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March 29, 2012
U.S. Taxes Corporate Income at Comparatively Low Rate

Full Text Published by Tax Analysts®

By Andrew Pike

Andrew Pike is a professor at American University's Washington College of Law.

The author thanks Barbara Sarshik and Elizabeth Pike for their substantive and editorial comments and suggestions, and Katherine Gibson and Christopher Woo for their valuable research assistance.

In this report, Pike argues that the United States does not tax corporate profits at a relatively high nominal rate.


Table of Contents

I. Introduction

II. Analysis of OECD Data


    A. Nominal Corporate Tax Rates

    B. Analysis of Data: VAT and Aggregated Data

    C. Conclusions From the OECD Data


III. The VAT Incorporates a Business Profits Tax

    A. Introduction

    B. Basic Operation of the VAT

    C. Conclusions About the VAT


IV. Conclusions

V. Appendix


I. Introduction

Andrew Pike Politicians and analysts of all ideological stripes agree on one -- and perhaps only one -- attribute of the tax system: The nominal U.S. corporate tax rates are among the highest of OECD countries.1 U.S.-based multinationals argue that the U.S. corporate tax hinders their ability to compete in markets outside the United States. Some policymakers, politicians, and lobbyists have asserted that the high U.S. corporate tax rates are partly responsible for the competitiveness problem. To remedy that perceived problem, they have proposed a simple and neat solution: Lower the nominal corporate tax rate.2 The reduction in corporate tax rates, however, would not be limited to the offshore profits of multinationals. Rather, it would apply to all corporate income, from both foreign and domestic sources.

This report challenges the conventional wisdom by asserting that the United States imposes a relatively low nominal tax rate on the corporate sector compared with other OECD countries. That conclusion results from two factors. First, corporations (and other businesses) in many OECD countries are VAT payers. Second, a business VAT payer computes its VAT liability based on its value added. Over the course of a year, that measure includes corporate profit that is comparable to the U.S. corporate tax base. Consequently, the imposition of the VAT represents an additional nominal tax imposed at the VAT rate on corporate profits. When one accounts for that additional nominal tax on corporate profits, the correct comparative picture comes into focus: The United States no longer is a high-tax-rate jurisdiction.

Policymakers often give independent weight to nominal tax rates as a separate policy concern in their public statements.3 For that reason, this report focuses exclusively on nominal tax rates -- that is, the numerical rates specified in tax statutes.

Despite that focus, one must acknowledge that effective tax rates are the more significant measure of the actual tax burden facing taxpayers. The code contains tax expenditures and other provisions that reduce the effective rate incurred by U.S. corporations.4 Also, passthrough entities conduct a large and growing share of business activity in the United States.5 The combined effect of those factors is that despite a relatively high nominal corporate tax rate, the overall effective tax rate imposed on U.S. corporations may be much closer to the effective tax rates of the major OECD trading partners.6

In addition to the overall effective tax rate of U.S. corporations, analysts have focused on the actual tax burden borne by U.S. multinationals on their foreign operations. Many U.S.-based multinationals take advantage of foreign tax havens to greatly reduce their overall tax burden.7 As Martin Sullivan and Edward Kleinbard have demonstrated, some multinational companies both benefit from low tax rates in tax haven jurisdictions and deduct against their domestic income interest costs that are economically attributable to their foreign operations. In effect, multinationals use those arrangements to shift, for tax purposes, their U.S. profits to their offshore tax havens.8 Rather than creating excessive burdens, U.S. tax treatment of the foreign operation of the multinationals' non-U.S. operations may in fact permit multinationals to reduce the net U.S. tax burden on their domestic operations. While recognizing the importance of those effective rate issues, this report leaves it to others to analyze the effective tax burden facing U.S. corporations, particularly on their foreign operations.

This report consists of three parts. First, the report analyzes the OECD data on corporate tax rates and VAT rates. Second, the report examines the basic structure of the VAT and its treatment of routine business expenses, capital expenditures, wages, and other compensation expenses. Also, it discusses the scope and consequence of exemption and the treatment of cross-border transactions under the VAT. Third, the report concludes that: (1) a tax on corporate profits is embedded within the VAT; and (2) the United States taxes corporate profits at a lower rate in comparison with other OECD countries.


II. Analysis of OECD Data

A. Nominal Corporate Tax Rates

For the last several years, analysts have drawn attention to the nominal tax rate that major industrial countries apply to corporate income. Analysts often derive their data from statistics that the OECD annually publishes, including a set of tables on corporate and capital income taxes.9 OECD Table II.1 reports the basic (non-targeted) corporate income tax rates for the central governments, subcentral governments, and the net combined nominal rate of taxation.

1. Central government corporate income tax rates. Appendix Table 1 contains the central government corporate income tax rates (the central government rate) and the combined national and sub-national corporate income tax rates (the combined rate) for each OECD member country from the OECD data for the year 2011. For purposes of the OECD data, the central government rate equals the basic statutory rate of tax that the central government imposes in its corporate tax law.10 If the corporate tax law uses a progressive rate structure, the central government rate included in the OECD data is the highest marginal corporate tax rate.11 The OECD data reflect the nominal statutory rates: No adjustment is made to reflect deductions or other provisions of law that reduce the tax burden of corporate taxpayers. Applying that method to the United States produces a central government rate of 35 percent.

A simple scan of the Central Government Corporate Income Tax Rate column of Appendix Table 1 demonstrates, in accordance with the accepted wisdom, that the United States imposes the highest central government nominal rate of corporate taxation of the OECD member countries. Among the other OECD members, the countries with a high central government nominal corporate tax rate are large economies like France (34.4 percent), Japan (30 percent), Spain (30 percent), Australia (30 percent), Italy (27.5 percent), and the United Kingdom (26 percent). The OECD countries with the lowest central government tax rate are Switzerland (8.5 percent) and Ireland (12.5 percent).

2. Sub-national corporate income tax rates. In eight OECD member countries, sub-national governmental authorities also impose taxes on corporate income.12 The OECD follows several steps to take the sub-national corporate income tax rates into account to derive a combined national corporate tax rate.

In the first part of the process, the OECD derives a single sub-national corporate tax rate. It may base that rate on the rate from a representative city or an average of subcentral rates.13 For the United States, the rate is calculated "by summing for all states the lowest corporate income tax rate (or the flat rate) in each state weighted by the state's share in personal income."14

In the second part of the process, the OECD analyzes whether the tax imposed at the sub-national level is deductible when computing the corporate income tax at the national level. Of the eight OECD member countries with sub-national corporate income taxes, only Japan and the United States permit a corporation to deduct the sub-national tax against its income when calculating its national corporate income tax liability.15 The OECD reflects that interaction in what it terms the "adjusted central government corporate income tax rate." For the United States, the deduction for sub-national corporate taxes reduces the adjusted central government rate to 32.7 percent.16 Of the other OECD member countries, both France (34.4 percent) and Belgium (34 percent) have adjusted central government corporate tax rates that exceed the U.S. rate.17

3. Combined national and sub-national corporate income tax rates. The final set of OECD comparative nominal tax rate data looks at the combined national and sub-national corporate income tax rates (combined corporate tax rates). Those combined rates represent the sum of adjusted central government rates and the sub-national corporate tax rates discussed above. Appendix Table 1, column 3 reports the OECD combined corporate tax rates. For the United States, the combined corporate tax rate equals 39.2 percent. Among the other OECD countries, only the combined corporate tax rate in Japan (39.5 percent) exceeds that of the United States. Apart from France (34.4 percent), Belgium (34 percent), and Germany (30.2 percent), no other OECD country has a combined corporate tax rate exceeding 30 percent.

As with the central government corporate tax rates, the conclusion drawn from a review of the OECD combined corporate tax rate data in Appendix Table 1 is also consistent with the accepted wisdom. The United States imposes the highest combined corporate tax rates of the OECD members, apart from the slightly higher Japanese combined corporate tax rate. Moreover, the relatively high rates of sub-national taxes in the United States result in a greater disparity between the U.S. combined corporate tax rate and the rates of the other high-rate OECD member countries (other than Japan).

But that does not tell the full story.

B. Analysis of Data: VAT and Aggregated Data

As discussed in Part III below, the VAT is properly viewed as incorporating an additional nominal tax on most domestic business profits, including profits generated by most corporate entities. Therefore, in countries where a VAT exists, corporate income is taxed under both the corporate tax laws and the VAT. If the nominal rate of taxation that applies to corporate income is important, then the relevant measure is not merely the corporate income tax rate. The more accurate measure is the sum of all tax rates that are imposed on corporate profits.

In the United States, corporate income taxes (imposed at both the national and sub-national levels) are the only taxes imposed on corporate profits. All of our significant trading partners, however, impose VATs in addition to taxes on corporate income. For those countries, the total nominal rate of taxation imposed on corporate profits equals the sum of the corporate tax rates plus the VAT rate.

Appendix Table 2 lists the VAT rates for the OECD countries in 2011. According to the data in Appendix Table 2, VAT rates in OECD countries range from a low of 5 percent (in Canada and Japan) to highs of 25 percent (in Denmark, Hungary, Norway, and Sweden) and 25.5 percent (in Iceland). Within the European Union, the minimum standard VAT rate is 15 percent,18 although each member state may apply reduced rates of VAT to specified goods and services.19 As a result, the standard VAT rate among the EU members ranges from 15 percent (in Luxembourg) to 25 percent (in Denmark, Hungary, and Sweden).

Appendix Table 3 sets out the aggregate nominal tax rate imposed on corporate profits in OECD countries. For purposes of this report, the term "aggregate nominal tax rate" equals the sum of the country's VAT rate and combined corporate tax rate. Because the United States does not impose a VAT, its aggregate nominal tax rate is the U.S. combined corporate tax rate of 39.2 percent.

The data make clear that other OECD member countries impose higher aggregate nominal tax rates on corporate profits than the United States does. Of the 34 countries that were members of the OECD in 2011, 25 imposed aggregate nominal tax rates of at least 40 percent. Those high aggregate nominal tax countries include such large economies as France (54 percent), Germany (49.2 percent), Spain (48 percent), Italy (47.5 percent), Mexico (46 percent), the United Kingdom (45.5 percent), and Japan (44.5 percent).

It is instructive to examine the data for the OECD countries with lower aggregate nominal tax rates than the United States. Of those eight countries, only three have aggregate nominal tax rates below 35 percent: Korea (34.2 percent), Canada (32.6 percent), and Switzerland (29.2 percent). Four had rates only slightly below the U.S. rate: Chile (39 percent), the Czech Republic (39 percent), Slovakia (39 percent), and Turkey (38 percent). Ireland, widely regarded as a corporate tax haven, imposes an aggregate nominal tax rate of 36.5 percent.

Finally, it is interesting to note two recent developments. According to the OECD data, the United Kingdom reduced its central government corporate tax rate from 28 percent in 2010 to 26 percent in 2011. Over the same period, it increased its VAT rate from 17.5 to 20 percent. Similarly, Greece reduced its central government corporate tax rate from 24 to 20 percent while increasing its VAT rate from 19 to 23 percent.20

C. Conclusions From the OECD Data

This analysis of the OECD data confirms the conventional wisdom concerning the magnitude of corporate tax rates in the United States: The United States imposes the highest central government nominal rate of corporate taxation of any OECD member country. It also imposes the highest combined central government and sub-national government tax rate of any OECD country apart from Japan.

A radically different conclusion is reached after aggregating all the taxes that countries impose on corporate profits, including the VAT. After that aggregation, the United States ranks in the low or lower-middle range of countries in terms of the aggregate nominal tax rate. Moreover, all of the largest economies that are members of the OECD (except Korea) have higher aggregate nominal tax rates than the United States, and those aggregate rates are substantially higher than the U.S. aggregate tax rate.

Finally, the recent developments in the United Kingdom and Greece suggest that countries may view corporate tax and VAT as complementary: When they increased their VAT rate, they also reduced their corporate tax rates.


III. The VAT Incorporates a Business Profits Tax

A. Introduction

The VAT, in substance, can be considered to incorporate a tax on business profits that is comparable to the corporate income tax.21 The assertion that the VAT incorporates a tax on business profits runs contrary to both the common perception -- and the technically precise understanding -- of the VAT as a tax on consumption.

That common perception is reflected both in scholarly works that recognize that the VAT "is usually intended as a tax on consumption"22 and in popular authorities such as Wikipedia, which states that a "VAT is like a sales tax in that ultimately only the end consumer is taxed."23 The price of goods and services sold at retail includes the VAT, and many purchase receipts record the amount of VAT paid as part of the retail price.24 That practice reinforces the notion that the VAT is a consumption tax analogous to a retail sales tax. Many tourists focus on receipts that record the amount of VAT paid on their purchases of goods because they may receive a refund on leaving the country they visited.

The idea that the VAT contains a tax on business profits, however, is hardly novel. The late professor David Bradford's famous X-tax proposal had two components: a tax imposed at a single rate on business profits (with a deduction allowed for compensation paid), and a tax on individuals' compensation imposed at progressive rates. Bradford recognized that:


    if we neglect the deduction of payments to workers, the business tax component of this system constitutes, in the jargon of the trade, a value-added tax of the consumption type, implemented by the subtraction method. . . . Provided the rate of tax is the same, a value added tax of the subtraction type is exactly equivalent to a value added tax of the invoice-and-credit type.25

Part III.B covers the general structure and the technical aspects of the VAT and demonstrates how, in the aggregate, the VAT incorporates a corporate income tax. It then discusses several technical features of the VAT. While those features appear to bear no resemblance to provisions of the corporate income tax, they cause the VAT to have similar effects on business taxpayers. First, the general equivalence of the subtraction method and the credit-invoice method of computing liabilities under the VAT is demonstrated. As a result, the VAT includes gross receipts in its tax base and effectively allows businesses to deduct most ordinary and necessary business expenses. The treatment of capital expenditures under the VAT is then examined, which is equivalent to the immediate expensing of those costs. It then compares that treatment with the current treatment of capital expenditures under the corporate income tax.

The remainder of Part III.B covers three major structural differences between the VAT and the corporate income tax: the nondeductibility of amounts paid as salaries and wages under the VAT; the exemptions from the VAT of transactions involving specific goods and services; and the VAT treatment of cross-border transactions. Finally, the net effect of the VAT and the corporate income tax on business taxpayers are compared to demonstrate that the corporate tax incorporated in the VAT closely resembles the U.S. corporate income tax.

B. Basic Operation of the VAT

1. A simple example. In practice, the VAT generally refers to the form of the VAT that uses the credit-invoice method.26 Example 1 illustrates the basic operation of the credit-invoice VAT as applied to the production and distribution of food that involves four persons: the farmer who grows crops; the processor that purchases the crop and converts it into a food product; the retailer that purchases the food product from the processor and sells it; and the consumer who purchases the food product.

An essential feature of the VAT is that it is imposed at each stage of production. In Example 1, the farmer, who has no purchased inputs (such as purchased seed or fertilizer), sells her output to the processor for $400 (plus the VAT due on the sales). The VAT rate is 15 percent. Therefore, the farmer is obligated to pay VAT liability of $60, which equals the sales proceeds of $400 multiplied by the VAT rate of 15 percent.

                     Example 1 -- Credit-Invoice VAT Method
 ______________________________________________________________________________

                                       Farmer   Processor   Retailer   Consumer
 ______________________________________________________________________________

 1. Sales (Excluding VAT)              $400       $700       $1,000
 2. Purchases (Excluding VAT)            $0       $400         $700     $1,000
 3. VAT Due on Sales (15 percent x 1)   $60       $105         $150
 4. VAT Paid on Purchases                $0        $60         $105       $150
 5. VAT Due (3-4)                       $60        $45          $45

The processor determines its VAT liability in two steps. First, it computes the VAT that it must collect on its sales in the same manner as the farmer collected the VAT on her sales. For the processor, the VAT due on its sales is $105 (that is, the sales proceeds of $700 multiplied by the VAT rate of 15 percent). Unlike the farmer, however, the processor paid a VAT of $60 on the inputs that it purchased from the farmer. Under the credit-invoice VAT method, the processor's VAT liability to the government is only $45: the difference between the VAT due on its sales ($105) reduced by the VAT that it paid for its inputs ($60).27 In this example, it is assumed that the VAT paid was shown on the farmer's sales invoice.

The retailer that sells the processed food product to the final consumers computes its VAT in a similar manner. The retailer's sales totaled $1,000, and the VAT due on those sales to the consumer equals $150 (at the 15 percent VAT rate). As with the processor, the retailer's VAT liability to the government is reduced to reflect the VAT it paid for the purchase of its inputs. Consequently, the retailer's VAT liability equals $45: $150 of VAT due on its sales less the $105 of VAT paid on its inputs.

At this point, two observations are often made concerning the systemic effect of the VAT. First, the total VAT collected in this example equals $150, which is the amount that would be collected if a 15 percent sales tax were imposed on sales at retail.28 Second, the same amount of tax is collected whether all stages of production are performed by one integrated producer or by separate businesses.

2. Nominal impact on each VAT payer. The foregoing description of the VAT should be familiar to readers of these pages. Unlike many of the articles published previously, however, this report does not focus on the VAT's systemic effects, its revenue-generating capacity, or its economic efficiency. Rather, it focuses on the nominal effect of the VAT on each business that incurs VAT liability.

From the perspective of an individual taxpayer, the VAT is simply a tax on the business's value added. As discussed below, the credit-invoice VAT is economically equivalent to the sum of three distinct taxes: (1) a territorial-based tax on business profit29; (2) a proxy tax on total compensation paid; and (3) an import tax imposed on the value of imported goods and services.30 The rest of this section analyzes the technical workings of the VAT that are necessary to demonstrate those equivalences.

a. General equivalence of the subtraction method and the credit-invoice method. Each VAT payer incurs a tax liability based on its own experience. For example, each of the taxpayers in Example 1 incurred a tax liability equal to 15 percent of its value added. Their actual liability, however, is determined indirectly. Their tax liability equals the difference between the VAT charged on their sales and the VAT paid (and shown on the VAT invoices) for the purchased inputs.

Although the prevailing practice in countries with a VAT is to use the credit-invoice method, it is generally recognized that that is economically equivalent to determining VAT liability under the "subtraction method." To compute VAT liability using this method, a taxpayer subtracts the amount that it pays for inputs from the sales proceeds.31 To illustrate, assume that the subtraction method was used for the transactions discussed in Example 1. The processor's value added would equal $300 (the difference between its sales of $700 and its purchases of $400). Assuming that the same VAT rate of 15 percent were applicable, the processor's VAT liability would be $45 (that is, value added of $300 multiplied by the 15 percent VAT rate). That is equal to the VAT liability determined under the credit-invoice method.

The general equivalence of the subtraction method and the credit-invoice method has long been recognized. In fact, most of the proposals for a consumption tax in the United States that were made in recent decades (such as the X-tax and the FairTax) have been based on a subtraction method VAT.32

The U.S. income tax uses a pure subtraction method in which all deductions (including all ordinary and necessary expenses incurred in connection with a trade or business) are subtracted from gross income.33 There is one significant difference between that pure subtraction method and the VAT credit-invoice method. A VAT payer receives input credit only for purchases (and, in terms of the subtraction method, in effect only deducts the costs) listed on VAT invoices. As a result, no credit is allowed for purchases from a seller that is exempt from the VAT or in a transaction that is exempt from VAT.34 For example, it is common to exempt small traders and financial services from the VAT.35 To the extent that VAT payers acquire inputs from small traders or incur financial services costs, the expenses become, in terms of the measurement of income, nondeductible.

In appearance, the methods used to determine tax liability under the VAT and the corporate income tax are quite different. In general, they are economic equivalents. To the extent there is a systemic difference between the two, it results from the treatment of exempt inputs under the VAT. In those circumstances, the VAT will result in a larger tax liability.

b. Full deductibility of capital expenditures. A bedrock principle of U.S. income taxation is that taxpayers cannot deduct the cost of acquiring long-lasting assets.36 Those expenditures must be capitalized and the acquisition costs of the assets recovered over a period of years -- either as depreciation or as a factor in determining the gain realized on the disposition of the assets.37

In almost all advanced economies using a VAT, the acquisition of a capital item (other than real estate) is treated in the same manner as the acquisition of other creditable inputs. Thus, the VAT paid for the acquisition is deductible immediately.38 In effect, VAT payers are allowed to expense the cost of capital expenditures when computing their VAT liability.

The contrast between the black letter articulation of the tax treatment of capital expenditures under the U.S. income tax and the VAT appears stark. The real-world difference, however, is much less dramatic.

First, the code contains provisions allowing taxpayers to elect to expense a specified amount of section 179 property.39 For property acquired in 2008 and 2009, the expensing limit was $250,000; for 2010 and 2011, it was $500,000.40 The limit is scheduled to decline to $125,000 in 2012 and to $25,000 thereafter.41 At a minimum, the current section 179 election allows most small and midsize businesses to expense rather than capitalize the cost of their depreciable equipment purchases.

Second, under section 168, businesses are allowed to compute depreciation for equipment purchases on an extremely accelerated basis. Under the permanent default provisions of section 168, taxpayers may compute depreciation using recovery periods shorter than the class lives of the assets,42 assuming a salvage value for all assets equal to zero43 and using the double declining balance method of depreciation.44 Also, for property placed in service between 2008 and 2012, taxpayers may elect to deduct 50 percent of the cost of the asset in the year in which the asset is placed in service, with the remaining cost depreciated using the normal depreciation rules.45 Thus, a taxpayer who acquires equipment treated as three-year property may deduct 66.67 percent of the cost in the year of acquisition,46 and a taxpayer who acquires equipment treated as five-year property may deduct 60 percent of the cost in the year of acquisition.47 Given the magnitude of those immediate write-offs, along with the existing accelerated depreciation rules and low interest rates, the difference (in terms of the present value of the deductions) between the VAT expensing treatment and the U.S. cost recovery rules is modest.

                      Example 2 -- VAT With Exempt Farmer
 ______________________________________________________________________________

                                       Farmer   Processor   Retailer   Consumer
 ______________________________________________________________________________

 1. Sales (Excluding VAT)              $400       $700       $1,000
 2. Purchases (Excluding VAT)            $0       $400         $700     $1,000
 3. VAT Due on Sales (15% x 1)           $0       $105         $150
 4. VAT Paid on Purchases                $0         $0         $105       $150
 5. VAT Due (3-4)                        $0       $105          $45

c. Nondeductibility of amounts paid as salaries and wages. One of the most notable disparities between the corporate income tax and the VAT is the treatment of amounts paid as compensation to employees. In terms of income taxation, an employer may deduct the amount of compensation paid, assuming that the compensation represents a reasonable allowance for personal services actually rendered48 and is not subject to any compensation-related limitation.

The treatment of compensation paid to employees under the VAT is radically different.

Because no country treats an employee as an independent business rendering services for purposes of the VAT,49 the employee does not charge VAT to her employer.50 As a result, the employer cannot deduct any input tax in connection with the payment of salaries and wages. In essence, VAT payers cannot deduct the cost of compensation paid to their employees when computing their VAT liability. For that reason, some have observed that the VAT can be viewed as economically equivalent to "a cash flow business tax and a tax on wage earnings."51

d. Exemptions under the VAT.

i. Effect of exemptions under a VAT. Exemptions exist under both the income tax and the VAT. The role of exemptions under the income tax is familiar: exemption relieves a taxpayer from income tax liability.52 The systemic effect of granting an exemption under the income tax is also clear: tax revenues are reduced.

The role of exemptions under the VAT is more complicated than under the income tax, and the systemic effect of exemption is less predictable. A VAT may exempt either a type of transaction or a type of entity.53 Moreover, depending where in the chain of production the exempt transaction takes place, exempting a specified type of transaction may increase or decrease aggregate VAT revenues.54

To illustrate, consider Example 2, which varies the basic VAT example discussed previously. In Example 2, the VAT exempts the farmer's output from the VAT.55 That exemption affects VAT payers other than the exempt taxpayer. Consider the processor that purchased all of the output from the exempt farmer. Again, the processor determines its VAT liability in two steps. First, the VAT due on its sales is calculated; in this case, it equals $105 (that is, the sales proceeds of $700 multiplied by the VAT rate of 15 percent). Second, the processor's liability is reduced by the amount of VAT paid for the processor's purchased inputs. Although the processor purchased inputs from the farmer, no VAT was paid. Under the credit-invoice method, the processor's VAT liability is not reduced to reflect its input purchases because no VAT was paid in connection with that purchase.56 Consequently, the processor's VAT liability equals $105. In effect, the processor pays the VAT for both the value added attributable to its activity and the value added that was attributable to the activities of the exempt farmer.57

Moreover, an exemption may increase the aggregate amount collected under the VAT. Typically, an exempt person who pays VAT in connection with its input purchases cannot recover those input VAT paid.58 For example, if the farmer in Example 2 had paid VAT of $10 in connection with her purchased inputs, she could not receive a refund of the taxes that she paid in connection with her purchased inputs. Consequently, the aggregate VAT collected would have increased from $150 to $160.

Of course, a VAT exemption may reduce VAT collections. For example, if the farmer sold her output to a final consumer (rather than a business that used the farmer's output as an input in further business production), then no VAT would be collected on the farmer's output. Similarly, if the retailer in Example 1 were exempt from VAT, then it would avoid the $45 in VAT liability in that example. Once again, as an exempt VAT payer, the retailer would not recover the $105 in VAT that it paid in connection with its purchased inputs. As a result, from a systemic perspective, exempting the retailer reduces the aggregate VAT collection from $150 to $105. That contrasts with the result under a retail sales tax, in which exempting an item from the scope of a sales tax results in the complete elimination of revenue attributable to that item.

ii. Common exemptions under the VAT. Although there is no uniformity for VAT exemptions, commonalities do exist. Some of the common exemptions reflect administrative and compliance concerns that relate to very small businesses and other participants in the informal sector of the economy.59 Most VATs contain small business or small trader exemptions,60 based on annual turnover or gross sales.61 For example, in the EU, the small business exemptions are modest, with France (€89,000),62 the United Kingdom, (£73,000),63 and Ireland (€75,000 for goods and €37,500 for services)64 having the largest exemption levels. The small business exemption in Japan is ¥30 million.65 Many VAT laws exempt the agricultural sector, particularly in countries with a large number of subsistence farmers.66 In the EU, many countries provide favorable treatment of food items under the VAT.67

A broad consensus also exists for granting exemptions for education, health, and financial services.68 The European Union requires member states to exempt specified transactions involving medical and hospital care,69 education,70 and insurance and financial services.71 The education and health exemptions may have arisen because the state provided those services on a nonprofit basis.72 The exemptions have been extended to nongovernmental providers to reduce the competitive disparity with the state institutions and to reflect the societal importance of health and education.73

The exemption for financial services reflects the difficulty in determining the value added resulting from financial intermediation.74 Historically, a common business model for financial intermediaries was to borrow funds from consumers and other customers, and to seek to profit from lending the funds at higher rates of interest. For example, the most basic forms of borrowing are savings accounts, checking accounts, or life insurance premiums. Typically, the consumer-customers are not VAT-registered payers. Consequently, the financial intermediaries would not obtain VAT invoices from the suppliers of a large portion of their capital if the VAT applied to them.75 Moreover, the financial intermediaries frequently provided services to their depositors and borrowers, with the result that it was difficult to identify the source and amount of value added.76 It therefore became common to exempt financial intermediaries from the VAT. As financial intermediaries developed more complex financial instruments, such as financial derivatives, swaps, forward contracts, and securitization arrangements, the difficulty of subjecting financial intermediaries to VAT increased.

The exemption of the financial services industry has significant consequences, one of which is not obvious. First, and most obvious, no VAT is collected from the financial institutions. Second, as exempt entities under the VAT, the financial institutions cannot deduct (and, in effect, recover) any VAT paid in connection with purchased inputs that are attributable to services that they provide to their business customers.77 Consequently, a few countries have taken steps to extend the VAT to financial intermediaries -- either broadly (Argentina and Israel) or narrowly (Australia, New Zealand, and Singapore) to limit the negative effects of exempting financial transactions from the VAT.78

The next major VAT exemption involves transactions relating to real property. In most VAT jurisdictions, transactions involving residential real property are exempt, although transactions involving nonresidential real property may be taxable.79 The EU requires that member states generally exempt from the VAT leases of both commercial and residential real estate and sales of existing real estate.80 However, it allows member states to authorize VAT payers to elect to treat those real estate transactions as taxable and therefore subject to the VAT.81 Moreover, the real estate VAT exemption does not apply to transactions involving real estate (or parts of a building) before its first occupancy,82 and the leasing exemption does not apply to the hotel sector and similar accommodations and to vehicle parking facilities.83

Many countries exempt a variety of transactions undertaken by governmental and some nonprofit organizations.84 The governmental and nonprofit sectors typically provide a broad array of goods and services. Governments distribute transfer payments to their citizens, provide police and fire protection to their residents, and provide (or pay for) medical care. Those sectors may also engage in activities that compete with private businesses. Governmental and nonprofit sectors may operate museums, restaurants, educational institutions, and sporting events that compete with activities organized by the private sector.85 For example, the United Kingdom exempts gambling transactions and lottery sales, admission charged by charities, and burial or cremation services.86 Again, the exempt VAT payer is relieved from the obligation to pay VAT on its output, but it is barred from recovering the VAT paid in connection with its purchased inputs.87

                      Example 3 -- VAT: Zero Rated Export
 ______________________________________________________________________________

                                       Farmer   Processor   Exporter
 ______________________________________________________________________________

 1. Sales (Excluding VAT)               $400      $700       $1,000

 2. Purchases (Excluding VAT)             $0      $400         $700

 3. VAT Due on Sales (15% x 1)
    0% Rate for Exports                  $60      $105           $0

 4. VAT Paid on Purchases                 $0       $60         $105

 5. VAT Due (Line 3 - Line 4)            $60       $45        ($105)

e. VAT treatment of cross-border transactions. Almost all countries apply the VAT to cross-border transactions in accordance with the destination principle,88 which has the ultimate effect of allocating all of the VAT to the country where the consumption of a good or service occurs.89 The country where a good or service is produced but not consumed ultimately collects no net VAT. Implementing the destination principle occurs separately for imports and exports.

i. VAT treatment of imports. In general, a VAT payer must pay VAT when it imports goods and services for use as inputs.90 If a country exempts the domestic supply of an item from VAT, importation of the same item would also be exempt.91 The treatment of imported services raises several difficult questions. One is whether the services are supplied where the user is located or where the service provided is located. In the EU, the general rule is that services are deemed to be provided where the service provider is located.92 The United Kingdom has adopted a contrary rule and treats some services (such as advertising and legal) as provided where the consumer of the services resides.93

For individual businesses that import goods or services, that treatment of imports has minimal net impact. Although an importer must pay VAT when it imports the good or service, the VAT paid for the imported input is comparable to what the importer would pay if it purchased an equivalent good or service from a domestic supplier. And, as with VAT paid on inputs acquired from domestic sources of supply, the VAT paid on imports offsets the VAT due on its sales in determining the taxpayer's net VAT liability to the government. In effect, the business VAT payer is effectively taxed on its value added, whether it acquires its inputs from domestic or imported sources. From a systemic perspective, however, the VAT treatment of imported goods and services operates as an import duty and increases national tax collections.

ii. Zero rating of exports. To implement the destination principle for the export of goods and services, most countries zero rate the export transaction.94 Zero rating an export transaction effectively eliminates the entire VAT burden from a good or service that is exported. To produce that result, the VAT characterizes an export as a taxable sale for which a zero tax rate applies. Because a taxable transaction has occurred, the taxpayer may claim a deduction for VAT paid for purchased inputs attributable to the zero rated sales.95 The application of zero rating of exports is illustrated in Example 3.

As Example 3 illustrates, the exporter generated a value added of $300, yet paid no VAT because the value added was earned in an export operation. As a result of the zero rate of tax on the export transaction, the taxpayer is allowed to deduct (and thereby recover) the VAT paid for the inputs that it purchased. In effect, zero rating eliminates the entire VAT burden previously imposed on the exported good or service. Thus, zero rating creates a territorial approach to taxation of value added.

C. Conclusions About the VAT

In appearance, the credit-invoice VAT bears no resemblance to a corporate income tax. In substance, however, embedded within the VAT is a tax on business profits. As discussed above, the tax bears several functional similarities to the U.S. corporate income tax. In effect, under both taxes:

  • the business is allowed to deduct the cost of purchased inputs to offset the revenue generated from sales; and
  • the cost of capital expenditures is broadly deductible under the VAT for all taxpayers; under the corporate income tax, for many small and midsize businesses the cost of equipment is fully deductible if they elect the benefit of section 179.

Despite those similarities, there are significant differences:
  • Compensation. Under the VAT, businesses may not recover the amounts paid as wages or other forms of compensation; under the corporate income tax, businesses generally may deduct those forms of compensation.
  • Interest. Under the VAT, businesses may not recover the cost of interest paid because financial transactions are exempt transactions; under the corporate income tax, businesses generally may deduct interest paid or accrued during the tax year.
  • Capital Expenditures. Under the VAT, the cost of a capital expenditure is effectively fully deductible at the time of acquisition; under the corporate income tax, while many businesses may deduct the cost of equipment immediately if they elect the benefit of section 179, others must calculate their depreciation costs under section 168. Although current law is not equivalent to expensing, the difference is less significant than in prior years because of the combined effect of the temporary bonus depreciation provisions and the accelerated depreciation in the permanent structure of section 168.
  • Cross-Border Transactions. Under the VAT, businesses are not taxed on the value added attributable to their exported goods and services. Consequently, the VAT operates as a territorial tax; under the U.S. corporate income tax, businesses are subject to tax on their worldwide income.

Over the course of a year, the embedded corporate tax base incorporated in the VAT will almost always be larger than the taxable income tax base of the U.S. corporate income tax attributable to the corporation's domestic operations. Although the treatment of capital expenditures is sometimes more generous under the VAT, that is more than offset by the more burdensome treatment of compensation and interest expenses.

As discussed above, significant exemptions exist under the VAT. Most notably, financial transactions are almost uniformly exempt from the VAT, and medical and educational services are frequently exempt as well. Also, all countries exempt small businesses or small traders. In comparison, many financial institutions are subject to the U.S. corporate income tax. Most educational institutions are exempt from taxation in the United States, and many medical service providers (such as hospitals or physician groups) are either exempt from taxation or taxed as passthrough entities. As discussed above, eligibility for the small business exemption under the VAT is limited to businesses with gross sales of less than €89,000, £73,000, or ¥30 million per year. It is unlikely that many businesses with sales of that magnitude are taxed as corporations in the United States, and those that are taxed as corporations are likely to be taxed at rates significantly below the maximum nominal corporate tax rate.96

Despite the exemptions, many industries are subject to VAT on their domestic economic activities. As a result, they are subject to the corporate profits tax embedded in the VAT. For example, almost all businesses engaged in the manufacture, distribution, and sale of most goods are subject to VAT on their domestic activities. That includes not only goods manufactured by domestic business, but also imported goods that are sold by domestic businesses to domestic consumers. In some countries, mining and oil and natural gas production, refining, and distribution are major industries. To the extent that their activities are domestic in nature, they are subject to the VAT. Similarly, the transportation sector, retailers, and wholesalers all have significant domestic operations, and all those industries are subject to the VAT.

Moreover, the VAT applies to a broad range of services. Most VAT statutes define services broadly. The definition includes businesses that provide legal services, accounting services, and engineering and other technical services. In the EU, the transfer of services includes transfers of intangible property.97 Similarly, the hotel industry and other travel services are generally subject to the VAT.

Although there are exempt sectors, much of the corporate sector is subject to the VAT.


IV. Conclusions

Politicians have focused a great deal of attention on the nominal U.S. corporate tax rates relative to those rates in other countries. Many analysts criticize the importance of the nominal (rather than the effective) rate of tax that applies to the income that flows through corporations. If nominal rates are important, however, then the proper analysis should take into account all taxes that apply to business profits; the exclusive focus on the corporate tax is too narrow.

As this report demonstrates, a complete analysis of the nominal tax burdens imposed on corporate profits should take into account the VAT. Embedded in the VAT is a tax on businesses that is comparable to, and indeed more onerous than, the corporate income tax. Thus, the relevant nominal tax rates are the sum of the applicable VAT and corporate tax rates.

Looking at the aggregate of taxes that countries impose on corporate profit (including the VAT), the comparative data refute the accepted wisdom. The United States does not tax business profits at an exceptionally high nominal rate. In fact, it ranks in the low or lower-middle range of countries in terms of the aggregate nominal tax rate. All the high-GDP OECD members (except Korea) have higher aggregate nominal tax rates than the United States, and those aggregate rates are substantially higher than the aggregate tax rate in the United States.

The most significant caveat relates to the foreign activities of U.S.-based multinationals. The VAT is effectively territorial in nature. If U.S. tax rates are higher than those of our trade partners, the higher rate -- in theory -- applies to the foreign operations of U.S multinationals because the VAT applies territorially. Any difference in nominal tax rates applicable to foreign operations would, at most, justify a reexamination of the tax treatment of the foreign operations of the multinationals. Empirical and analytic studies question whether many U.S.-based multinationals are taxed to a meaningful extent on their foreign operations. A legislative response to the purported problem of overtaxation of the multinationals' foreign-source income would need to examine whether overtaxation really exists.

The more significant conclusion focuses on the nominal tax rate applicable to corporations operating solely domestically (and the tax rate applicable to the domestic operations of the multinationals). Those sources of income are not taxed at high nominal rates compared with the rates affecting businesses in other countries. If the justification for reducing the tax rate on those sources of income is the relatively high nominal rate to which they are subject, no rate cut is justified. Many of those who point to the purportedly excessively high U.S. corporate tax rates have a simple and neat solution: reduce the highest U.S. corporate tax rate, ideally to a rate comparable to the average corporate tax rates in other OECD countries. Given the reality that the United States already subjects businesses to a low to moderate rate of tax, across-the-board corporate tax rate reductions cannot be justified.


V. Appendix

                Table 1. OECD Corporate Tax Rate Dataa
 _____________________________________________________________________

                                              Combined
                     Central                  National and
                     Government               Sub-National
                     Corporate                Corporate
 Country             Income Tax Rate          Income Tax Rate
 _____________________________________________________________________

 Australia                30                        30
 Austria                  25                        25
 Belgium               33.99                        34
 Canada                 16.5                      27.6
 Chile                    20                        20
 Czech Republic           19                        19
 Denmark                  25                        25
 Estonia                  21                        21
 Finland                  26                        26
 France                 34.4                      34.4
 Germany               15.83                      30.2
 Greece                   20                        20
 Hungary                  19                        19
 Iceland                  20                        20
 Ireland                12.5                      12.5
 Israel                   24                        24
 Italy                  27.5                      27.5
 Japan                    30                      39.5
 Korea                    22                      24.2
 Luxembourg             22.5                      28.8
 Mexico                   30                        30
 Netherlands              25                        25
 New Zealand              28                        28
 Norway                   28                        28
 Poland                   19                        19
 Portugal                 25                      26.5
 Slovak Republic          19                        19
 Slovenia                 20                        20
 Spain                    30                        30
 Sweden                 26.3                      26.3
 Switzerland             8.5                      21.2
 Turkey                   20                        20
 United Kingdom           26                        26
 United States            35                      39.2
 ______________________________________________________________________________

                          FOOTNOTE TO TABLE 1

      a These rates are from "OECD Table II.1 Corporate income tax rate,"
 available at
 http://www.oecd.org/document/60/0,3746,en_2649_34533_1942460_1_1_1_1,00.html#C_CorporateCapital.

                      END OF FOOTNOTE TO TABLE 1

                   Table 2. OECD Reported VAT Ratesa
 _____________________________________________________________________

                   Australia                      10
                   Austria                        20
                   Belgium                        21
                   Canada                          5
                   Chile                          19
                   Czech Republic                 20
                   Denmark                        25
                   Estonia                        20
                   Finland                        23
                   France                       19.6
                   Germany                        19
                   Greece                         23
                   Hungary                        25
                   Iceland                      25.5
                   Ireland                        21
                   Israel                         16
                   Italy                          20
                   Japan                           5
                   Korea                          10
                   Luxembourg                     15
                   Mexico                         16
                   Netherlands                    19
                   New Zealand                    15
                   Norway                         25
                   Poland                         23
                   Portugal                       23
                   Slovak Republic                20
                   Slovenia                       20
                   Spain                          18
                   Sweden                         25
                   Switzerland                     8
                   Turkey                         18
                   United Kingdom                 20
                   United States                   0
 _____________________________________________________________________

                          FOOTNOTE TO TABLE 2

      a These rates are from "OECD Table IV.1. VAT/GST rates in OECD
 member countries," available at
 http://www.oecd.org/document/60/0,3746,en_2649_34533_1942460_1_1_1_1,00.html#C_CorporateCapital.

                      END OF FOOTNOTE TO TABLE 2

           Table 3. OECD Reported VAT Rates, Corporate Tax Rates, and
                              Aggregate Tax Rates
 ______________________________________________________________________________

                                        Combined Central
                                        and Sub-National       VAT + Combined
 Country                VAT Rate        Corporate Tax Rate     Corporate Rate
 ______________________________________________________________________________

 Australia                 10                   30                    40
 Austria                   20                   25                    45
 Belgium                   21                   34                    45
 Canada                     5                 27.6                  32.6
 Chile                     19                   20                    39
 Czech Republic            20                   19                    39
 Denmark                   25                   25                    50
 Estonia                   20                   21                    41
 Finland                   23                   26                    49
 France                  19.6                 34.4                    54
 Germany                   19                 30.2                  49.2
 Greece                    23                   20                    43
 Hungary                   25                   19                    44
 Iceland                 25.5                   20                  45.5
 Ireland                   21                 12.5                  36.5
 Israel                    16                   24                    40
 Italy                     20                 27.5                  47.5
 Japan                      5                 39.5                  44.5
 Korea                     10                 24.2                  34.2
 Luxembourg                15                 28.8                  43.8
 Mexico                    16                   30                    46
 Netherlands               19                   25                    44
 New Zealand               15                   28                    43
 Norway                    25                   28                    53
 Poland                    22                   19                    41
 Portugal                  23                 26.5                  49.5
 Slovak Republic           20                   19                    39
 Slovenia                  20                   20                    40
 Spain                     18                   30                    48
 Sweden                    25                 26.3                  51.3
 Switzerland                8                 21.2                  29.2
 Turkey                    18                   20                    38
 United Kingdom            20                   26                  45.5
 United States              0                 39.2                  39.2
FOOTNOTES

1 President Obama's speech to Congress on jobs, joint session before Congress (Sept. 8, 2011), available at http://www.nytimes.com/2011/09/09/us/politics/09text-obama-jobs-speech.html?pagewanted=all; Curtis Dubay, "U.S. to Have Highest Corporate Tax Rate in the World," available at http://blog.heritage.org/2010/12/15/u-s-to-have-highest-corporate-tax-rate-in-the-world; Mitt Romney, "My Plan to Turn Around the U.S. Economy," USA Today, Sept. 6, 2011 ("Our corporate tax rate is among the world's highest. It leaves U.S. firms at a competitive disadvantage and induces them to park their profits abroad, benefiting the rest of the world at our expense"); press release, U.S. Chamber of Commerce, statement of the U.S. Chamber of Commerce on fundamental tax reform (Jan. 20, 2011) ("Currently, the United States has the second highest marginal corporate tax rate among OECD countries"), available at http://www.uschamber.com/sites/default/files/110119taxreformtestimony.pdf.

2 See id. ("The Chamber believes that tax reform legislation should lower the corporate tax rate to a level that will enable U.S. businesses to compete successfully in the global economy, attract foreign investment to the United States, increase capital for investment, and drive job creation in the United States").

See also Romney, "Believe in America: Mitt Romney's Plan for Jobs and Economic Growth" (2011), at 43 ("It is vital that we move quickly to reduce the corporate tax rate and put American companies on a level playing field").

3 This argument is distinct from the policy arguments for lowering rates while broadening the base without reducing the overall effective tax rate. See, e.g., "The President's Framework for Business Tax Reform," at 2-5 (2012).

4 Some of those provisions are available for a broad range of business taxpayers. See, e.g., section 199 (allowing a deduction equal to 9 percent of qualified production activities income); section 168 (allowing cost recovery for tangible personal property using the accelerated cost recovery system). Others target specific technologies or industries. See, e.g., section 40A (allowing a tax credit for biodiesel and renewable diesel used as fuel); section 45C (allowing a 50 percent tax credit for clinical testing expenses for orphan drugs). For a discussion of the overall effect of corporate tax preferences on the effective tax rates of large U.S.-based multinationals, see Robert S. McIntyre, "Business Subsidies Administered by the IRS," Tax Notes, Apr. 18, 2011, p. 309, Doc 2011-6139, or 2011 TNT 76-5.

5 See Martin A. Sullivan, "Passthroughs Shrink the Corporate Tax by $140 Billion," Tax Notes, Apr. 18, 2011, p. 987, Doc 2011-3935, or 2011 TNT 39-2 (C corporations' share of business receipts declined from 86.6 percent of total business receipts in 1980 to 64.1 percent in 2007); Peter Merrill, "The Corporate Tax Conundrum," Tax Notes, Oct. 8, 2007, p. 174, Doc 2007-21273, or 2007 TNT 196-40 (reporting that compared with other OECD countries, the United States had an unusually large number of passthrough business entities and the highest number of passthroughs with profits exceeding $1 million).

6 See Amy S. Elliott, "Large U.S. Firms' Tax Rates Surpass OECD Average," Tax Notes, Apr. 18, 2011, p. 244, Doc 2011-8176, or 2011 TNT 73-3, discussing three different studies of effective tax rates in different OECD countries. The most recent cited, commissioned by the Business Roundtable and prepared by PricewaterhouseCoopers LLP, calculated effective tax rates based on the amount of income taxes recorded on financial statements rather than actual tax payments. In that study, the effective tax rate for U.S.-based multinationals was significantly below the rate in Japan, slightly below those in Italy and Germany, and slightly above those in Australia and Mexico.

7 See, e.g., Edward D. Kleinbard, "Stateless Income's Challenge to Tax Policy," Tax Notes, Sept. 5, 2011, p. 1021, Doc 2011-14206, or 2011 TNT 172-5.

8 Id.; Sullivan, "Why Not an Investment Credit for Overseas Operations?" Tax Notes, Mar. 14, 2011, p. 1241, Doc 2011-5071, 2011 TNT 49-3.

9 Available at http://www.oecd.org/document/60/0,3746,en_2649_34533_1942460_1_1_1_1,00.html#C_CorporateCaptial. For an example of reliance on the OECD data, see Dubay, supra note 1.

10 OECD Corporate Tax Table II.1, n.2.

11 Id.

12 Those countries are Canada, Germany, Japan, Korea, Luxembourg, Portugal, Switzerland, and the United States. See OECD Corporate Tax Table II.3. Subnational authorities include state, provincial, and city governments. Id.

13 Id. at n.1.

14 OECD Explanatory Annex at 53, available at http://www.oecd.org/dataoecd/44/44/38402588.pdf.

15 OECD Corporate Tax Table II.3.

16 This rate reflects the 2.3 percent tax saving that results from deducting the sub-national tax when computing the central government tax liability. See OECD Corporate Tax Table II.1.

17 Id.

18 Council Directive 2006/112/EC, article 97, 2006 OJ (L347) 23 (EC) (recast Sixth Directive).

19 Id. at article 98.

20 See OECD Corporate Tax Table II.1 for years 2010 and 2011; OECD Table IV.1; VAT/GST rates in OECD member countries for years 2010 and 2011.

21 This section does not discuss classification of the corporate income tax and the VAT as direct or indirect taxes. The distinction between direct and indirect taxes may affect a country's ability to rebate a tax without violating its WTO treaty obligations or may create domestic constitutional issues. See Alan Schenk and Oliver Oldman, Value Added Tax: A Comparative Approach 5-8 (2007).

22 Liam P. Ebrill et al., The Modern VAT 1 (2001). Itai Grinberg, "Where Credit Is Due: Advantages of the Credit-Invoice Method for a Partial Replacement VAT," 63 Tax L. Rev. 309 (2010).

23 Available at http://en.wikipedia.org/wiki/Value_added_tax.

24 See http://www.hmrc.gov.uk/vat/sectors/consumers/basics.htm (most retail prices on bills and receipts include VAT; it is not shown separately. However, some receipts may also show the VAT element as a separate line. That doesn't mean you're being charged extra -- it just shows how much tax is included in the price).

25 David F. Bradford, "Blueprint for International Tax Reform," 26 Brooklyn J. Int'l L. 1449, 1451 (2001).

26 See Grinberg, supra note 22; Schenk and Oldman, supra note 21, at 39; Sijbren Cnossen, "A VAT Primer for Lawyers, Economists, and Accountants," in The VAT Reader: What a Federal Consumption Tax Would Mean for America (2011) at 25, n.2.

27 In the credit-invoice method, a VAT payer obtains a credit for the VAT paid for purchases that are eligible for credit. As its name suggests, the method mandates the use of invoices from the seller of the input that record the price and amount of VAT paid for the transaction. Schenk and Oldman, supra note 21, at 20-21. Because the purchaser has an incentive to demand an invoice with an accurate record of the purchase price, the requirement creates a paper record that helps the tax authorities audit the VAT payments.

28 Ebrill, supra note 22, at 18-19; Cnossen, supra note 26, at 26-28.

29 The VAT may apply to both corporate and noncorporate business entities.

30 See Ebrill, supra note 22, at 18-19.

31 Ebrill, supra note 22, at 20-22; Schenk, "Prior U.S. Flirtations With VAT," in The VAT Reader: What a Federal Consumption Tax Would Mean for America, at 52, 59-60. Japan is the only country that uses the subtraction method VAT at the national level. Schenk and Oldman, supra note 21, at 41-42; Ebrill, supra note 22, at 20. Structurally, however, the VAT is a transaction-based tax in which some consequences (such as the applicable rate of tax) focus on each transaction rather than the aggregate result in the accounting period. Schenk and Oldman, supra note 21, at 40. The transactional nature of the credit-invoice VAT method links the purchaser's tax credit to the seller's official invoice, thereby creating an auditable paper trail. The transactional approach also facilitates the use of multiple VAT rates applicable to different goods or services. Ebrill, supra note 22, at 20-22.

32 Reuven S. Avi-Yonah, "Summary and Recommendations," 63 Tax L. Rev. 285, 290 (2010).

33 Sections 62(a)(1) and 162.

34 Schenk and Oldman, supra note 21, at 39; recast Sixth Directive, supra note 18, article 168.

35 Ebrill, supra note 22, at 83-85.

36 Section 263.

37 Sections 167-168, 1001.

38 Schenk and Oldman, supra note 21, at 36-38, 143-144. In some countries, such as China, VAT payers are not allowed a full input credit for the VAT paid for capital expenditures. Ebrill, supra note 22, at 1; Schenk and Oldman, supra note 21, at 37-38. Input credit may be limited or denied when the capital expenditures is attributed to nonbusiness use. Id. at 144-158.

39 Section 179. Section 179(d) defines section 179 property as depreciable tangible property or computer software that is acquired for use in the active conduct of a trade or business.

40 Section 179(b)(1)(A)-(B). Those limits are reduced if the taxpayer acquires section 179 property costing more than $800,000 in 2008 or 2009, or more than $2 million in 2010 or 2011. Section 179(b)(2)(A)-(B).

41 Section 179(b)(1)(C)-(D). Whether the scheduled reduction in that limit will occur is unclear. Over the past decade, Congress has regularly raised the dollar limits in section 179(b) and postponed the effective date of scheduled reductions in the limits. President Obama has proposed that the section 179(b) limit be increased to $1 million. See "The President's Framework for Business Tax Reform," at 17.

42 See section 168(e)(1).

43 See section 168(b)(4).

44 See section 168(b)(1). Taxpayers must use the 150 percent declining balance method for a limited class of depreciable assets. See also section 168(b)(2).

45 See section 168(k).

46 See section 168(k)(1); Rev. Proc. 87-57, 1987-2 C.B. 687.

47 Id.

48 Section 162(a)(1).

49 Schenk and Oldman, supra note 21, at 73. See also recast Sixth Directive, supra note 18, article 10 (the term "taxable person" defined in article 9 "shall exclude employed and other persons from VAT insofar as they are bound to an employer by a contract of employment or by any other ties creating the relationship of employer and employee").

50 Id. at 42, n.41.

51 Ebrill, supra note 22, at 19.

52 Section 501(a). Despite the broad scope of section 501(a), the exemption from income taxation is not absolute: Section 501(b) provides that an organization exempt from taxation under section 501(a) may be subject to tax under provisions relating to private foundations (section 507 et seq.), unrelated business income (section 511 et seq.), and political organizations (section 527).

53 Schenk and Oldman, supra note 21, at 263.

54 See Ebrill, supra note 22, at 85-88; Schenk and Oldman, supra note 21, at 268.

55 Exemption of agricultural products is common. See Ebrill, supra note 22, at 83.

56 The treatment of exemptions under the Japanese subtraction method VAT is distinctive. Under the Japanese VAT, a purchase may claim an input credit for VAT paid from an exempt seller (such as the farmer in Example 2) but may not claim an input credit for purchases on items that are exempt from tax. Schenk and Oldman, supra note 21, at 49.

57 The negative impact of exemption may induce the customers to prefer purchasing inputs from nonexempt suppliers or to self-supply the inputs. Id. at 78-80. It is therefore common for VAT laws to allow a person who qualifies for exemption to voluntarily forgo exemption and become a VAT payer. See, e.g., recast Sixth Directive, supra note 18, Article 290.

58 Schenk and Oldman, supra note 21, at 49; recast Sixth Directive, supra note 18, article 289.

59 See Ebrill, supra note 22, at 90, 101-103.

60 Schenk and Oldman, supra note 21, at 49; recast Sixth Directive, supra note 18, articles 286-288.

61 Ebrill, supra note 22, at 113-116. The Internal Revenue Code definition of small business corporation used in defining the term "S corporation," which focuses primarily on the number of shareholders and the corporate capital structure (see section 1361(b)(1)), contrasts markedly with the VAT small business exemption.

62 European Commission Taxation and Customs Union, VAT in the European Union, Thresholds -- Annex 1, available at http://ec.europa.eu/taxation_customs/resources/documents/taxation/vat/traders/vat_community/vat_in_ec_annexi.pdf.

63 HM Revenue & Customs, VAT rates, thresholds, fuel scale charges, exchange rates, available at http://www.hmrc.gov.uk/vat/forms-rates/rates/rates-thresholds.htm#2.

64 Irish Tax and Customs, available at http://www.revenue.ie/en/tax/vat/registration/thresholds.html.

65 Schenk and Oldman, supra note 21, at 49.

66 Id. at 101-102.

67 For example, the United Kingdom zero rates food and drink for human consumption although it taxes such processed items as "alcoholic drinks, confectionary, crisps and savoury snacks, food for catering or hot takeaway, ice cream, soft drinks and mineral water" at the standard VAT rates. HMRC, "Rates of VAT on Different Goods and Services," available at http://www.hmrc.gov.uk/vat/forms-rates/rates/goods-services.htm#1.

68 Ebrill, supra note 22, at 83.

69 Recast Sixth Directive, supra note 18, article 132(a)-(e).

70 Id. at article 132(i)-(k).

71 Id. at article 135(1)(a)-(g).

72 Ebrill, supra note 22, at 93.

73 Id. at 93-94.

74 Id. at 94-95. The issues that arise in connection with the exemption of financial services are exceedingly complex and raise many questions that are beyond the scope of this report. They are discussed in Schenk, "Taxation of Financial Services (Including Insurance) Under a U.S. Value-Added Tax," 63 Tax L. Rev. 409 (2010).

75 Schenk and Oldman, supra note 21, at 301.

76 Id. at 306-313.

77 See Schenk, supra note 74. Although the financial services provider pays no VAT, the systemic effect of the exemption is less clear. Without the exemption, consumers would pay VAT in connection with their consumption of financial services. Financial services companies, however, would be allowed to recover the VAT paid in connection with their inputs that are attributable to the provision of financial services, and businesses would be allowed to recover the VAT paid in connection with the financial services used as business inputs. Id. at 419-422.

78 Schenk and Oldman, supra note 21, at 327-334.

79 Satya Poddar, "Taxation of Housing Under a VAT," 63 Tax L. Rev. 443, 447 (2010).

80 Id. at 408-412; recast Sixth Directive, supra note 18, article 135(1)(j)-(l).

81 Id. at article 137(1)(b)-(c).

82 Schenk and Oldman, supra note 21, at 411; recast Sixth Directive, supra note 18, articles 135(1)(j)-(k), 12 (1)(a) and (b). In effect, that results in imposing the VAT on the cost of the durable asset in lieu of taxing the consumption of income from the durable (i.e., the rental value resulting from the use of the asset). In those circumstances, the VAT may be viewed as imposed "under the 'pre-collection' method." Poddar, supra note 79, at 453.

83 Recast Sixth Directive, supra note 18, article 135(2)(a)-(b).

84 Schenk and Oldman, supra note 21, at 282-289.

85 Pierre-Pascal Gendron, "How Should the United States Treat Government Entities, Nonprofit Organizations, and Other Tax-Exempt Bodies Under a VAT?" 62 Tax L. Rev. 477, 481-482 (2010).

86 HMRC website, "Rates of VAT," supra note 67.

87 Gendron, supra note 85, at 487.

88 Ebrill, supra note 22, at 176.

89 Id.

90 Schenk and Oldman, supra note 21, at 183. A reverse charge rule may apply to the importer of some services. When it does, the importer pays no VAT on the value of the imported service, but it cannot claim an input credit for the service in computing its net VAT liability.

91 Id. at 203.

92 Recast Sixth Directive, supra note 18, article 44.

93 Schenk and Oldman, supra note 21, at 190.

94 Id. at 205.

95 Id. at 50-51; recast Sixth Directive, supra note 18, article 169 (b) (authorizing a deduction for the amount of VAT paid on inputs used for the supply of goods or services transported outside the community).

96 See Sullivan, "The Small Business Love-Hate Relationship With Corporate Tax," Tax Notes, Sept. 26, 2011, p. 1321, Doc 2011-20120, or 2011 TNT 186-1 (Many small businesses, defined as entities with less than $10 million of total receipts, choose subchapter C treatment to take advantage of graduated tax rates, the low tax rate on dividends, and the possible ability to avoid payroll taxes on distributions).

97 Schenk and Oldman, supra note 21, at 127.


END OF FOOTNOTES

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