Tax harmony in the European Community leaves much to be desired.

• Author: Knight, Ray A.

Until recently, only minimal attention was given to tax harmony in the development of European Community (EC) tax directives. The priority in the EC was originally given to the indirect value-added tax (VAT) over corporate tax harmony, because there was no way that two major tax projects could be conducted at the same time. The need for stability of the member states and their inability to deal with the revenue of two simultaneous programs have been cited as reasons for the emphasis on VAT.

Before looking for the pitfalls in the EC's corporate tax and VAT systems, the VAT and its history must be briefly discussed. In addition, tax planning opportunities or loopholes are highlighted. Much can be gained by interested parties in the United States from focusing on the EC's tax environment.

Value-Added Tax

VAT is a tax levied on the value added to goods and services by each business entity at various levels in the production and distribution chain. It is an indirect tax levied on consumption and borne by the final consumer of goods or services. It is included in the price that the ultimate purchaser pays. Thus, it differs from adirect tax such as income or inheritance tax. In certain respects, a VAT is similar to a retail sales tax. There is a fixed rate of tax and there are exempt products or users. The similarity, however, stops there. Whereas a retail sales tax applies only to the final sale, a VAT applies to each sale in the commercial process: from supplier of raw materials to manufacturer, from manufacturer to wholesaler, from wholesaler to retailer, and from retailer to consumer. In theory, the tax base relates to the increase in value added to the product at each level; in practice, it is measured by the increase in sales price at each level.

Ultimately, the full weight of the tax falls on the final consumer. In the normal situation, each business in the process collects the VAT on its sales, takes a credit for any VAT it has paid on purchases, and remits the net amount to the government. If the business pays more VAT than it collects during the period, it receives a refund or credit. Only the retail consumer is not entitled to a refund or credit for VAT paid.

History of VAT in the U.S. and EC

From time to time during the last 60 years, there have been proposals for a system of taxation bearing a resemblance to VAT. As long ago as 1921, T.S. Adams proposed a form of VAT for the United States. In fact, a bill calling for a federal...