The new VAT Act: A compromise outcome – I
In the FY2019/20 budget speech, the Minister of Finance announced the introduction of a new VAT Law effective from July 01, 2019. The Value Added Tax and Supplementary Duty Act 2012 was enacted in December 2012 after three years of preparations for completing the draft with inputs from international and national experts and extensive consultations with the business community. At the time of enactment of the law it was understood that effective implementation of the new law will require three years of preparations in terms of automation of the VAT administration and restructuring of the VAT administration along functional line. Accordingly, as per the original plan, the VAT Act 2012 was supposed to be implemented on July 01, 2016 (at the beginning of FY2016-17 budget).
In the event, due to delays in automation and resistance from the business community, a new VAT Law has been introduced after seven years. However, the new VAT law is a compromise outcome entailing fundamental and sometimes arbitrary changes to the original VAT Act 2012.
The purpose of this paper is to: identify the major changes made to the VAT Act 2012; analyse the implications of the changes for the operations of the VAT administration; assess the implications of the changes in terms of tax incidence and the consequent price impact on the consumers; impact on the level of protection offered to domestic producers through Supplementary Duty (SD) applied at the import stage; and infer about the impact on industrial structure and for the Small and Medium Enterprise (SME) sector.
MAJOR CHANGES MADE TO THE VAT ACT 2012: The budget speech of the Finance Minister and the accompanying Finance Bill mentioned a number of major changes to the VAT Act 2012 as part of government's understanding or political compromise with the business community represented by the Federation of Bangladesh Chamber of Commerce and Industries (FBCCI). The changes were made to ensure smooth implementation of the new VAT Act.
First, the most important change was with respect to introduction of multiple VAT rates. Under the new VAT Act 2012 (as Amended in 2019), the government will move away from a uniform 15 per cent VAT rate envisaged in the VAT and Supplementary Duty Act 2012 and instead introduced many VAT rates: 15 per cent at the import stage; 10 per cent at domestic manufacturing stage; 7.5 per cent at wholesale stage; 5.0 per cent at retail stage; and several other lower effective rates-ad valorem and specific as stated in Schedule 3 - on selected products primarily to limit price pressures arising from the changes made under the new system. One saving grace is that, domestic manufacturer, wholesalers and retailers may still opt for the original 15 per cent VAT rate with full input tax credit, if they consider that advantageous from their business point of view.
Secondly, the second most important change was elimination of input tax credit, which is at the heart of any VAT system, when VAT paid by suppliers are at rates different from 15 per cent. Domestic manufacturers and other suppliers paying VAT at rates different from the 15 per cent rate will not be able to take input tax credit. The decision to eliminate the input tax credit provision for supplies at rates different from 15 per cent is understandable because if input tax credit is allowed, in many instances there will be refund of taxes to the manufacturers and other suppliers entailing substantial revenue loss for the government. The input tax credit will generally exceed the VAT on the output at every stage of production and sales as long as downstream VAT rates are lower than 15 per cent. For example, take the case of a domestic manufacturer who adds 20 per cent value at the manufacturing stage on inputs imported from abroad (valued at Tk 100) and sells the product to a wholesaler at Tk 120 after including the value addition of Tk 20 for nation-wide distribution. The manufacturer paid TK 15 as VAT at the import stage, and after completion of the manufacturing process his total VAT will be (10 per cent of TK 120) BDT 12. If the manufacturer is allowed to take full input tax credit, he will deduct BDT 15 from his BDT 12 output tax, and claim BDT 3 as net refund from the VAT authorities. The same situation will be repeated at the wholesale and retain levels. Thus a fully operational input credit system is not possible under the multi-rate and multi-stage VAT rates system as designed and implemented in Bangladesh.
Thirdly, reliance on advance collection of VAT at the import stage has further increased under the new VAT law by requiring all importers to pay advanced VAT at 5.0 per cent rate. This withholding rate is too high which implicitly assumes that the importers would be adding at least 33.3 per cent value addition when they sale the imported products or processes further through the manufacturing process. There is no way that a commercial importer will be adding 33.3 per cent value addition by selling the imported items in the domestic market. There is no way that commercial importers would be able to adjust this advance VAT by selling the products in the domestic market, and accordingly they will simply increase prices by this amount and pass on this tax to buyers and create cascading of taxes. Even for most manufacturers it will be difficult to adjust this advance tax against their output tax because their manufacturing/processing stage value addition may fall well short of the 33.3 per cent level.
The principle of not using supplementary duty for protection purpose was once again violated as it was the case under the VAT and Supplementary Duty Act of 1991. The original 2012 VAT Act intended to reduce dependence on supplementary duty and also lower the level of domestic protection by reducing the long list of items subject to supplementary duty and applying the SD rates equally on both domestic and imported goods and services. In the event, the new VAT Act maintained the discriminatory nature of SD by applying it primarily on imports. As a result, instead of reducing the degree of protection offered through SDs, the level of protection further increased in FY2020 budget.
Fourthly, in most respect the new VAT Law deviates fundamentally from the VAT Act of 2012 and is very similar to the VAT Act of 1991. First, the number of items subject to rates other than 15 per cent under the new law are listed in Schedule 3 of the VAT Act which is part of the FY2019-20 Finance Bill. The list is very similar to the list of products subject to truncated base or tariff value based system under the VAT Act of 1991. Second, similar to the 1991 law, the new VAT law does not allow input tax credit for those firms which are producing/supplying items listed in Schedule 3 of the new VAT Act. Third, with the loss of input credit chain, the documentary connection or paper trail will be lost for the truncated suppliers which will reduce tax compliance. Fourth, the loss/truncation of input credit chain will affect other VAT registered persons or sellers of goods and services who buys these products because they would not be able to take credit for whatever amount of VAT they paid even if the VAT registered persons are paying VAT at the rate of 15 percent. Finally, the original version of VAT Act 2012 did not have any requirement for price declaration by VAT registered suppliers/sellers because this provision was considered to be unnecessary and contrary to the way businesses are operated in any country. However, the new VAT law has inserted a new provision (under Section 72.5) which requires all registered firms to submit input-output coefficients in specified manner to their respective VAT offices. This new provision is completely unnecessary and fundamentally deviates from the accounts based operation of the VAT system.
ADMINISTRATIVE CHANGES ENVISAGED AT THE TIME OF VAT 2012: The originally envisaged 3-year lag in implementing the 2012 VAT Law was to (i) introduce a fully automated VAT administration without any or very little manual intervention; (ii) restructure the VAT administration along functional lines from the current geographical based system in which one VAT official is responsible for the jurisdiction-VAT commissioners for the commission rates, Deputy Commissioners for Divisional Offices, and Assistant Commissioners for Circle Offices (the lowest level of VAT office)-- looks after all relevant issues associated with VAT administration in that VAT jurisdiction; and (iii) introduction of Electronic Cash Registers at all important retail outlets to monitor turnover at retail level VAT outlets. In order to put in place an automated VAT system, the National Board of Revenue (NBR) initiated a comprehensively designed VAT online project with financial and technical support from the World Bank. The VAT online project aimed at ease of doing business through fully automated registration system, fully automated on-line VAT return submission, and fully automated VAT payments through VAT registered person's bank account.
At the NBR front, the project also aimed at: (i) automated return processing along with flagging of any identified inconsistencies; (ii) sending amended tax returns (if needed) or sending automatic non-filers notices to those who have failed to submit their VAT returns on time; (iii) automated tax file or case management including automated personal tax records and e-mail and SMS communications with taxpayers without personal (face to face) interactions; (iv) selection of tax returns for audit purpose based on criteria based online system; and (v) management of audit program and audit reports using off-site and on-site visits.
CURRENT STATE OF AUTOMATION OF THE VAT ADMINISTRATION: Progress with VAT automation process has gone through periods of ups and downs, depending on the signals from the political authorities. The project gained a lot of traction during 2015-17 till the 2-year postponement right before the formal introduction with the FY2018 budget. Although preparations were not completed some of the important modules like VAT Taxpayer Registration and VAT on Line Return Submission were completed with field testing. Other modules like setting up the online payment system and on-line taxpayer ledger were almost ready. The phone/mobile phone help desk to assist taxpayers with different aspects of the VAT system was also set up under the VAT on-line project. These help centres were operated by private sector entities under contract with the project.
As the implementation became uncertain and the implementation period extended by 2 (two) years but no systematic enhancement of resources was made available, most of the national and international consultants engaged under the project had to move on to their other activities and the project essentially started to drift. The persons responsible for the project on the NBR side also retired or transferred to other positions as part of regular rotation, leaving the project virtually on a drifting state and not much progress could be made until the recent introduction of the VAT Act 2012 with the FY2020 budget. (To be continued tomorrow)
Ahsan H. Mansur is Executive Director of Policy Research Institute (PRI)