The VAT exemption regarding financial transactions is often used in Sweden as an argument to raise taxes in the financial sector. However, the exemption is harming the business climate as well as growth and development. Therefore, instead of additional tax burdens, a reform of the current VAT exemption should be initiated. This is proposed in a missive from the Confederation of Swedish Enterprise based on a report by docent Oskar Henkow (summary in English).
Contrary to public belief, exempt from VAT is not the same as free from VAT. Instead, being exempt simply means being treated as a consumer, i.e., the input VAT is non-deductible. This cost (the VAT) must therefore be compensated for, meaning that it most likely will be passed on through the transaction chain – embedded in the price of the goods or services. This results in a non-deductible “hidden” VAT. The hidden VAT will never be deductible, irrespective of the following businesses’ VAT status. On the contrary, it will even be VAT on the hidden VAT. Therefore, it is not only the value added which will be taxed, but also previous tax will be taxed. These problems are well known in the international debate, being mentioned by the OECD, EU and IMF among others, but unfortunately seem unknown in the Swedish tax discussions.
A shocking (although not surprising) example of the VAT-impact on exempt business was given during an interesting seminar at this year’s IFA Congress by a large Banking Group. The Group’s largest tax cost was irrecoverable VAT. Almost 31% of the Group’s total tax cost was VAT (remember that the group is supposed to be an “exempt” business)! Thus, an incentive is given for companies conducting exempt activities to make investments which have no, or little, VAT instead of investing in projects with VAT. This result in undesired effects on businesses’ decisions.
The exemption entails large problems for both businesses and society – but there is no debate about it. Furthermore, the exemption is complex and IT-systems are not capable of handling all aspects of it. This occupies many tax advisors, officials and judges on top of the distortive effects it has on the society. Especially in Sweden, with one of the world’s highest VAT rates, the problems following hidden VAT can be expected to be relatively larger and therefore constitute a competitive disadvantage versus foreign businesses.
A possible solution could be an option for taxation in respect of financial transactions – which is suggested in the above-mentioned missive. This is a possibility in the current VAT Directive which has been used by six Member States already. An option to tax would mitigate a lot of the problems following today’s system and would create a simpler VAT-administration. A good starting point for a review of today’s system and tomorrow’s possibilities is the report from docent Oskar Henkow. Furthermore, The European Commission Group on the Future of VAT has communicated that the results from a study regarding the VAT rules for financial and insurance services can be expected by summer 2020. The technical development since the last review of the exemption for financial transactions makes the possibility of an VAT reform even more interesting.