A New Approach to Taxing Financial Intermediation Services Under a Value-Added Tax

Abstract

This paper contains a proposal (referred to as the modi- fi ed reverse-charging approach) to tax fi nancial intermediation services under a VAT. At the heart of the proposal is the application of a reverse charge that shifts the collection of the VAT on deposit interest from depositors to banks, in conjunction with the establish- ment of a franking mechanism managed by banks that effectively transfers the VAT so collected to borrowers as credits against the VAT on their loan interest on a transaction-by-transaction basis. The proposal is fully compatible with an invoice-credit VAT and is capable of delivering the correct theoretical result at minimal administrative costs.