INDIRECT TAX SYSTEM:
VALUE ADDED TAX (VAT)
(EVIDENCE FROM THE CZECH REPUBLIC)
Taxation – Lecture 7
Content
• VAT – basic concepts, taxable persons
• Evidence from the Czech Republic
• Literature
VAT – adoption of VAT
• Value-added tax (VAT) is still a relatively new tax. It was first
introduced as a comprehensive national tax 40 years ago in France.
Since then, it has been adopted as the main form of indirect
taxation by many countries in different parts of the world and at
different stages of economic development. In particular, it is a
key common form of taxation for the 28 member states of the
European Union. It has also been adopted by Japan, China,
Canada, Korea, and many other states in Asia, North and South
America, and Africa, besides being adopted in almost all the states of
Europe and of the former Soviet Union. Further, the process of
expansion of the European Union, together with the alignment of the
laws of potential candidates for membership, has ensured increasing
consistency in the form of VAT operating in Europe. Of the major
economies, only the United States and Australia do not have a VAT at
the federal level (partly because of problems in introducing the tax in
federal states), although both have considered in detail how it might
be implemented.
VAT – adoption of VAT
• As a result of this rapid and widespread adoption of a VAT, the laws
implementing the tax have adopted different terms and forms in
different states. Tait has rightly described it as an "unparalleled tax
phenomenon.” There has therefore been little chance to evolve a
settled vocabulary or considered common approach. In particular,
there is no international organization with the specific role of
supervising the operation of value-added taxes among states in
the way that the OECD Fiscal Affairs Committee keeps an eye on
double taxation agreements and the International Customs Union
(formerly Customs Cooperation Council) coordinates the collection of
customs duties. Although the European Commission performs that
function within the European Union, and assists elsewhere in Europe,
it does not have competence to act globally. Nonetheless, despite
varying names and terminology, the VAT has a common core
form throughout the world.
VAT - economic scope
• The unique nature of the VAT is its potential scope in identifying
and taxing the economic contribution - or added value - made by
any economic operator in connection with any activity of a
business or commercial nature. The formal principles of this
method are set out in the EC First VAT Directive as follows:
“The principle of the common system of value added tax involves the
application to goods and services of a general tax on
consumption exactly proportional to the price of the goods and
services, whatever the number of transactions that take place in
the production and distribution process before the stage at
which tax is charged.
On each transaction, value added tax, calculated on the price of the
goods or services at the rate applicable to such goods or services,
shall be chargeable after deduction of the amount of value added
tax borne directly by the various cost components.”
VAT - territorial scope
• Because the VAT is an indirect tax focusing on the transaction or
activity rather than on the economic operator, the primary
determination of the territorial scope of the charge to VAT is by
reference to the location of a transaction. If the transaction occurs
within the state, then it is within the charge to VAT.
• There are two conflicting principles on which the territorial
scope of a VAT can be based: the origin principle and the
destination principle. As these names suggest, the origin principle
charges a transaction, only part of which occurs within the
jurisdiction, if the transaction originates or is created within the
state, and the destination principle charges the transaction if it is
destined for consumption in the state. For example, if goods are
exported from state A to state B, then state A will charge the
transaction if it has an origin-based VAT, and state B will charge if it
has a destination-based VAT. For services, it may in practice be
harder to determine where the service is provided, or where it is
VAT - territorial scope
consumed. Subject to that practical problem, an origin-based tax will
concentrate on the state of origin of the person supplying the
service, while a destination-based tax will charge supplies
consumed in the state.
• Potential problems of double taxation and absence of taxation
arise if these rules clash. For example, assume state A has an
origin-based VAT and state B has a destination-based VAT. Exports
from state A to state B will be taxed in both states. Exports from
state B to state A will not be taxed in either state. The result, in a
free market, would be that goods from state A would be too
expensive to be competitive in the market in state B, so only
limited exports would occur. However, there would potentially be
high levels of exports from state B to state A because the goods
imported from state B would be tax free, while locally made
goods in state A would be subject to tax. In practice, state A could
not afford this imbalance and would impose a charge on the goods
from state B - in other words, a destination-based charge, unless the
VAT - territorial scope
charge is to be a discriminatory border charge. This would avoid the
absence of a VAT, but not the double taxation.
• To avoid double taxation, states that impose a VAT on imports
remove exports from the charge to tax (and conversely, they
should exempt imports where exports are taxed). This will also
remove double taxation if both states have the same system
(whether the origin system or the destination system). The
example shows that those sets of rules cannot in themselves
deal with a situation where the two states have different
approaches to this question.
• There is no international agreement determining either that
states should follow one of these principles rather than the other
or seeking to reach common rules to avoid double taxation (or
double exemption from taxation). There is, therefore, no
commonly agreed set of answers to these issues.
VAT - territorial scope
• In practice, however, and with limited exceptions, states have
adopted the destination basis as the primary basis. There are
some cases where, within a customs union or trading bloc, the origin
base is used or has been proposed for adoption, but these practices
are limited exceptions to the general approach.
VAT – internal charge of VAT
• The common pattern of an invoice-based VAT is that a charge to
VAT is imposed on all transactions within the state and within
the scope of the VAT. Each taxable person is allowed a
deduction against the total VAT charged by the person to take
account of any VAT paid by the person on inputs related to
transactions within the scope of the VAT.
• A transaction within the scope of VAT and on which VAT is imposed is
commonly called an output and the VAT collected on it is called
output tax. A transaction made to the person making the output is
known as an input, and the VAT paid by that person when obtaining
the input is an input tax. The internal charge to tax, consistent with
the principles noted above, is therefore a charge amounting to the
output tax received by a person less the input tax paid by that
person. The charge to tax must therefore identify on which outputs,
and by which persons, output tax must be collected, and what input
tax is available as a deduction against that output tax.
VAT – internal charge of VAT
• The normal approach is to impose output tax on transactions and
persons if:
(a) the transactions are "supplies of goods and services;”
(b) those supplies are "taxable" and not exempt from VAT;
(c) those taxable supplies are made by a "taxable person," that
is, a person within the scope of the charge to VAT; and
(d) the taxable person makes those supplies as part of the
person's business activities, and not as part of a hobby or
noncommercial activity.
VAT – approach to charging VAT on imports
• States have normally adopted the practice of treating imports of
goods separately from imports of services. Imports of goods are
identified by the physical entry of the goods. Services cannot be
identified in this way. Instead, states have chosen to adopt rules that
treat a supply of a service as occurring within a state if the
supply meets certain criteria (and not so occurring if it does not). In
this way, states have usually avoided the concept of "import of
services" by defining or deeming services to be supplied either in the
state or outside it (and not "to" it).
• Principle of nondiscrimination - the products of the territory of
any contracting party imported into the territory of any other
contracting party shall not be subject, directly or indirectly, to
internal taxes or other internal charges of any kind in excess of
those applied, directly or indirectly, to like domestic products.
VAT – taxable persons
• A person within the scope of VAT is usually described as a
taxable person. A VAT law should include all legal persons
created under the law of the state (or of a foreign country) that
engage in economic activities of any kind, as well as all physical
persons. The text should be drafted to bring all legal and physical
persons potentially within the category of "taxable persons." It may
usefully refer to the precise laws of the state under which such
persons or entities derive their juridical status.
• One problem arising here is whether the law should include
partnerships and associations as taxable persons. The extent to
which associations and partnerships have juridical personality
separate from the individuals who are its members varies from one
state to another, and the law may need to reflect this.
• A VAT law does not usually need to expressly mention foreign
legal persons, that is, persons that derive their legal personality
from the law of some other state, as with a company registered
VAT – taxable persons
in a foreign state. However, it is intended that all legal persons
be registered for VAT if they conduct within the state activities of
the kind and level defined in the law. In practical terms, this means
that some branches or permanent establishments are required to
apply to be registered, while others are found, following the
jurisdictional rules of the state, not to be making supplies of the
required level within the state. This problem has some similarities to
that of deciding whether a person is a resident for income tax
purposes. In most states, for example, a foreign company becomes
"resident" and, therefore, within the jurisdiction of the state if it
establishes a branch, agency, or permanent establishment within the
state. There is an agreed definition of "permanent establishment" in
article 5 of the OECD Model Tax Convention. A similar approach
could be adopted for the VAT.
VAT – taxable persons
• Most states require only some of the many persons active in
business within the state to be taxable persons. This is normally
achieved by setting a minimum level or threshold of business
activity and requiring only those persons with levels of activity
above the minimum to be taxable persons. Those with levels of
activity below that level are not required to be taxable persons,
although they are often given the right to voluntarily choose to be
taxable persons. The usual measure of business activity is the
total turnover of taxable goods and services supplied by the
person over a set period.
• The total to be taken into account for the threshold is the total
taxable supplies of that person. This means the total of all supplies
made by that person that are treated as taxable supplies within the
definition of the law. The total does not include supplies exempted
from VAT or outside the scope of VAT. This means that a person
conducting a business that is largely exempt is outside the
VAT – taxable persons
scope of the registration provisions if the taxable activities reach
a total less than the threshold, although the total economic
activity of the business is high.
• The precise level of threshold varies widely from one state to
another and, within a state, varies from one time to another.
There are several reasons for this. Limits vary partly as a reflection
of the economic structure of a state. Some states have a
comparatively greater number of marginal small businesses involving
one person or one family than other states. Even taking account of
the differences, in many states self-employed individuals or single
families engaged, for example, in subsistence farming or small market
trading will contribute little to the collection of VAT. It is also
administratively difficult - and therefore expensive - to collect tax from
such people. In addition, the exclusion of smaller traders from VAT
through the use of a threshold limit is particularly useful at the
introduction of the tax, when there are limits on available
VAT – taxable persons
administrative resources and taxpayer knowledge of the tax is at a
minimum.
• The law may be drafted to allow the authorities to alter the
amount set from time to time, both to ensure that the tax is
working properly and, in any event, to ensure that inflation does
not have too significant an effect on the practical level of the
threshold as the minimum monthly or annual wage. The
threshold then adjusts automatically with that factor.
• To administer the VAT, it is standard practice to establish a
formal state register of those who are registered persons. There
must then be a requirement that any person who is, or should be, a
taxable person take the necessary action to seek to be registered for
the VAT. The law or regulations need to confirm the register and give
it official status. Penalties will also be needed to ensure that all those
required to do so apply to be registered. Recognizing this
requirement, laws sometimes refer to taxable persons as "registered
persons" or "persons required to register.
VAT – taxable persons
• States sometimes decide to adopt and adapt an existing register,
such as the register for companies or a general register of
taxpayers, to act as the VAT register. That is for a state to decide,
but the register must be capable of generating a unique VAT number
for each taxable person, as well as providing the tax authorities with
an up-to-date list of those, and only those, who are taxable persons.
For reasons of good administration, states with more limited
administrative resources find it increasingly attractive that the VAT
number be the same as the taxpayer identification number used for
income and other taxes. The practice must meet the need to provide
all those registered for VAT, whether or not they are income tax
payers, with a unique number at the time they are registered for VAT.
• Once a taxable person has been issued a VAT registration
number or has had the registration confirmed under a given
number, the law should require the person to use that number on
VAT – taxable persons
all official communications. For example, the number should be
indicated on all communications with the tax authorities and perhaps
other documents, such as official orders or official stationery.
• States often allow those who are not required to be registered
(because their activities are below the level of the threshold) to
register voluntarily. This may be appropriate for many organizations
that intend to have a large turnover, but have not yet reached it; incur
large expenditure in one year, expecting the income in the next year;
or are carrying out business activities at a level that does not reach
the registration limit, but that do not wish this information to be known
by customers (e.g., younger self-employed providers of services).
Voluntary registration also allows those operating just below the
threshold level to avoid any competitive disadvantage compared
with other operators who are required to be registered.
VAT – taxable persons
• There is sometimes a danger to the integrity of a tax system in
allowing uncontrolled voluntary registration. First, this may allow
those who are not in reality engaged in business to register with a
view to claiming rebates of input tax when they have no real intention
of paying much output tax. Such persons should not be entitled to
register unless they are genuinely involved in business, but both
practical and legal safeguards are needed to ensure that the tax
authorities can control this situation. Failure to control it may result in
significant revenue loss. It may be deterred to some extent by placing
a minimum period on voluntary registration, as noted below.
• Provided that the tax authorities can ensure that the integrity of
the VAT is safeguarded, economic neutrality will be achieved
only if voluntary registration is allowed. A compromise adopted
by some states introducing a VAT is to set a minimum activity
level for compulsory registration and a lower minimum level for
voluntary registration. Where these rules operate, a person can
VAT – taxable persons
register voluntarily only if the lower minimum is met. This excludes
those persons with no real economic activity or whose
businesses have not yet started. At the same time, it allows some
voluntary registration to control distortions between those just above
and those just below the compulsory threshold.
• The law should provide for three situations where VAT
registration should be canceled:
 The first case is where a person has been registered for
VAT properly, but where the registration is no longer
appropriate. This will occur where a person was required to
register because the person's business activities exceeded the
threshold but where, subsequently, the person's level of
business activities has declined to below the threshold. If
the person is continuing in business, then, if the person so
wishes, a voluntary registration may be maintained. However,
the person should have the right to deregister. Mechanisms are
needed to allow a person to remove the person's
VAT – taxable persons
name from the register when this occurs.
 The second case is where the person has ceased to carry
on business activities (or has ceased to qualify for some
reason for voluntary registration). If so, the person's name
should be removed from the register whether or not the person
applies for deregistration. Subject to safeguards for the integrity
of the VAT collection process, deregistration should take place
when the person ceases to be entitled to register or no longer
wishes to be registered.
 The third case is where the person has been registered by
mistake or by misrepresentation on the part of the person.
In these cases, it will usually be appropriate to provide that the
person is removed from the register retrospectively to the
moment of registration. In other words, the registering
authorities can take action so that the person registered
wrongly can be treated as if the registration had never
occurred.
Evidence from the Czech Republic
• Taxable transactions in the Czech Republic include:
 supplies of goods by a taxable person,
 intra-EU acquisitions in an EU country of goods from
another EU country,
 supplies of services by a taxable person,
 imports of goods from outside the EU (a third territory or a
non-EU country).
• The subject to VAT is not supplies of goods by:
 a taxable person established in the Czech Republic, which
is not a taxpayer,
 exempt person, which is not a taxpayer,
 taxable person who carries out only exempt transactions
without the right for deduction of tax,
 taxable person, which is in another Member State subject
to the common flat-rate scheme for farmers or legal nontaxable
person.
Evidence from the Czech Republic
• A taxable person is:
 A person who, independently, carries out in any place any
economic activity, whatever the purpose or results of that
activity,
 A person who, on an occasional basis, supplies a new
means of transport transported to another EU country.
• Economic activity includes any activity of producers, traders or
persons supplying services, including mining and agricultural
activities and activities of the professions.
• States, regional and local government authorities and other bodies
governed by public law are not regarded as taxable persons.
• In the Czech Republic a taxable person becomes a taxpayer
when his turnover in the last 12 consecutive months exceeds 1
000 000 CZK. This taxable person becomes a taxpayer since the
1st day of the 2nd month after the month in which the turnover
Evidence from the Czech Republic
exceeds the limit.
• This taxable person is obligated to register as a taxpayer in 15
days after the month in which the turnover exceeds the limit.
• A taxable person which carries out transactions with a claim for
deduction of tax could register voluntarily.
Literature
• MCGEE, Robert W. The philosophy of taxation and public finance.
Boston: Kluwer Academic Publishers, 2004. viii, 313.
ISBN 1402077165.
• RADVAN, Michal. Czech Tax Law - 3rd ed. 3. vyd. Brno: Masarykova
univerzita, 2010. 65 s. Fac. of Law Publ. no. 4 (Edition of textbooks).
ISBN 978-80-210-5269-7.
• Victor Thuronyi, ed. Tax Law Design and Drafting. International
Monetary Fund, Vol. 1, 1996, 1222. ISBN 978-1-55775-633-6.