By Chaim Even-Zohar. Reprinted from Diamond Intelligence Briefs by special arrangement.
The phone went silent. I had just outlined the underlying principles of the new turnover tax contemplated for Antwerp’s diamond sector to an Indian friend in Dubai – it made him speechless. When he finally did speak, he said: “Wow, if what you say is true, then we can come back to Antwerp. There would be no reason whatsoever to be here in Dubai. We’ll be close to my children again.”
To me, this reaction was the Litmus test for the viability of the recently announced pure turnover tax system. The Belgian government and its economic policy makers had to make a decision as to what serves Belgium better: to allow the diamond industry to wither and perish, or to pro-actively facilitate a new renaissance. It has decisively opted for the latter option.
For well over three years, a select team of diamond industry officials – duly mandated by the industry’s elected leaders – have been negotiating with the Belgian government’s economic decision makers in the greatest secrecy. Not a word about this process leaked out. The taxation talks were conducted by a “new generation,” and everything was on the table. There were no self-delusions and no propaganda; realism and pragmatism were the guiding principles.
The jumping off point for these talks was the realization that if there are 1,700 diamond companies in Belgium, every year the government collects some 1,700 annual reports that are all skillfully (and some less skillfully) “cooked.” They are largely works of fiction. Actually, the number is less: some 500 out of these 1,700 companies have no, or hardly any, business to report to begin with.
It’s not that the diamantaires are dishonest. No, there is a frank recognition that Belgium’s prevailing taxation system itself, the so-called assessment guidelines based on turnover taxation formulas (which were last revised in the 2004 fiscal plans) are not practical. They invite creative accounting. Except for the occasional situation in which the company’s actual annual results and the tax assessment guideline happen to coincide, balancing exercises (through inventory valuations and other ways) distort reality. This situation has, more than anything else, been a contributory factor in the withdrawal of the diamond-financing institutions from Antwerp. Financing, which once was the great attraction of the trading center, has largely moved away, making room for branches of Indian banks.
But the most serious side effect of Belgium’s current taxation system is that it has put every diamantaire in Antwerp in potential legal jeopardy: at any time, anyone can find himself accused of bookkeeping fraud or money laundering just because of efforts to comply with, what can be called, the current “hybrid turnover cum profit-based taxation methods.” Respectable and honest diamantaires – which we believe describes the overwhelming rank-and-file majority in Antwerp – are also faced with the dilemma to stay or leave.
When the government (and that includes the anti-money-laundering authorities) fully understood the intricacies of the ever-growing industry taxation imbroglio, it made a courageous decision. It decided that it wanted to turn the tide and enable Belgium once again to become the world’s center of a flourishing diamond trade. It also decided to create the conditions that would give the industry a chance to do just that.
The Belgian government’s release of the 2015 budget, which makes references to the accord with the diamond center, prompted the Antwerp World Diamond Centre (AWDC), the Belgian diamond industry’s coordinating body and official representative of the diamond sector, to release a short announcement. In its press release, the AWDC says that it “takes note of the government decision to introduce a tax system calculated on a lump-sum basis. ‘Diamantaires are willing to pay higher taxes in exchange for financial predictability and legal certainty’, says Ari Epstein, CEO of the Antwerp World Diamond Centre.”
Local politics played a role in the timing of the announcement. Belgium’s new center-right government of Prime Minister Charles Michel has announced tough austerity measures, which are said to be necessary to keep the budget deficit down. The new turnover tax system is called the “Carat Tax” and, according to the budget, it is expected to raise some US$54 million in its first year – though it most likely will be more. Indeed, in the 2015 fiscal year, the government will collect some two and half times more from the diamond industry than was collected in 2014 – and it is certainly significant from a budgetary perspective.
It must not be ignored that most taxation income in the diamond sector comes from taxes on wages, indirect taxes, etc., and the total sector contribution to the state coffers are estimated in the US$150-$200 million range. The carat tax refers only to the income of the companies. The message is that the diamond sector plays its part in enabling the government to meet its budget obligations.
Nevertheless, various parliamentarians are asking some pertinent questions “about the legitimacy and effectiveness of the measure,” according to Belgium’s De Morgen newspaper. They take issue with the governmental view that “a favorable tax regime for diamond represents a corrective measure.” It is, in fact, more than corrective. It has become a matter of industry survival.
While a “real system” of business income taxation is based on actual income less expenses, a presumptive tax regime implies procedures under which the desired tax base is not itself measured, but is inferred from some simple indicators, which are more easily measured than the base itself. The Carat Tax is a presumptive tax and the “indicator” is turnover. However, as we shall elaborate on later, the term “turnover” will be defined differently than under Belgium’s present system. The turnover under the Carat Tax will only apply to sales transactions.
The enthusiasm by which the industry embraced this new Carat Tax immediately boomeranged in Belgium’s political opposition circles – and raised suspicion. If the diamond people are “happy,” it is reasoned, “there must be a catch.” Some articles were vicious and abused the diamond community for political and opportunistic reasons.
Unfortunately, specific details of the new arrangements have not yet been disclosed – and all information in this article that goes beyond the brief AWDC press release was informally secured from what we consider reliable sources within industry and government. No further official comment could be obtained. It is for this reason that the AWDC release’s language warrants careful reading – as it “says everything,” while actually giving away “almost nothing.” [See text in box.]
This DIB will focus on what the AWDC statement omits to say. Indeed, everything points to a dramatic change for the better if it all comes to materialize.
The creative accounting, which also takes place in other diamond countries that maintain presumptive turnover-based taxation systems, impacts the declared values of both inventories and profits. The proposed Belgian system will make these two parameters tax-neutral.
PURE TURNOVER TAX. The taxation will be based on sales transactions only. One can almost compare it to Value Added Tax or a Sales Tax. On each transaction, the final tax element will be known. All company income tax will be levied on this basis. The tax will apply both on export sales and on transactions in the local market. The method of collection is not known at this point. This also depends on how the regressive rates are set – if there is no uniform rate.
ACTUAL PROFITS IRRELEVANT. As the tax is removed from the “actual results,” one no longer needs to “cook the books.” If a company is successful and has huge profits, it can report these profits in its financials. Thus, it can present an honest and accurate picture to banks, shareholders, suppliers or any other stakeholder.
COSTS CANNOT BE DEDUCTED. In current assessment guidelines, the gross margins are calculated by deducting certain manufacturing costs (wages, materials, depreciation, etc.) As the tax base is now only the actual sales price, costs don’t need to be recognized for tax purposes. They remain, of course, an inherent part of proper bookkeeping.
INVENTORIES DON’T REQUIRE ADJUSTMENTS. In the past, governments in diamond manufacturing and trading countries resorted to turnover taxation mostly because of the administrative inability to effectively audit diamond companies and to assess the precise values of inventories. This was exacerbated by companies’ prevailing opaque bookkeeping practices. It is precisely in these areas that enormous progress has been made in the past decade and companies, especially the larger ones, meet today’s international accounting standards. Today, inventories reflect true values. By neutralizing the inventory element for tax purposes, the diamantaire doesn’t need to “contaminate” his books by artificially increasing or decreasing values. Thus, there is a much greater incentive to maintain auditable, responsible and transparent inventory management systems. (Some companies may require new software…)
As we’ve alluded to, the current “hybrid turnover” presumptive taxation system in Belgium has severely eroded the equity base of the industry. Its presumptive taxation system had led to a disconnect between inventory values and accrued equity in the diamantaires’ financial reports. Though the assessment guidelines-based turnover tax provided the government a steady and predictable income, the diamantaires’ real profits or losses were absorbed in the “cooked” inventory figures or in the books of related entities – not in visible cash or by any growth in equity in the Belgian company. This is not what suppliers want, what the banks require, and what the changing external compliance and transparency environment can tolerate.
The architects of the Carat Tax mechanism want the diamond companies to bring their capital home. The AWDC statement specifically refers to “the fact that diamond traders often see no reason to realize their turnover and profits in Belgium.” The government wants the industry to keep its equity at home – and use it for the business.
Outdated and misguided marketing models, such as DTC’s Supplier of Choice, urged the diamond players to resort to debt financing rather than using their own funds – which would then artificially increase the return on own capital (ROC). This is something which, in turn, would improve one’s score for rough allocation eligibility. It led to the withdrawal of capital from the diamond companies (into real estate, stock markets and other ventures). However, it backfired in a big way when, in adverse economic times, overleveraged diamantaires needed to resort to distress sales to pay their banking debts.
The Carat Tax architects believe that some countries where diamond companies currently “park” their capital are more risky, dangerous or unstable than Belgium and the Belgian banking system. They want capital creation in Belgium.
The new Carat Tax turnover system, which may already be implemented in the 2015 and/or 2016 tax years, will only apply to the future. It does not contain an amnesty element. This has to do with the very strict Anti-Money-Laundering legislation in force in Belgium (and not only in Belgium). But funds which have very clear origins will be warmly welcomed.
The concise AWDC statement introduces a very relevant concept: it refers to “a tax system calculated on a lump-sum basis.” That’s a giveaway and points to a specific form of turnover tax. Though, in most instances, a lump sum refers to the very same tax rate for all, sometimes it is a reference to a regressive tax. In a regressive tax, the lower the income is, the higher the percentage of income applicable to the tax and this has been the common practice in Antwerp and Israel for many years.
Historically, the government has applied specific definitions and methods to arrive at its tax calculations. When the minimum taxable income level is set, five different levels (brackets) of income are calculated. For each bracket, a different tax is applicable. At the lowest level, there is a 3.2% tax. This gradually goes down to a 1.2% tax on the highest income bracket. This may be the situation today, but it won’t continue this way.
ONE RATE FOR ALL. The political prowess of the large players (traditionally the DTC Sightholders) had convinced government that the larger the turnovers, the smaller the margins. This constituted the basis of the multiple regressive tax brackets. Now the government realizes that the small and medium-size units are struggling. There is no reason anymore for differentiations. DIB sources confirm that, henceforth, there will be one rate for all!
The new system should not be misunderstood. The normal corporate tax rates will continue to apply to the diamond sector. What the Carat Tax does, is set the amount of taxable income. Based on that amount the normal taxation laws apply. The Belgium corporate tax rate is 33%, but there are some surcharges totalling 3%, thus the combined rate (all-in rate) is 33.99%. There are also targeted corporate income tax rates which can be applied when the taxable profit does not exceed certain levels.
Basically, Belgium’s normal taxes are progressive – the rates go up when the profit levels increase. Thus, on the lowest level, the rate is 24.98%, going up to a maximum 33.99%. These are the percentages to be applied to income levels arrived at through the Carat Tax.
There are many obvious advantages to the Carat Tax. In the post-Omega and post-Monstrey environment, the whole issue of transfer pricing and declared import values will fall away. Not only that, but for accounting purposes, there is no advantage to be gained from any under- or over-valuations. There will also be no further need for complex arm’s length pricing mechanisms – at least not from a Belgian perspective.
Nevertheless, when setting a taxation regime, one needs to consider international tax agreements, efforts to combat tax evasion and avoidance, and various advanced and transparent accounting practices. The Carat Tax studiously upholds the principle that taxation in any jurisdiction should reflect the fruits of the economic activity taking place in the relevant jurisdiction. Irrespective of the enormous efforts toward international tax harmonization, and a myriad of double-taxation agreements, at the end of the day, taxation policy is mainly set at the national level.
The discretion shown by Belgium’s policy makers with regard to this new taxation proposal – and the reluctance to reveal too many details about it – stems partly from the fact that there are vested political interests that may wish to forestall the implementation of the new tax, and partly from the need to secure approval from the European Competition (EC) authorities. It doesn’t seem to us that the EC would object – to the contrary. There is a vast body of literature originating with IMF, OECD, World Bank and similar organizations that greatly encourage the use of presumptive taxation mechanisms. A recent OECD survey shows that in virtually every member country, the taxation systems have various forms of presumptive taxation.
One scholar argues that “most of the literature on presumptive taxation limits its application to the less developed economies. In this paper I argue that presumptive taxes are well entrenched in the modern world, although usually not classified as such. Presumptive taxes can take many forms, and can be incorporated in sections of a tax law that is not generally presumptive. The difficulties that developed economies face collecting tax revenues, the rising fear from an intrusive government, and efficiency considerations may all portend a larger role for presumptive taxation – whether or not so designated – in the developing and developed economies.”
One can hardly think of a more appropriate place and time to introduce a pure, simple and straightforward presumptive taxation regime than in Antwerp. It cannot start early enough - but it’s not yet a done deal. As in any opera, it ain’t over till the fat lady sings...