Why the VAT Refund Industry is Ripe for Disruption
Tax-free shopping was a concept conceived over 40 years ago in Europe. VAT refunding started as a mechanism to give individual exports a similar tax-free status to goods exported en masse by businesses. Soon, governments recognized that promoting these individual exports to tourists led to the consumption of all sorts of additional services locally. Any form of tourist entertainment raised the national income, be it hotel stays, meals at restaurants, visits to sports venues, theaters and museums. This consumption impact became known as the tourism multiple on national income and helped boost Europe’s attraction as a leading tourist destination.
The status quo: missing out on tourist dollars
The processing of tax refunds came with the responsibility of handling taxpayer funds with due care. Similar to other consultants like auditors and income tax agents, VAT Refund Operators or VROs grew a specialized industry responding to retailers' obligations for compliance in maintaining tourist tax-free exports.
By comparison to other third party financial service providers, however, VROs and indeed the tax-free shopping industry as a whole was a cottage industry for the longest time. Tracking bits of paper from tax invoice issuance at stores to Customs export validation checks on tourists and finally to refunding relatively small amounts of money per transaction, was a cumbersome and costly proposition. The VRO focus was on winning retailer accounts by introducing a process which minimized time taken at the till upon checkout.
VROs, instead of charging the retailer to fulfill their obligation to refund tax belonging to the tourist, ended up taking a cut from the uninformed shopper instead. In 2020, a SPAC prospectus of one of the two behemoths of third party VAT refunding suggests that out of the US$5.1 billion of VAT governments refunded for tourist shopping, only US$3 billion reached shoppers. The US$2.1 billion refund cost to shoppers is a deadweight loss to tourism as this leakage reduces the propensity to spend due to artificially lower refunds effectively causing higher prices. The fact that a handful of countries newer to the VAT refunding program mandate 85% refunds exacerbates the scale of the problem in the majority of countries that only refund between 50-60% of the VAT. VROs and retailers should be working together to incentivize tourists to shop more. Unfortunately, the opposite is currently the case.
For the tourists themselves, the process of receiving tax refunds is cumbersome and clunky. It often starts with handwritten forms in-store, followed by long queues at airport customs export validation desks, finally ending with substantial waiting times for refunds to be received. Each of these activities causes shopper drop-off, which is estimated to be as large as 50%.
The future of tax refunds lies with business model transformation
From more powerful handheld devices with higher data transmission speeds, to cloud based services and apps simplifying complex functions, the opportunity for technology to act as an enabler is undisputed. Unfortunately, in VAT refunding, the business model of old that prevents tourists from exercising their choice of refund operator in over 75% of the industry, has persevered. However, If we go beyond viewing VAT refunding as the administration of a tax service and instead look at how it can play its part in an integrated tourism platform, we are opening a new vista into tourism commerce inviting innovation and collaboration and higher in-country sales.
Imagine connecting all tourism players into a connected commercial platform, including restaurants, hotels, airlines and tax-free shopping. As we have seen from other industries, technology can unleash value in cross-platform interconnectedness. Driving value for the customer releases new benefits and income streams far beyond the wildest imagination of tax-free shopping operators whose only route to increased profit margins has been taking an ever increasing percentage of a tourist’s refund.
"The electric light did not come from the continuous improvement of candles."
I have always believed that we need a different lens to solve the missing value gap in VAT refunding. We must use technology to drive shopper centricity and choice, helping tourists exercise their free choice and pick a VAT refund package from an operator that works best for them. Some shoppers wish to maximize the refund in cash while others may opt to choose a bundle of goods and services which they perceive to maximize their value.
Tax refunding will be liberated from its shackles as an administrative service with new age technology-based refund agents finally being able to break-down the barriers that have existed in the market for so long. The pace of governments harnessing VAT refund export value for their countries will be limited by their speed to comply with a single source of legislation which is the European Union VAT Directive. This contains the principle that the non-EU traveller is free to choose how to handle his VAT credit arising from the export of non-business goods. The EU is home to the bulk of the global VAT refund industry.
Then disruption will come not just from the technological innovators, but from players who have a deep understanding of how to correct a broken business model. It is about solving the problem of how to return the 40% of the VAT not refunded today with value for the missing $2.1 billion.
Asad Jumabhoy is co-founder and CEO of utu, a travel technology company transforming the VAT refund industry through rewards.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.