The GST and Financial Services: Pausing for Perspective

Authors

  • Michael Firth PricewaterhouseCoopers LLP
  • Kenneth J. McKenzie University of Calgary

DOI:

https://doi.org/10.11575/sppp.v5i0.42399

Abstract

The treatment of financial services has long been viewed as one of the more technical, and difficult, areas in value added taxation. Financial intermediaries add value by reducing transaction costs for clients. While in principle this value added should be taxed under a comprehensive VAT, this has proven to be difficult to do in practice because of measurement issues.  The predominant approach adopted in most countries — albeit with several variations on the theme — has thus been to exempt most financial services from VAT. This was the approach adopted in Canada at the initiation of the GST just over twenty years ago. While this approach is far from perfect, and introduces several distortions into the economy, it has by and large been concluded that it is the most practical approach to dealing with financial services under a VAT. Two decades of legal wrangling and Ottawa’s habit of retroactively legislating changes to the GST as it relates to financial services have served to muddy the waters in Canada.  Recent changes have significantly altered the scope for exemption and resulted in an uneven playing field across financial services. This paper argues that the best solution for Canada is to stick with the exemption approach, but to go back to basics with an eye for reducing existing distortions and restoring a semblance of neutrality. Specifically, the paper calls for a reset of the “arranging for” exemption for financial services; the creation of a new GST-recovery system for financial services; a new structure for taxing imported supplies; and a limit to retroactive legislative amendments and minimum requirements for future amendments. The authors also argue that consideration should be given to zero-rating “business to business” financial transactions so as to remove the GST embedded in transactions between financial institutions and businesses.

References

Atkinson, Anthony and Joseph Stiglitz (1976), “The Design of Tax Structure: Direct versus Indirect Taxation,” Journal of Public Economics 6, 55-75.

Auerbach, Alan J. and Roger H. Gordon (2002), “Taxation of Financial Services Under a VAT,” American Economic Review, 92(2), 411-416.

Auerbach, A. and J. Hines Jr. (2002), “Taxation and Economic Efficiency,” Chapter 21 in Handbook of Public Economics, Volume 3, A. Auerbach and M. Feldstein eds., Elsevier Science.

Boadway, Robin and Michael Keen (2003), “Theoretical Perspectives on the Taxation of Capital Income and Financial Services,” in Patrick Honohan (Ed.), Taxation of Financial Intermediation: Theory and Practice for Emerging Economies, Washington, DC: The World Bank.

Browning, Martin and Costas Meghir (1991), “The Effects of Male and Female Labour Supply on Commodity Demands,” Econometrica 59(4), 925-951.

Corcoran, Terrance (1996), “Minister of Retroactivity,” op-ed column in Globe and Mail, Tuesday May 14, 1996.

Corlett, W.J. and D.C. Hague (1953), “Complementarity and the Excess Burden of Taxation,” Review of Economic Studies (21), 21-30.

Chia, Ngee-Choon and John Whalley (1999), “The Tax Treatment of Financial Intermediation,” Journal of Money, Credit, and Banking 31(4), 704-719.

Dasgupta, Partha and Joseph Stiglitz, 1971. “Differential Taxation, Public Goods and Economic Efficiency”, Review of Economic Studies, Vol. 38(114), pages 151-74, April.

Dasgupta, Partha and Joseph Stiglitz, Joseph E, 1972. “On Optimal Taxation and Public Production”, Review of Economic Studies, Vol. 39(1), pages 87-103, January.

Deaton, Angus (1981), “Optimal Taxes and the Structure of Preferences,” Econometrica 49, 1245-1260.

Diamond, Peter and James Mirlees (1971), “Optimal Taxation and Public Production I: Production Efficiency,” The American Economic Review 61(1), 8-27.

Diamond, Peter (1975), “A Many-person Ramsey Tax Rule,” Journal of Public Economics, 335-43.

de la Feria, Rita and Ben Lockwood (2010), “Opting for Opting In? An Evaluation of the European Commission’s Proposals for Reforming VAT on Financial Services,” Warwick Economic Research Paper No. 927.

Denis, D. J., and V. T. Mihov (2003), “The Choice Among Bank Debt, Non-bank Private Debt, and Public Debt: Evidence from New Corporate Borrowings,” Journal of Financial Economics, 70(1), 3–28.

Ebrill, Liam, Michael Keen, Jean-Paul Bodin, and Victoria Summers (2001), The Modern VAT (Washington: International Monetary Fund).

Economic Intelligence Unit (2010), “Canada financing: A hidden danger tax”, Economic Intelligence Units, Industry Magazine, The Economist Magazine.

European Commission (1997), Value Added Tax: A Study of Methods of Taxing Financial and Insurance Services (Brussels: European Commission).

Firth, Michael (2006), A Confluence of Uncertainties: The GST and Financial Services, CICA 2006 Commodity Tax Symposium.

Firth, Michael and Wurts, Brian (2008) GST and Pension Funds; The Hole Story (CICA Commodity Tax Symposium)

Firth, Michael (2010a), “‘No new taxes?’ No: new taxes. Definitely new taxes,” CCH GST Monitor, Sep, no 264

Firth, Michael (2010b), “GST Exemption of Financial Intermediation or “Arranging for” (CICA Commodity Tax Symposium)

Gendron, Pierre-Pascal (2008), “VAT Treatment of Financial Services: Assessment and Policy Proposal for Developing Countries,” Bulletin for International Taxation, 62(11): 494-507.

Grubert, Harry and James Mackie (2000), “Must Financial Services Be Taxed Under a Consumption Tax?,” National Tax Journal, 53(1), 23-40.

Huizinga, Harry (2002), “A European VAT on Financial Services?,” Economic Policy, October.

Kaplow, Louis (2006), “On the Undesirability of Commodity Taxation Even When Income Taxation is Not Optimal,” Journal of Public Economics 90, 1235-1250.

Kopczuk, W. and J. Slemrod (2006), “Putting Firms into Optimal Tax Theory,” American Economic Review (Papers and Proceedings) 96(2): 130-34.

Kleven, H.J., W. Richter and P.B. Sørensen (2000), “Optimal Taxation with Household Production,” Oxford Economic Papers 52, 584-594.

Lockwood, Ben (2010), “How Should Financial Intermediation Services be Taxed?,” Warwick Economic Research Papers No. 948.

Meade, James, ed. (1978), The Structure and Reform of Direct Taxation. London: Allen & Unwin.

Murray, Brent (2009), “Input Tax Credit Entitlement as Determined by the Courts,” (CICA Commodity Tax Symposium)

Piggott, John and John Whalley (2001), “VAT Base-Broadening, Self-Supply and the Informal Sector,” The American Economic Review 91(4), 1084-1094.

Poddar, Satya and Morely English (1997), “Taxation of Financial Services under a Value-Added Tax: Applying the Cash-Flow Approach,” (1997) National Tax Journal Vol. 50, No.1, 89-111.

Poddar, Satya (2003), “Consumption Taxes: The Role of the Value-Added Tax,” in Patrick Honohan (Ed.), Taxation of Financial Intermediation: Theory and Practice for Emerging Economies, Washington, DC: The World Bank.

PriceWaterhouseCoopers (2011), How the EU VAT Exemptions Impact the Banking Sector: Study to assess whether banks enjoy a tax advantage as a result of the EU VAT exemption system.

Rosen, H., J-F Weh, T. Snoddon, T., B. Dahlby. and R. Smith (2008), Public Finance in Canada, 3rd edition. McGraw-Hill.

Smart, Michael (2012), “Departures from Neutrality in Canada’s Goods and Services Tax,” SPP Research Papers, Volume 5, Issue 5, February. The School of Public Policy, University of Calgary.

Zee, Howell H (2006), “VAT Treatment of Financial Services: A Primer on Conceptual Issues and Country Practices,” Intertax 34(10): 458-74.

Downloads

Published

2012-09-14

Issue

Section

Research Papers