Enforcing taxation on overseas retail purchases

The surge in online retailing is causing a revolution in the retail sector, with retailers being forced to develop an adequate online presence for their business or risk being left by the wayside. As is always the case with change, some are embracing it with gusto, while others are digging in their heels and complaining. Although most retailers’ complaints are flimsy objections to increased competition, one justifiable concern is that purchases from overseas-based online retailers typically avoid GST.

This taxation loophole unfairly disadvantages domestic retailers by distorting consumer prices in a way that favours their overseas-based competitors. However, as you will soon see, designing policies to remove this distortion, and level the competitive playing field, is not an easy matter.

So how relevant is this issue of tax distortion for the retail industry? Unfortunately it is difficult to get good estimates about the size of online retailing in New Zealand. With official statistics not yet adequately accounting for the sector, we are left with private reports and anecdotal snippets from courier companies noting rapid increases in deliveries of international parcels to residential addresses.

A widely-cited private study by PWC/Frost & Sullivan estimates that online shopping by New Zealanders will total $3.2bn in 2012, up 19% from a year earlier. Furthermore, with online retailing only accounting for 5.9% of total retail sales, much lower than countries like the US and the UK, there is significant room for expansion of the industry.

Of New Zealanders’ total annual online retail purchases in 2012, some $1.1bn is expected to go into the pockets of overseas-based retailers. A large proportion of this spending will be free of GST and tariff duties, as the New Zealand government has a policy of not collecting taxes on overseas purchases if the total tax payable is less than $60. Effectively this means that, for goods which do not attract a duty (such as books and DVDs), someone can purchase up to $400 worth of goods without paying any GST. The limits for footwear and clothing is slightly lower ($226.42) because a 10% tariff, as well as GST, is imposed on these goods.

At first glance, it may seem odd that the government has chosen to impose a policy which allows overseas retailers to have a tax advantage over their domestic counterparts. But the government’s stance was not an active decision to endorse such an unfair competitive environment – it was a practical response to ensure that taxes collected exceed collection costs. Customs has presumably estimated that it costs $60 on average to investigate and collect taxes on an inbound delivery, so does not enforce collection for taxes owing below this price point.

However, changing policy to reduce this distortion, and level the competitive playing field, is not a simple matter. Policies must be designed in such a way that both reduces collection costs, and creates an incentive for consumers to pay taxation obligations before being chased.

To cost effectively collect taxes, Customs could follow a two-pronged approach. One part of this approach would involve Customs entering into agreements with larger and trustworthy overseas-based retailers to collect taxes at the time of sale. The other part of this approach would involve Customs creating some kind of web-based system where New Zealand consumers could pay taxes on purchases made from smaller retailers that had not entered into tax agreements. This second approach would also need to be accompanied by a fine for tax avoidance to ensure that consumers had an incentive to ‘voluntarily’ pay their taxes before being chased. The remainder of this article discusses these two approaches in turn.

When negotiating agreements with larger overseas-based retailers, Customs would need to convince the retailers that it was in their interests to collect taxes on Customs’ behalf. This assurance could be given by pointing out that consumers would find purchasing from such retailers easier, as they could fulfil their taxation obligations at the point of sale, rather than by having to also visit the Customs’ website. Customers could also face shorter deliver times for purchases from these sources because, aside from biosecurity checks, Customs’ clearance could be more streamlined.

For purchases made from smaller retailers which had not entered into taxation agreements, Customs would need a system to ensure that consumers had fulfilled their taxation obligations. Such a system could involve Customs randomly opening a proportion of inbound packages (let’s assume 10%) and fining those consumers who had not voluntarily paid tax through an online system. As well as this fine, Customs could also impose a standard fixed fee to recoup the cost of collection.

As an example of this second approach, consider the case where I have purchased a book for $100 from a small overseas-based online retailer and am deciding whether to voluntarily pay the $15 of GST owing on this purchase. To neutralise my incentive to avoid this tax, my potential fine would need to be set at $150. This fine may seem hefty, but remember I have assumed there is only a 10% chance of getting caught by Customs, so my fine would equate to $15 in risk-adjusted terms (10% of $150). By designing the fining system in such a way, Customs would be seen to be ensuring compliance was in a neutral manner, rather than in a way which could simply be seen as a backhand way of generating additional revenue.

With purchases from overseas-based online retailers increasing at a rapid rate, it is high time that the government rethinks its taxation strategies. The government needs to look past the direct costs of collection and tax avoidance, and consider the unfair manner in which the current tax system favours foreign retailers. Of course no system of collecting GST and tariffs on overseas purchases will be perfect, but the system described above is certainly a step up from what is currently in place.

Benje Patterson is an economist at Infometrics Ltd

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