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III. DESCRIPTION OF S. 442: VALUE ADDED TAX
S. 442, introduced by Senator Hollings on February 23, 1989, would amend the Internal Revenue Code of 1986 (the Code) to impose a 5-percent value added tax (VAT) (title I). The bill also would establish a trust fund in the Department of the Treasury that would restrict the use of the revenues from the VAT to deficit and debt reduction (title II).
A. Description of Tax Provisions (Title I of the Bill) Imposition of the value added tax
In general, the bill would impose a VAT on the sale of property and the performance of services in the United States pursuant to a commercial transaction. In addition, a VAT generally would be imposed upon any sale or leasing of real property and any importing of property, whether or not pursuant to a commercial transaction. The amount of tax generally would be 5 percent of the value of the property sold or the services performed and would be imposed on the seller at each stage of production and distribution, including the retail stage. Each taxable person in the production and distribution chain would receive a credit for the VAT previously paid by its suppliers on its purchases of goods and services in taxable transactions. Thus, each taxable person generally would pay a net tax equal to 5 percent of the value added by that person to property or services sold. The total VAT paid with respect to any property or service provided to a consumer (taking into account the net taxes levied at all stages of production) would equal 5 percent of the retail value of the property and services.
The VAT would be imposed on persons who engage in taxable transactions. Taxable persons generally would include corporations, persons engaged in business transactions, sellers and lessors of real property, and importers.
In general, in the case of a sale of property in the United States, the VAT would be imposed on the seller. For property imported into the United States, the VAT would be imposed on the importer. In the case of the performance of services in the United States, the VAT would be imposed on the service provider. However, an employee would not be subject to the VAT with respect to activities engaged in as an employee.
In the case of cash transactions, the amount subject to the VAT would be the price charged to the purchaser of the property or services, including all invoiced charges for transportation and other items payable to the seller, but excluding the VAT and any State
and local sales and use taxes. In the case of any exchange of property or services, the taxable amount would be the fair market value of the property or services transferred by the taxable person.
In the case of imports, the taxable amount would be the U.S. customs value plus the U.S. customs duties. If there is no specified customs value, the taxable amount would be the fair market value of the property.
The bill would provide a special rule for the determination of the taxable amount for sales of certain used consumer goods. If a taxable person sells tangible personal property that was acquired in a nontaxable transaction from an ultimate consumer, the taxable amount would be reduced by the amount paid for the property by the taxable person.
Exceptions to imposition of the VAT
The bill would provide various exceptions to the imposition of the VAT. For instance, the bill would impose a zero tax rate 11 with respect to certain sales of food, housing, and medical care. A zero rating would also be provided for farmers, fishermen, mass transit services, exports, interest, and certain transactions with governmental entities and section 501(c)(3) organizations.
The bill also would provide a de minimis exemption from the VAT that may be elected by certain small businesses.
Special rules and treatment of certain transactions
The bill would provide special treatment with respect to the personal use of business property by any owner of the taxpayer, gifts of business property or services, the disposition of nonbusiness real property, and insurance.
Coordination with the Federal income tax system
Under the bill, the basis of any property for Federal income tax purposes would not include the portion of the purchase price that represents a creditable VAT. In addition, the amount allowed as an income tax deduction for any VAT would be determined without regard to any VAT credit. For purposes of computing percentage depletion, gross income would be reduced by the amount of VAT imposed and taxable income would be determined without regard to any deduction allowed for the VAT.
The VAT credit
A taxable person would be permitted to claim a credit for the VAT paid on its purchases of property and services to the extent such property and services are used in a business. The VAT credit would be applied first to reduce the VAT liability, with any excess treated as a refundable overpayment of tax. Generally, in order to claim a credit, the taxable person would be required to have an invoice that indicates the amount of VAT paid.
11 In a zero-rated transaction, a rate of 0 percent is substituted for the normal VAT rate of 5 percent.
VAT administrative procedures
The "credit-invoice" method
The VAT system imposed by the bill would utilize the "creditinvoice" method. Thus, any taxable person engaged in a taxable transaction would be required to give the purchaser a tax invoice with respect to the transaction if the taxable person has reason to believe that the purchaser is a taxable person. The invoice would be valid only if it indicated the name and identification number of the seller, the name of the purchaser, the amount of VAT imposed on the sale, and certain other information.
The invoice generally would be required to be furnished no later than 15 business days after the tax point of the taxable transaction. The tax point would be the earlier of (1) the time that the taxable person must recognize income from the transaction for Federal income tax purposes, or (2) the time that payment is received. In the case of imported property, the tax point would be when the property is entered, or withdrawn from warehouse, for consumption in the United States.
Time for filing return and claiming the credit
The bill would require the taxable person to file a VAT return during the first month following the close of the taxable period. The taxable period generally would be a calendar quarter. The return would reflect the VAT due on taxable transactions having a tax point within the taxable period.
To the extent provided in regulations, monthly deposits may be required for the estimated VAT liability for any taxable period.
A VAT credit with respect to a taxable transaction would be allowed no earlier than the first taxable period by the close of which the taxable person has paid or accrued the VAT liability and has received a VAT invoice.
Treatment of related businesses
To the extent provided in regulations, a taxable person would be allowed to elect to treat all businesses under common control (as defined by section 52(b) of the Code) as one taxable person for purposes of the VAT. However, for purposes of the small business exemption, all businesses under common control would be considered one taxable person.
To the extent provided in regulations, a taxable person would also be allowed to elect to treat any of its divisions as separate taxable persons.
Treasury notification and regulations
The bill would require a taxable person to notify the Internal Revenue Service if certain events occur. The reportable events would be described in Treasury regulations and generally would include a change in the form of a business or any other change that would affect VAT liability, a VAT credit, or VAT administration with respect to the business.
The bill also would grant the Secretary of the Treasury broad authority to issue regulations with respect to the VAT.
The bill would apply to transactions occurring after December 31, 1989.
B. Allocation of Revenues from Value Added Tax (Title II of the Bill)
The bill would establish a Deficit Reduction Trust Fund (DRTF) in the U.S. Treasury. Amounts equivalent to current estimates of receipts from the VAT would be transferred monthly from the General Fund in the Treasury to the DRTF. Correcting adjustments to these amounts would be made subsequently as more accurate information became available.
Amounts in the DRTF would be used solely to retire outstanding public debt obligations of the United States and to pay any administrative costs incurred in collecting the VAT and in operating the DRTF. Debt would be retired by paying off obligations at maturity, or by redeeming or buying obligations before maturity and retiring them (i.e., obligations redeemed from the public before maturity could not be resold to the public).
For purposes of calculating the maximum deficit amount under the Balanced Budget and Emergency Deficit Control Act of 1985 (Gramm-Rudman-Hollings), amounts received in, and disbursed from, the DRTF would not be included in total revenues and budget outlays. Consequently, VAT receipts could be used only to retire outstanding debt obligations and could not be used to finance current expenditures.
C. Analysis of Specific Issues
1. Definitions of taxable transactions and taxable persons
a. In general
Under the bill, the VAT would be imposed on each taxable transaction. The term "taxable transaction" means (1) the sale of property in the United States, (2) the performance of services in the United States, and (3) the importing of property into the United States, by a taxable person in a commercial-type transaction. A "commercial-type transaction" would mean a transaction engaged in by a corporation (other than an S corporation) or by any other person engaged in a business. Commercial-type transactions also would include any sale or leasing of real property or any importing of property, whether or not engaged in by a corporation or in connection with a business. Importing of articles by a consumer free of duty under the personal exemptions of the United States Tariff Schedules would not be subject to the VAT.
"Taxable persons" would mean persons who engage in a business or in a commercial-type transaction. The term "business" would include a trade and an activity regularly carried on for profit. An employee would not be considered a taxable person with respect to activities engaged in as an employee.
b. Sales of property
Under the bill, the term "sale of property" would not be restricted to the sale of property for cash in the usual sense. For purposes of the VAT, a sale of property would include:
(1) the exchange of property for property 12 or services;
(2) the transfer of property to an employee as compensation (unless the transfer is a type for which no amount is includible in the income of the employee);
(3) a sale of property to a governmental entity; 13 and
(4) a sale of property by a governmental entity or by certain taxexempt entities. 14
The bill would define "property" to mean any tangible property. Thus, the sale of such intangible property as stocks, bonds, securities, franchise rights, patents, copyrights, and other intellectual property would not be subject to the VAT. This dichotomy in the treatment of tangible versus intangible property raises certain issues. For instance, certain assets possessing characteristics of both tangibility and intangibility (such as computer software) would be difficult to classify for purposes of taxation. Such classification issues often have arisen in the area of State sales and use and property taxation and in the area of the investment tax credit as it existed before the Tax Reform Act of 1986.15
In addition, since the sale of tangible property by a corporation would be subject to the VAT, while the sale of intangible property by an individual would not, a shareholder who wishes to dispose of his or her wholly-owned corporate business may sell his or her stock rather than have the corporation sell its assets and liquidate in order to avoid the VAT.16 Alternatively, an individual may wish to dispose of an asset that would otherwise be subject to the VAT (such as real property). In order to avoid the VAT, the taxpayer could contribute the property to a newly formed corporation and sell the stock.
c. Performance of services
The performance of services in a commercial-type transaction would be subject to the VAT. The bill would provide several examples of includable items rather than an overall definition of services. Activities treated as the taxable performance of services would include (but would not be limited to) permitting the use of property, the granting of a right to the performance of services or
12 Such an exchange presumably would include a like-kind exchange of property which would be tax-free under section 1031 of the Code. Administrative and procedural issues arise as to how the VAT would be collected and reported on such a transaction without affecting its tax-free status under the income tax.
13 Note, however, that the sale of property to a governmental entity will be zero rated for purposes of the VAT, as further discussed at pp. 20-21 of this pamphlet.
14 Certain sales of property by a governmental entity or a tax-exempt organization would have a zero rating while other sales would be subject to the VAT at the full five percent rate. See pp. 20-22 of this pamphlet.
15 See, for example, Robert W. McGee, Software Taxation, National Association of Accountants, 1984, chapters 1 and 3.
16 Under the British VAT this is not a problem, as the U.K. Treasury has exercised its authority to rule that the transfer of a business as a going concern is not a transaction subject to tax. See, Alan Schenk, Value Added Tax-A Model Statute and Commentary, A Report of the Committee on Value Added Tax of the American Bar Association Section of Taxation (hereinafter "ABA Report"), 1989, p. 29.