IMPLICATIONS OF THE MODIFIED/ AMENDED VAT ACT 2012: What is understood according to the VAT law details provided is that only taxpayers paying 15 per cent VAT rate are eligible for input tax credit while taxpayers paying VAT at various other rates will not be eligible for input tax credit. This situation will put taxpayers subject to different rates and VAT registered persons buying inputs from these taxpayers in a difficult position. The input tax credit system is a mechanism which is at the heart of a proper VAT system so that under this system, total tax incidence cannot exceed 15 per cent, if 15 per cent is the maximum VAT rate. Now under the new structure, all importers would need to pay 15 per cent on their imports, but manufacturers can opt for 10 per cent or 15 per cent VAT rate. If the manufacturers opt for 10 per cent VAT rate, then their tax incidence may go up to 25 per cent if they used imported raw materials subject to 15 per cent VAT on import stage. On the other hand, if a manufacturer uses 15 per cent VAT rate then he is eligible for input tax credit tax and the total tax incidence will not exceed 15 per cent. On the contrary, if manufacturers do not use input tax credit and the products are sold to wholesalers and retailers in subsequent stages, than total incidence of VAT due to tax on tax (cascading effect) can go up to a maximum of 37.5 per cent, comprising: import stage 15 per cent + manufacturing stage 10 per cent + wholesale stage 7.5 per cent + retail stage 5.0 per cent = 37.5 per cent. This tax incidence should be compared with a maximum of 15 per cent VAT incidence in a properly designed VAT system.
Many countries have multiple VAT rates but that generally ranges between 3-5 rates and are applied at different rates on different products and services taking into account socio-economic and health-related issues. But Bangladesh is now the only country in the world where different VAT rates will be applied to same products at different stages of processing/sales. To illustrate this more clearly, for example the product is television. If the VAT rate on the product is 20 per cent, in all other countries applying VAT, the same VAT rate of 20 per cent will apply at the import stage, at the manufacturing stage, at wholesale and at retail levels. But as designed in Bangladesh, the same TV could be subject to 15 per cent VAT at the import stage, 10 per cent VAT at the domestic stage, 7.5 per cent tax at wholesale stage, and 5.0 per cent tax at the retail stage - there will be multiple rates based on stages of sales. This is a unique characteristic of the newly-introduced Bangladesh VAT system. In other countries, if product is at say 15 per cent VAT rate then that rate remains uniform at all stages. We will therefore be applying a VAT system where there will be different rates at different stages of production/sales, along with different rates for different classification of products/product groups. For instance, all manufacturing will be charged at 10 per cent even if the product falls under a lower tax bracket.
The complications in tax administration that may arise due to this political compromise are as follows:
a) Uniform tax rate is administratively very efficient and reduces scope for rate changing and loopholes for tax shifting by taxpayers. This also makes consumers more aware of the prevailing tax rates and the prices of products accordingly. Therefore, multiple rates will make the tax system much more complicated and hence difficult to administer and create more room for tax evasion and shifting by tax-payers, which will eventually result in loss of revenue.
b) Loss of input tax credit up to the retail level will essentially mean that it will be impossible to determine how much will be the tax component and price and consequently tax incidence on consumers. Different combinations of import, production and sales would lead to different tax incidences and price impacts for the same product. It will no longer be the same for the same product.
c) The most important reason for input tax credit is to make the indirect tax system independent of industrial or production structure. Manufacturers can sub-contract components to other firms without any additional incidence of taxes on production cost. Under the new VAT system, if Bangladeshi manufacturers sub-contract components of the production process to other firms such sub-contracting will be considered a new manufacturing activity/process causing additional 10 per cent tax on the subcontracted component which cannot be adjusted by the parent firm against its output tax. In the process, horizontal structure of production--with large factories and companies sub-contracting part of the production processes to smaller ones--will become non-viable and production process will become increasingly vertical going against the global norm.
We know in countries like Germany, Mercedes-Benz sub-contracts most component of the automobile production process to small and medium enterprises (SME), which creates an ecosystem of production, help create more new entrepreneurs and large number of jobs in the SME sector, thereby contributing to thriving economy as a whole. This situation is same for all other major automobile manufacturers (like Toyota, Nissan or Hyundai) or electronics manufacturers across the globe, and this practice is only possible since these countries have developed and implemented a fully functioning proper VAT system that does not hamper with the production structure (which is a choice to be made freely by the business enterprises and not in response to the tax structure) or in other words, the production structure should remain VAT neutral for the VAT system to be efficient. One of the prime reasons for more than 160 countries to adopt properly functioning VAT by replacing the old-fashioned excise tax system is to avoid cascading of taxes and put in place a tax system that is neutral to industrial organisation and promote horizontal business integration/expansion.
As a result of our new VAT law, our factories/companies will integrate all the production processes under one roof/premise through a process termed as "vertical integration" and the biggest loser of this will be the SME sector. This will impact the RMG (ready-made garments) sector as well, because large RMG enterprises often outsource a part of their production to smaller factories that cannot compete and export orders directly from the international sourcing companies. This will effectively put SMEs in a serious disadvantageous position. Most countries around the world have adopted the VAT system because of the tax neutrality of the production system; this inherent benefit will be completely lost under the new VAT system.
The new VAT system will also be disadvantageous for the firms who will be operating under the 15 per cent VAT rate as originally in operation since 1991. Any purchases made from VAT-registered firms who are paying at rates different from the 15 per cent rate, will not be able to get input tax credit even if the purchaser is paying VAT at 15 per cent rate. Thus even 15 per cent VAT payers would also not be immune from the tax-on-tax (cascading) effect. Since most retailers and wholesalers are likely to opt for the lower VAT rates, the scale of the problem may become significant.
The multiple VAT rates will also create problem with transparency in accounts. Most VAT registered persons who are engaged in wholesale and retail trade would opt for lower VAT rates and forego input tax credit in order to avoid transparent books of accounts. For the most part value addition at the retail level is about 10 per cent to 20 per cent at best, which means with proper VAT at 15 with full input tax credit the tax incidence at that level will be 1.5 per cent to 3 per cent. But these entities are interested to pay 5.0 per cent or more and opt out of the standard VAT system just to avoid standard books of accounts. These businesses are aware of the fact that proper VAT is in their interest because its tax incidence will be low and VAT will be entirely passed on to the final consumers. But, they are more afraid of dealing with income tax liability resulting from transparency in books of account than paying VAT at higher rates. The net result is that, the buoyancy in direct taxes that many countries have obtained through the introduction of VAT and improved accounting will not be applicable for the NBR in Bangladesh.
WILL THE STATE OF AUTOMATION AND ADMINISTRATIVE RESTRUCTURING BRING ANY BENEFITS TO THE TAXPAYERS? Although the VAT Law 2012 envisaged a completely automated taxpayer-friendly system of tax administration and registration and payment systems in reality NBR is very far from that. This automated system is not ready as yet and only VAT registration process has been automated and online return submission process has been tested with large taxpayers. It is also regrettable that even the VAT online registration process has been manualised to a great extent by the NBR. As designed, persons can apply for VAT registration on line but the online process is only limited to submission of online registration form. The form then goes from the central server to the field offices for field verification which takes time and very often following up with the field officers by the applicant. This manual intervention is completely unwarranted and undermines the automation process by delaying the whole process and establishing direct contacts with the VAT field offices and officers. Since this so-called automated registration process is not free from human intervention, this still leaves room for delays, corruption and speed money. There are plans for automation at submission of returns and payments of taxes, we have not yet seen how this process will work, but apprehensive that the NBR in all likelihood would try to make the process manually controlled and require physical presence of taxpayers at tax offices. All other modules like development of taxpayer's ledger with all relevant financial information related to taxpayers, automated processing of returns and payments, and audit module are being developed. The automated system is still in the testing stage and knowing the nature of NBR, it runs the risk of becoming manualised with human interventions at every stage.
The other key element of improving VAT revenue collection was the introduction of Electronic Fiscal Devises (EFD) at every VAT outlet and its effective monitoring with a view to increase compliance with the new VAT system. The idea is good, but if we review the past performance of NBR with Electronic Cash Register (ECR) system we should be sceptical about the EFD introduction as well. ECRs were supposed to be introduced at least 10-15 years ago. It was mandated by law for many types of VAT-registered enterprises, but there was no follow-up and no compliance. A few years back the former Minister of Finance announced that ECR machines will be imported by the government and distributed to the registered outlets. In the event, years passed but the tendering process for ECRs could not be completed. In the mean time ECRs have been replaced by EFD world-wide, but NBR could not complete its tendering process. Since FY17 the government has decided to introduce EFDs in place of ECRs because of their enhanced functionality, but as of now no single EFD is operational in Bangladesh. Furthermore, NBR has not made any preparations for monitoring the EFDs at the central monitoring unit.
THE RESTRUCTURING OF THE NBR ADMINISTRATION, FROM GEOGRAPHICAL TO FUNCTIONAL LINE, WHICH IS A STANDARD PRACTICE IN ANY MODERN TAX ADMINISTRATION, HAS ALREADY BEEN DISCARDED BY THE NBR DUE TO OPPOSITION FROM THE FIELD LEVEL: A plan was prepared to align VAT administration along functional lines with strengthened capacity-building at the NBR level, but it never got accepted for implementation, perhaps because of strong opposition from within the NBR. There was an expectation that once the VAT administration is reorganised along functional lines, this will serve as the model for other NBR wings (Direct tax and Customs) to be reorganised along similar lines. Given the disappointment with the reorganisation of VAT administration, it is very clear that administrative restructuring of the NBR along functional lines is not going to take place in the foreseeable future.
CONCLUDING OBSERVATIONS: The new VAT Law has all the characteristics of VAT Act of 1991 which it replaced, and also made it more complicated in terms of withholding of Advanced Tax at 5.0 per cent rate at the import stage and by combining multiple tax rates on different products with multi-stage VAT. In essence the new VAT law has all the characteristics of the 1991 VAT Act and additional distortions. It is not only "old wine in a new bottle" but in all likelihood should be more appropriately characterised as "more contaminated wine in a new bottle". In this sense, Bangladesh is moving backward rather than forward, whereby we are reverting back to the old excise system instead of a proper VAT system, which was the objective of the VAT Act of 2012, as it was enacted in December 2012. Consultations with business community is important, and some trade-offs at the margin are also acceptable, which was already done before the parliamentary approval of the 2012 VAT Act. However, the major changes that have been made to the already parliament-approved original VAT Act of 2012 just before its implementation in 2019 have fundamentally changed the character of the 2012 VAT Act by trading away the basic principles of VAT for having something which is basically excise duty. Bangladesh does not have a VAT system anymore, what we have should be renamed as Excise-cum-VAT Act of 2019 not the VAT Act of 2012 and what we have is a very complicated mixed system not to be found anywhere in the world!
We are not sure how much adverse impact this new VAT law will have on the consumers, on revenue collection, and on the SME sector. Only time will tell. However, it can be foretold that the NBR and the government should be prepared for another round of VAT reform and related tax administration reform in not too distant future if they really want to put the VAT system back on track. (Concluded)
[The article is excerpted from July, 2019 issue of Policy Insights, the quarterly publication of PRI]
Ahsan H. Mansur is Executive Director of Policy Research Institute (PRI)