For over half a century, countries have struggled to reconcile the principles and
design of a VAT or GST system and the unique features of financial supplies.
A VAT taxes the value of transactions, which is relatively straightforward where
explicit fees are charged, but intriguingly difficult where implicit fees are charged as
is the case with some types of financial services. At the same time, the VAT has
mechanisms to remove tax from business-to-business transactions involving no
final consumption but these, too, are difficult to apply to some types of financial
services. The fundamental design features of the tax also appear problematic in
terms of the goal of removing tax from pure savings in the form of financial
instruments. Relieving financial services from the tax altogether runs counter to the
character of the VAT as a broad-based tax levied on all final consumption. Equally
at odds with the design principle of the VAT is imposing a limited tax on
business-to-business transactions along the supply chain or imposing a limited tax
on pure savings. No VAT or GST systems have yet achieved these objectives
consistently.
Financial services constitute an important and large economic sector and the
application of VAT to financial services is particularly complex and has given rise
to a multitude of problems and selective solutions. At the same time, financial
services are becoming increasingly globalized. The growth of cross-border trade
and investment has led to financial service providers providing global services to
entire company groups. Consumers, too, have access to cross-border services from
internet gambling to investment and personal banking facilities. With the increasing
number of free trade agreements, there is pressure on governments to simplify
oversight regulation to allow foreign financial service providers such as banks and
insurance companies access to their markets. This will exacerbate difficulties arising
from inconsistent treatment of financial services across different VAT regimes.