Future 'zero rate' urged for business financial services


Tribune Business Editor


The Government has been told to consider ‘zero rating’ financial services supplied to Bahamian businesses once a Value-Added Tax (VAT) regime has been in place for several years.

And the two New Zealand tax consultants, Dr Don Brash and John Shewan, in their May 6 report to the Christie administration, also suggested that the Government consult with the general insurance industry on making it ‘VAT-able’ “within one or two years” of reform implementation.

Both domestic financial services and insurance (life/health and general) were initially proposed as ‘exempt’ under the initial 15 per cent VAT model, meaning that they would have been unable to reclaim the tax paid on their ‘inputs’.

The Government, while promising “far fewer exemptions” under its restructured 7.5 per cent VAT model, has yet to release the revised draft Bill and regulations, along with a new list of ‘exempt’ products and services.

But, given that New Zealand also treats domestic financial services as ‘exempt’, it appears likely that the Bahamas will follow its VAT lead, especially as the Christie government has placed great credence on the advice from Messrs Brash and Shewan.

International financial services will likely be treated as ‘zero rated’ to protect the so-called offshore industry, and the initial Bahamian model called for domestic services provided for a fee to be ‘VAT-able’.

The New Zealand consultants said: “It is normal to exempt most financial services from VAT because it is generally not possible to determine the component of the price (for example, interest on a bank loan) that represents the charge for the service provided.

“Taxing the full amount of gross interest would significantly over tax the financial services element in the hands of the consumer.”

They added that the exemption meant the VAT cost would fall directly on domestic financial institutions, as opposed to the consumer.

The “VAT recovery rate” in New Zealand was just 10 per cent in 2005, but had now risen to 40 per cent. In the Bahamas, the New Zealanders said, this ‘recovery rate’ would largely depend on the amount of exported financial services.

“An alternative to the exempt treatment of financial services would be to zero-rate them,” Messrs Brash and Shewan said.

“The basis for doing so would be to relieve financial institutions of the burden of irrecoverable VAT on the basis that this amount will most likely be shifted forward in the form of higher prices charged to households for the consumption of financial services. This treatment would also reduce compliance costs.”

However, the conceded that New Zealand and other countries had decided not to ‘zero-rate’ financial services because it gave the sector privileged status, and shifted the VAT tax burden to other industries. It also undermined the policy of having the broadest possible tax base.

Nevertheless, persisting with the ‘zero rating’ theme, the New Zealand duo suggested the Bahamas consider applying this VAT status to domestic financial services supplied to local businesses only.

“Although the exemption approach is conceptually justifiable in relation to supplies of financial services to end consumers, it is difficult to justify in relation to supplies to taxable businesses,” Messrs Brash and Shewan said.

“New Zealand addressed this issue comprehensively in 2002, and after significant industry consultation, financial services supplied from banks to businesses were zero-rated in 2005.....

“The Bahamas Government may wish to consider this refinement to the financial services provisions at some future point. The regime is complicated, however, and based on the New Zealand experience is best added to an existing regime where there is a reasonable amount of practical experience with the workings of VAT in financial services. Attempting to implement this approach now would be likely to delay implementation of VAT.”

Turning specifically to the insurance industry, the consultants said the Bahamas’ initial decision to treat them as VAT ‘exempt’ was consistent with other countries.

“As with banking, the exemption causes VAT to become a cost to insurance businesses, and premiums can be expected to increase to recoup this,” the New Zealanders wrote.

“To repeat the point made earlier, it is a fallacy to think that prices charged by an exempt supplier will not increase following the introduction of VAT.”

New Zealand, though, no longer exempts general insurance from VAT as it is possible to “separate and value the service or value-add component”. This, the New Zealanders added, could not be done for life insurance or banking.

Australia and others have since followed New Zealand’s lead, and Messrs Brash and Shewan added: “Once the general insurance industry understood that being taxable meant that they could recoup all VAT paid, relative to a recoupment of close to zero if they were exempt, they recognised the commercial benefits of being included.

“While there was a significant education campaign required, and the actual implementation phase was complex due to the role of reinsurers, agents and other intermediaries, within a couple of years of the October 1986 start date, the system had settled down and operated smoothly. There have been no calls to apply exempt status to the industry, and if efforts were made today to change their status to exempt, there would be significant resistance.”

The life insurance industry, meanwhile, would also like to be ‘exempt’ if an appropriate formula could be found.

“The Mission is not suggesting that general insurance be included in the Bahamian VAT at this point,” Messrs Brash and Shewan concluded.

“The time required for design, education and system changes would be significant, and would result in delays to the implementation date. However, the Government may wish to consult with the general insurance industry with a view to bringing general insurance into the VAT within one or two years.”