace over the true price of goods and services. It would, for example, create confusion to have some goods and services sold at a tax-inclusive price while others are sold with taxes separately added to the invoice.
IV. Principles of Reform
A. Transition and Administrative Costs
The cost to business of implementing the GST were both extraordinarily large and involuntarily incurred. These compliance costs, especially those associated with costs of establishing new administrative systems, represent an overhead expense that will likely not be recovered from customers. Likewise, the government was compelled to divert substantial expenditures to develop a system for administering the GST and to provide training and education for its employees.1 Consequently, any alternative system should be designed to avoid such substantial transition costs.
To benefit from the administrative and compliance systems in place, a replacement tax should be structured in a fashion similar to the GST--i.e., the value added by each enterprise in successive stages of the production and distribution process should be subject to tax, but only to the extent of the value added. Without a mechanism for recouping taxes paid to suppliers, cascading taxes will result. In order to minimize economic inefficiency, the system should permit businesses to recover fully the taxes embedded within their purchases. We believe that the best means to achieve the government's goals is to retain the basic principles embodied in the GST and to limit the changes to incremental improvements that promote compliance and increase the overall efficiency of the system. In any event, substantial transition costs must be minimized to prevent a self-inflicted wound to Canada's still fragile recovery.
The current GST system incorporates two attributes consistent with the value-added tax systems employed by most industrialized countries. First, although the tax is collected in stages in the production and distribution of goods or services, the incidence of the tax rests upon the ultimate consumer of those goods or services. Second, the GST is based on the destination principle. Consequently, imported goods sold in Canada are subject to the tax in the same fashion as domestically produced goods, while exports are relieved of the tax through a border adjustment. Incorporating the destination principle in the system permits Canadian businesses to compete more effectively on price terms with foreign businesses, both within Canada and abroad. This aspect of the GST should be retained in an alternative system.
C. Public Acceptance
No tax system will ever be popular. What is fundamentally necessary is that taxpayers understand that taxes are the price paid for a civilized society. They must also understand that the amount to be collected must correspond to the level of government expenditures and that those expenditures are driven by the demand for government services or programs. Thus, in enacting a replacement tax, the government must ensure that the new system is viewed as such (and not as an additional tax). The GST experience has underscored the need for taxpayer education and acceptance. It is incumbent upon the government to demonstrate that a revised GST system or its alternative will redound to the benefit of all Canadians. We set forth specific recommendations to improve the GST in section VI.
D. Federal-Provincial Harmonization
Since the inception of the GST, the provinces have opted to retain their separate retail tax systems. The lack of harmonization creates confusion and expense for taxpayers who must interpret and comply with differing definitions, exemptions, rates, etc., with respect to the tax imposed on the sale or provision of various goods and services. In commenting on the 1989 tax reform, TEI expressed regret that the reform proposals then under consideration did not encompass the provincial sales tax systems. TEI advised that an integrated federal-provincial program would clearly be preferable because it would reduce the complexity and administrative costs associated with separate tax systems. The experience of taxpayers in the years since the GST came into force has borne out our observation that a truly workable system requires a "piggyback' mechanism to facilitate the expeditious implementation of a joint system.
To increase Canadian competitiveness, full and complete harmonization--i.e., an identical tax base with a single tax rate and a unified administrative system for the federal and provincial taxes--is necessary. The long-term objective should be to establish a unified federal and provincial multi-stage sales tax. We recognize, however, that it may be unrealistic for all the provinces to opt into the system by the proposed January 1, 1996, effective date for a revised system. Accordingly, the system should be flexible enough to permit the provinces to elect to participate in the revised system under a schedule that accommodates their special transitional concerns. Moreover, in the event that constitutional restrictions are viewed as a barrier to achieving full harmonization, TEI urges the government to refer the issue to the Supreme Court of Canada for a ruling whether constitutional amendments are necessary and, if so, what changes will permit the federal and provincial governments to administer jointly a harmonized VAT.(2)
E. Expanded Tax Base With Lower Rates
One issue that a tax system must grapple with is the delicate balance between, on one hand, complexity and fairness (or neutrality) and, on the other, simplicity and the ability to comply with and pay the tax. Although it may not be possible to craft a truly simple GST, TEI believes that an expansion of the tax base coupled with a decrease in the overall rate of tax will improve compliance and diminish the incentives to evade the tax system. Thus, the Committee should consider decreasing the number of exempt items (especially business supplies) and exempt entities. Concomitantly, the tax rate could be reduced and the threshold for GST registration by small businesses could be increased without materially affecting the amount of revenue flowing to the fisc.
Accountability for both revenue and expenditure decisions is crucial in maintaining a government's credibility and legitimacy. Consequently, TEI believes that the GST, or its replacement, must be "visible" to taxpayers. Should the Committee determine that the price of goods or services be rendered on invoices as a tax-inclusive price, then, we recommend that the sales invoice or slip show the vendor's registration number and also a include statement to the effect that "The invoiced price includes federal tax of 'x' percent and provincial tax of 'y' percent." The disclosure of the tax rate will enhance government accountability, even though the amount of tax must be computed by the customer.
G. Financial Institutions
Taxing financial institutions under a value-added tax system is problematic. Increasingly, the financial marketplace is global in scope; borrowers seek the best price or rate in capital and money markets throughout the world. The trend toward international competition and globalization in financial services, moreover, will likely continue. As a result, it seems unfeasible to subject financial products to a value-added tax without rendering Canadian lenders uncompetitive. To permit Canadian financial institutions to remain competitive, TEI recommends that the GST's zero ratings for financial products be retained with slight modifications.
Our proposed modifications relate to the taxation of deemed financial institutions. We recommend (1) increasing the dollar amount for the de minimis threshold and (2) revising the de minimis threshold from a gross financial income test to a net financial income test. TEI does not believe, for example, that a business should be subject to the rules for financial institutions merely because it issues credit cards as means of increasing customer loyalty and not as a source of significant net financial revenue. In other words, the replacement tax should distinguish between an issuer of a general purpose credit card (as are issued by financial intermediaries), which may be used at any participating vendor, and an issuer of company-specific credit card, which is generally limited in use to the purchase of goods or services at a particular company. In addition, a manufacturing company should not be considered a financial institution merely because it receives a substantial amount of interest from temporary investment, or in connection with a large tax refund. Therefore, TEI recommends that the de minimis threshold be revised as the greater of 25,000,000 or ten percent of net financial income rather than gross income.
V. Alternative Tax Systems
TEI believes that a modified version of the present GST represents the best alternative among the competing proposals. Our recommendations to improve the present system are contained in section VI. Before discussing those modifications, we offer the following comments on several alternatives. Broadly speaking, the alternatives fall into two categories: (1) a single-stage, retail-level sales tax imposed on and collected from the consumer; and (2) varying forms of value-added taxes collected directly at levels preceding the consumer level and recovered indirectly from the consumer through the retail-level price.
A. Single-stage Retail Sales Tax
TEI opposes a single-stage retail sales tax as an alternative to the GST. Experience with single-stage sales taxes at the provincial level demonstrate that (1) businesses have difficulty recovering taxes embedded in their suppliers' invoices and (2) the potential for tax evasion is much higher. Either of these deficiencies should, in our view, cause the Committee to reject a single-stage retail sales tax as a viable replacement for GST.
B. Payroll Tax
Another proposed alternative to the GST is a new payroll tax. A payroll tax is a form of pre-retail level value-added tax levied solely on the wage component of production. TEI believes that a payroll-based tax should be rejected as the worst form of pre-retail level substitute for GST. Admittedly, payroll costs are a proxy for the value added by any enterprise, but the tax paid by business suppliers is not directly recoverable by subsequent business purchasers. Consequently, significant exposure to cascading tax liabilities results. Indeed, a payroll tax would be similar in effect to the FST because it would favour the purchase of imported goods or services over domestically produced goods. Furthermore, without some form of rebate (which may well be illegal under the General Agreement on Trade and Tariffs), exports of domestically produced goods and services will be more expensive to foreign purchasers and consequently uncompetitive to the extent of the embedded payroll tax. Finally a new payroll tax could trigger an inflationary wage spiral seriously hindering economic recovery and job creation or retention. TEI strongly recommends against the substitution of a payroll tax for GST.
C. Business Tax
Another form of pre-retail, value-added tax is the business transfer tax (BTT). Broadly speaking, there are several variations of business transfer tax or subtractive method value-added taxes.(3) We refer to these systems collectively as business taxes (BT) because of the widespread notion that the tax is borne by business, even though the tax is collected directly from the consumer in the ultimate price paid for goods or services. The tax base for BTs share the following features:
* An enterprises's net taxable income is determined under the Income Tax Act;
* Untaxed inputs, such as payroll and interest expense, are added back;
* Net investments (disinvestments) in capital assets are subtracted (added back) and deductions for capital cost recovery amounts are added back; and, finally,
* The net result is adjusted further to remove export sales or profits.
The tax rate is applied to the resulting tax base to determine the tax liability. Under this scheme, the tax liability is computed, in effect, like the GST on the untaxed inputs and domestic profit of each business enterprise. Unlike the GST, the tax is not imposed and collected on a transaction-by-transaction basis. Generally, installment payments may be computed and paid on under this method at various times throughout the year (either monthly or quarterly) and an annual return may be filed with any balance due payable with the return.
The advantages of a BT are:
* Only the value added at each level of distribution is subjected to tax;
* After the transitional costs to establish the necessary information systems are incurred, the tax is relatively simple for taxpayers to compute and pay and similarly easy for the government to collect and administer;
* The requirement to account for and document the tax paid with respect to each purchase is eliminated;
* No distinctions need be made among types of retail-level purchasers;
* Full harmonization is easier to achieve;
* There is no need to provide special rules for tax-exempt entities inasmuch as the starting point in the determination of tax liability is the Income Tax Act;
* The retail-level tax may be separately stated or not;
* The tax likely will be perceived as falling upon businesses rather than consumers;
* Tax return filings may be reduced to one per year, with multiple instalment payments to accelerate revenue for the government, thereby reducing government and taxpayer administrative costs; and
* The proper level of small business exception from filing may be set without affecting competition on retail pricing.
Were the Committee to design a new replacement system with a clean slate, a business tax holds considerable theoretical appeal. Practically speaking, though, adopting a BT would require the implementation of another totally new administrative and compliance system--the cost of which would likely dwarf the cost incurred in the transition to GST. In terms of both actual expense and further loss of productivity from the diversion of employee time, the likely substantial transition costs present a serious and fundamental drawback that speaks forcefully against enacting a BT.
Moreover, there are additional disadvantages to the BT. For example, financial institutions would require special rules, adding to the complexity of the system. Furthermore, government revenues would be less predictable and more volatile because the starting point for the determination of the BT would be net income under the Income Tax Act. As a result, revenues from the federal government's two principal tax systems would tend to increase and decrease in line with the rise and fall of the economy. Finally, it is difficult to provide exemptions under a BT-type tax.(5)
VI. Alternative Tax System-Summary
To establish and maintain a sound economy in Canada, the tax system must meet certain essential criteria. First and foremost, it must produce revenues sufficient to fund essential government services and programs. Second, it should encourage (or, at a minimum, not discourage) job creation and retention. Third, it must not harm the competitiveness of Canadian businesses, either in Canada or in foreign markets. Fourth, the implementation costs and complexities of any alternative system must be minimized. Fifth, the operational costs of an alternative system must be minimized. Sixth, harmonization of the federal and provincial systems, with an identical tax base and administrative practices must be attainable. Finally, the public must be convinced of the fairness and necessity of the tax system.
To achieve these objectives, the Committee should favorably consider a multi-stage, value-added tax highly comparable to the present GST system. Certain modifications to improve the structure and operation of the GST, however, are desirable. In particular, the Committee should --
(1) Substantially increase the threshold amount for registration;
(2) Expand the tax base to the maximum feasible including, for example, basic groceries and prescription drugs.
(3) Reduce the number of exempt supplies and entities to minimize the complications of the GST.
(4) Reduce the tax rate such that any increase in revenue from (2) and (3) is offset by a decrease arising from items (1) and (4).
(5) Provide for the inclusion of GST in the listed price of goods or services, subject, though, to a requirement that the sales slip or invoice show both the vendor's registration number and the statement that "The price includes both federal tax of |x' percent and provincial tax of |y' percent.'
The rationale for recommendations (2) through (5) have been previously discussed. The increase in the threshold for registration will yield cost reductions for both small businesses and the government. TEI believes that one substantial improvement to the current system would be raising the $30,000 threshold amount for GST registration. Retaining the present value-added structure and increasing the threshold registration amount tenfold would reduce the number of GST registrants by more than half.(6) Eliminating a large number of smalI registrants would likely reduce government administrative costs by as much as 50 percent, while reducing the next government revenues by a fraction of that amount.(7)
To mitigate the effect of the proposed expansion of the GST tax base, the Committee should also consider providing additional GST relief to low-income persons. In the event that such relief is deemed proper, we recommend that an increase in the refundable GST amount would be the proper mechanism since the necessary, administrative system to distribute such refunds is operating well.
TEI is pleased to have the opportunity to present its views on the Committe's study and review of alternatives to replace or reform Canada's GST. Should you have any questions on our comments please call either Hugh D. Berwick, TEI's Vice President for Canadian Affairs, at (514) 848-8235 or Paul J. DeWinter, Chair of our Canadian Consumption Tax Committee, at (416) 968-4506. (1) The Auditor General, Mr. Denis Desautels, has estimated that the implementation of the GST in 1990 cost $820 million in start-up costs and an additional $900 million in support payments to small businesses preparing for the new tax. (2) The government of Quebec has already announced its intention to refer the question to the Supreme Court. TEI urges the federal government to support the referral. (3) For a more complete description of the operation of various forms of business value-added taxes, we refer the Committee to the book written and published by TEI in November 1992. The book, Value-Added Taxes: A Comparative Analysis, is included as an attachment to the submission. (4) The unpredictability of the government's revenues from the BT would also be exacerbated by the all-too-frequent amendments to the Income Tax Act. (5)A tax in the form of a BTT has been enacted by the State of Michigan. A number of studies of Michigan's Single Business Tax have been performed and may provide further background for the Committee. (6) Setting the registration threshold requires a delicate balance between administrative and compliance savings for the government and taxpayers on one side and conferring undue competitive market advantages upon viable businesses on the other. Indeed, the threshold at which a business is truly viable will vary from industry to industry and our recommended $300,000 threshold may be excessive in certain cases (e.g., restaurants and retail convenience stores). (7) Nonetheless, we believe a small business should be able to elect to participate in the system even though its gross revenues do not exceed the threshold amount. The choice between incurring additional input taxes or administrative costs should lie with the taxpayer.
|Printer friendly Cite/link Email Feedback|
|Title Annotation:||Tax Executives Institute|
|Date:||May 1, 1994|
|Previous Article:||Taxpayer involvement in competent authority process.|
|Next Article:||Ontario Government's response to TEI's comments on 1993 budget proposals.|