ES1.3.2 Assessment of current legislation in the field of research

The main issues within the field of research – enterprise financing – relate to the purport of VAT and the way in which it is interpreted in practice with regard to entrepreneurship and the right to deduct input VAT. Although these issues primarily affect those providing finance, they may also affect those receiving it. This applies specifically when a liability for VAT arises on non-consumption by financers as the latter will normally seek to pass on the tax charge to the recipient of the financing.

As far as entrepreneurship is concerned, another possible problem is that, with a certain element of good will, the economic activity of exploiting ‘tangible or intangible property for the purpose of obtaining income therefrom on a continuing basis’ can be interpreted so widely that even private individuals with a savings account can be seen as entrepreneurs. In my view, this interpretation goes too far. Whatever the case, however, the boundary lines essentially distinguishing businesses from consumers have become blurred. In addition, the effort to obtain income from supplies for consideration (income production criterion) that is required for an activity to constitute an economic activity also results, for example, in group holding companies and certain businesses that purchase receivables not being regarded as entrepreneurs. Such parties are certainly not consumers and, in line with the purport of VAT, should properly be regarded as entrepreneurs. Lastly, there is the regularity criterion, which sometimes results in incidental economic activities falling outside the liability for VAT, but sometimes not. Reasons justifying these anomalies can be found primarily in the case of the income production criterion.

The fact that the provision of finance does not usually constitute a taxed supply largely accords with the purport of the tax. This is because, in itself, this does not result in consumption, certainly not if the financing is provided to businesses. For the same reason, the fact that disposals of equities and bonds are not subject to VAT also reflects the purport of the tax. The fact that the value added by, for example, banks and securities traders is not liable for VAT is admittedly a problem, but only insofar as this value accrues directly to end users (or entrepreneurs not entitled to deduct all their input VAT). This anomaly can be justified by the technical difficulty of taxing such added value.

Various problems are associated with the right to deduct input VAT. This is because, in view of the purport of the tax, an entrepreneur providing finance to a business could be expected to be fully entitled to deduct input tax on the costs incurred in this respect, given that there is no consumption by this party. The same applies to the disposal of shareholdings or transferrable debt instruments. As it currently stands, however, the legislation does not always allow full deduction of input VAT. This applies specifically in the case of exempt services, such as the granting of credit and the disposal of securities. De facto, therefore, non-consumption is taxed. Although certain grounds justifying this position are conceivable, none is entirely convincing.

The only problem affecting the recipients of financing in this respect is that transfers of receivables may restrict their right to deduct input VAT. In my view, there are no strong grounds to justify this restriction.

Lastly, opportunities currently exist for tax planning in the capital sphere, partly because there is no requirement in VAT to apply arm’s length pricing in relationships between associated parties. In certain cases, parties may have an incentive to agree lower (or higher) remuneration for supplies of goods or services. The loss (or surplus profit) can then be adjusted through the capital relationship, providing this effectively serves to reduce the VAT payable. One reason that may justify allowing these tax planning opportunities to persist is that seeking to combat them by introducing an open market value would have a substantially adverse effect on legal certainty, simplicity and enforceability, while the extent to which such planning occurs is also unclear. Maybe the problem is not particularly widespread.