New VAT Law and the issue of multiple rates
The Value Added Tax and Supplementary Duty Act, 2012 (the new VAT law) is scheduled to come into effect from July 01, 2016. Meanwhile, several issues have cropped up; of them, the issue of package VAT was dealt in this newspaper on May 14, 2016. The present article deals with another such issue - the issue of multiple rates which has generated widespread stir among the concerned quarters.
VAT system is a very scientific system. Successful functioning of a VAT system depends upon the establishment of an input tax credit mechanism across all VATable economic activities. Input tax credit mechanism (henceforth called the credit mechanism) is the backbone of VAT system. The VAT system is different from its predecessor excise tax system only because of its inherent credit mechanism. Let us shed some lights on credit mechanism. At every stage of production, distribution or sale the producer, distributor or seller will pay VAT on the total sale amount. But he will take credit of the VAT paid earlier on the purchase of the inputs (raw materials) required to produce or procure the goods. Thus, what transpires is that at a given stage, the VAT is paid only on value addition. For instance, a producer purchases inputs worth about Tk 60. On Tk 60 he pays Tk 9.0 as VAT. Processing these inputs he produces a goods which is sold at Tk 100, i.e, there is Tk 40 value addition. Selling the goods at Tk 100 at this stage, the producer pays Tk 15 VAT. He takes credit of Tk 9.0 VAT paid earlier on the inputs. So, his net payment of VAT is Tk 6.0 (15-9) at this stage only on value addition part i.e, Tk 40. The more the credit mechanism functions across the various activities of the economy, the better is the performance of the VAT system. Therefore, a basic principle of the VAT system is: lowest possible single rate and widest possible coverage. In a standard VAT system, there should be a single rate that needs to be as low as possible and the coverage of VAT needs to be as wide as possible.
But there are some overriding social, cultural, religious or other objectives a state needs to look into for the welfare of the citizens. As a result, there intrudes the concept of exemptions and reduced rates in a VAT system. Since the notions of exemptions and reduced rates can not be done away with, it needs to keep the scope of these as small as possible. Economic activities covering a small portion of the economy, which are very basic necessities for the poor or very much needed for development are generally exempted from VAT. Some other economic activites again covering small portion of the economcy, which are also like basic necessities and needed for development but can not be exempted are covered with reduced rates. Suppose about 10 per cent of the economic activities are exempt, about 10 per cent of the economic activites are with reduced rates and 80 per cent of the economic activites remain under standard VAT system where the input tax credit mechanism functions. Thus, we can have a standard VAT system. Contrarily, if about 20 per cent of the economic activities are exempt and about 30 per cent economic activites are with reduced rates and only 50 per cent of the economic acitivites remain under standard VAT system, then the credit mechanism does not properly function. The VAT system can not develop with its inherent basic features.
Tariff value and truncated base are the two systems of reduced rates in our VAT system. Tariff value remains fixed on some goods. The tariff value is much low than the market price. VAT is paid on the tariff value but no input tax credit is allowed on the raw materials of these goods. The base of about 18 services has been truncated on which VAT is paid and so input tax credit is not allowed on these services. If input tax credit is taken on these goods with tariff value and services with truncated base, lower VAT is required to be paid than what is paid now. It requires more compliance with regard to accounts to pay VAT at standard rate. In that case, comparatively lower VAT is required to be paid. To pay VAT on the basis of tariff value and truncated base, less compliance is required with regard to accounts but comparatively higher VAT is to be paid.
The government wants compliance and establishment of a system but not adhocism. Adhocism may give some more revenue today but it will not be helpful in the long run. If a system can be developed, it will be helpful in the long run. If the lion's share of the economy remains exempt and with reduced rates, then the system will turn into excise tax-type which we have shun long ago. We want to look into decades ahead. So, we need to establish a standard VAT system that allows exemption and reduced rates in the case of a small portion of the economy and the lion's share of the economy remains under a standard rate.
Dr. Md. Abdur Rouf is Additional Director General of the Bangladesh Customs Excise and VAT Training Academy under the National Board of Revenue (NBR).