VAT (Value Added Tax)

“At December 31, 2010 $94 billion of earnings have been indefinitely reinvested outside the United States. Most of the earnings have been reinvested in active non-U.S. business operations and we do not intend to repatriate these earnings to fund U.S. Operations. Because of the availability of U.S. foreign tax credits, it is not practicable to determine the U.S. federal income liability that would be payable if such earnings were not reinvestment indefinitely.”  –  p.63 GE 2010 Annual Report.

WHAT IS A VAT – VAT stands for Value Added Tax. It is a tax based on the easily documented economic activity (purchases and sales) of a company rather than on assets or profits, which are values subject to interpretation and manipulation. Every company that sells merchandise or a service is taxed based on the amount of sales, minus the amount that they paid for the inputs into those sales. For the simple case of a bread company it would pay the VAT tax rate for the amount of sales for the tax period minus the cost of inputs (flour, sugar, fuel for the ovens, payments to a delivery company, etc.). Depending on the details of implementation, most countries also allow deductions for expenses that do not add to the value of the product such as local tax payments, and employee benefits.

WHY WAS IT DEVELOPED – Developed by European industrialized nations, the Value Added Tax is the means by which economic activity by Corporations and other large entities is taxed. The growth of the US multinational corporation in the period after WW2 was responsible for development of this method of taxation.  These large US companies operated from the relatively low tax rate United States with tremendous economic advantage. It was easy for them to avoid taxes by shifting various parts of their business from one country to another.  The VAT was developed to tax these companies on the basis of the economic activity in each country.

HOW IMPORTS ARE HANDELED – Generally imports are treated as having zero value until imported into the country. This means that the full value of the imported item or service is subject to the VAT.

WHY A VAT IS NOT A TARRIF – Tariffs are specific taxes on particular products, and are generally levied on particular products based usually on the political influence of the industry that the imported item competes with. They are specifically set to allow domestic industries to compete with cheaper imports and as such provide an economic disincentive for efficiency. A VAT taxes imports and domestically produced goods at the same rate. While a domestic product may not be taxed at the full sale value that is mainly because taxes on inputs are collected further down the production steam.

WHY 100% TAXATION OF IMPORTS IS FAIR – As mentioned above, the deductions from the VAT liability of a domestic company would mainly be due to the cost of “Upstream”  inputs. However, VAT taxes are already collected on domestic production and service inputs from the companies that supply those inputs. As for deductible items such as employee benefits, environmental costs and local taxes, it is also fair to collect that tax as an offset to the loss of US Tax revenues compared to domestic production. This way both domestic products and imports have the "level playing field".

WHAT IS PROFIT SHIFTING – This is an accounting operation by which goods that are shipped across borders is priced to generate profits at the location with the lowest taxes on profits. For example, (actually this is a real case of an electronic meter) suppose that a meter that sells for $1400 costs $300 to manufacture, has a marketing cost of $300, an engineering cost of $200, and sales and distribution costs of $300 yielding a profit of $300 per meter. The meter manufacturer can have the meter produced offshore for $300, set up a foreign subsidiary to purchase the meter and resell it to the US company for $600. This would effectively reduce the income tax liability to $0 by moving the profit offshore.

August, 2011