Why VAT Holidays May Not Be a Good Idea During Coronavirus

Tax Holidays & COVID-19

Value added tax (VAT) seems to be the go-to tax to stimulate the economy in the current coronavirus (COVID-19) crisis. Tax holidays, in which governments delay the collection of VAT, are one specific measure some countries are considering. At first glance, this seems like a practical and easy way to implement a strategy to stimulate the economy and improve the cash flow position of many businesses. However, this incentive could be the wrong measure given that it is potentially risky and unfair.

VAT collected and accrued by businesses is already in their accounts. Releasing them from an obligation to remit this to the government or delay such remittance for a few months provides these businesses with extra cash during the crisis. As such, this is a positive incentive.

However, COVID-19 is causing a crisis on a global scale and should be managed as one from a tax perspective. By allowing businesses to retain VAT for a few months, governments lose the opportunity to allocate these funds where they are most needed.

Liquidity Risks for Businesses

Regarding the aforementioned allocation issue, there is also a future risk for the businesses “benefitting” from such VAT holidays in the short run. The purpose of an accrual is to set funds aside for future obligations. By allowing businesses to delay the remittance of VAT, which will still be due at a later stage, does (or should) not release any cash. The principle of prudence, a basic principle of accounting, requires a business to record liabilities and expenses as soon as they occur.

VAT holidays do not take away the VAT liability, and as a result, an accrual for VAT cannot be released. Businesses are at risk of facing liquidity issues once the tax authorities resume collecting VAT. This, in daily practice, is how many first-time entrepreneurs go wrong — by not having the assets available to pay their taxes at a later date. If this results in bankruptcy, both the business that initially benefitted from a VAT holiday, as well as its suppliers, will be affected.

Short-Term Fixes with Long-Term Consequences

Ultimately, there is an element of unfairness in these measures at a time where solving issues collectively is more important than ever. As an example, many businesses in the medical industry are exempt from VAT and will not benefit from a VAT holiday the same way other companies will.

Although VAT holidays are intended to be a short-term fix, they could have consequences lasting long after COVID-19 subsides. Instead, governments should look to provide economic relief measures that help stimulate the economy during and after times of crisis.

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