Reforming Value Added Tax regime — a critique

The Financial Express published an article titled 'Reforming Value Added Tax regime' by Manzur Ahmed, Trade Policy Advisor to the Federation of Bangladesh Chambers of Commerce and Industries (FBCCI), on October 01, 2014 (page-4). Mr. Ahmed is an erudite person having enough knowledge and experience on the subject dealt. The article was well written, informative and thought-provoking. Without disputing his points I would like to shed some more light on some of the points for better understanding of the readers.   
Introducing some basic principles of VAT, the article initiates discussion with the definition of VAT. The term, Value Added Tax (VAT), is self-explanatory. In any business activity some inputs are used. Works are done on the inputs, thus value is added with the inputs. Tax on this added value is called Value Added Tax (VAT). In some cases, such value addition cannot be determined. For instance, License Fee. There is no value addition. So, in some countries, this type of tax is called Goods and Services Tax (GST). By this term, all the business activities can be brought under this concept. However, it can be said that in almost all cases this type of tax is the tax on value added. VAT has got different variants in the course of application.  
Gross-product VAT is the earliest version of VAT. Under this variant, to calculate tax an enterprise deducts its raw material purchases but not capital equipment purchases from its total sales and applies the tax rate to this base. Because capital is taxed this form of VAT tends to discriminate against capital-intensive industries. This type of VAT was extensively used throughout Europe in the 1950s but was replaced with other forms later. Income-type VAT is another variant of VAT. The calculation of tax under an income type of VAT is basically the same as a gross-product VAT except that depreciation on capital goods is deducted from total sales.
Another variant is consumption-style VAT where all business purchases are deductible. Under a consumption-style VAT, there are three different methods to calculate tax liability. The first of these is generally known as additive method. Under this method, a firm calculates its liability by adding together its wages paid, rent and interest expenses, and profit, and then applying the tax rate to this sum. A second method of calculating a consumption-style VAT liability is the sales-subtractive method. To determine tax base under this method, a firm adds together all sales and subtracts all purchases including capital equipment. The last and most common method of calculating VAT under consumption-style is the credit-subtractive method. Under this method, a firm calculates its tax liability by applying the tax rate to each individual sale and subtracting all taxes previously paid on purchases.
There are advantages and disadvantages with all these types and methods. However, consumptions-style VAT is widely used today with sales-subtractive or credit-subtractive method. Bangladesh has adopted credit-subtractive method. However, in course of application this does not always remain same rather variations arise as Mr. Manzur Ahmed has rightly said in his article that unlike Customs Act, VAT Act is not governed by any multilateral framework and therefore is susceptible to changes as per national needs. The most basic thing is that VAT is to be collected only on the value addition part of any transaction. So, there has to be value addition and that value addition is to be determined either by VAT authorities, which the new VAT law does not envisage, or by the VAT-payer himself. I find solution to these problems lie in the operational procedures and good governance but not in theory itself.    
Mr. Ahmed mentioned about multiple rates of VAT in the European Union (EU) structure and argued for the same in our country. In fact, multiple rates are there in our VAT system under both current and the new VAT law. The relevant contents of the current VAT law go without mentioning since it is one of the basic reason for the adoption of a new VAT law. Under the new VAT law, the enterprises with annual turnover of Taka 2.4 million or below will remain outside the VAT net. The enterprises having annual turnover of Taka 8.0 million or below will require to pay Turnover Tax at the rate of 3.0 percent only. Taka 8.0 million yearly turnover is not a less amount. By these provisions almost all small and lower medium enterprises will fall outside VAT net or will involve 3.0 per cent Turnover Tax only. Other higher medium and large enterprises will enjoy input tax credit and pay 15.0 per cent VAT. These enterprises will require to keep proper books of accounts that will facilitate them to take input tax credit properly. This goes to their advantage. Opposition to this, in my opinion, arises from tax culture and the state of governance which has to be addressed by the government: the taxpayers are to be educated and the VAT system automated.
A concept is rife at the field level that under the new VAT law, the package VAT system, which is prevalent under the current VAT law, will be eliminated and small enterprises will have to bear the burden. This is a misnomer. Lack of understanding about the provisions of the new VAT law has given rise to such misperceptions at the field level. As per the explanations given in the previous paragraph, the enterprises requiring to pay package VAT under the current VAT system shall not require to pay any VAT under the proposed system  because they will hopefully fall below Taka 2.4 million threshold. Thus, the proposed system is advantageous to them. A question may arise: how is the government anticipating more revenue under the new VAT system? It is proper application of VAT through automated system upon higher middle and large enterprises that will ensure robust revenue growth. An instance may suffice. At present, we have about 28 thousand enterprises enlisted under Turnover Tax. Yearly total receipt of Turnover Tax is so insignificant that it goes without mentioning. Yearly 50 or 60 million Taka is a very meagre amount for the government. So, no matter if these enterprises go tax-free.   
       Mr. Ahmed has dealt the issue of denial of tax exemption to local inputs for exports. The issue is again procedural. In principle, government wants to allow zero rate on exports and deemed exports. Deemed exports are those local sales which are exported by the purchaser. Export and deemed export have been given the facility of zero rate because these activities earn foreign exchange which we badly require to pay for our imports. In case of imported raw materials it is relatively easy to track the path towards export. It needs to be sure that the item has been exported and foreign currency against the export has been repatriated through banking channel. To ensure this there are some conditions and regulations. We can work together on how repatriation of foreign currency can be ensured and procedure can be made easy for exporters.
Mr. Ahmed has also dealt with discretionary powers of the VAT officials under the new VAT law in the areas of freezing of bank accounts, confiscation of property, seizure of goods and vehicles even by forcibly breaking doors, imposing penalty on various grounds, including alleged incorrect statements. Fiscal laws are generally harsh since the very objective of the law is to take away money from people's pockets. In the country like Australia, arrest for violations of GST (VAT) provisions is frequent. In China, capital punishment is awarded for large-scale violations. Compared to those, we have much lenient applications. Discretions can not be done away with. Discretions are required in some areas where legal provisions can not decide the things conclusively. However, it has to be realistic, implementable and trouble-free.  Let us work together in this area.
Reforming Value Added Tax regime is a hard task. VAT legislation is nothing but a description of the economic activities as these take place and fixation of strategy to collect VAT on those economic activities. Economic activities are dynamic phenomena. So, with the changes in economic activities, legislation needs to be changed i.e. economic activities and legislations need to go in tandem which do not occur in our case. In our case, economic activities run faster than legislations. Delegated legislations, i.e., rules, general orders etc. need to be made quickly to resolve the issue. So, in my opinion, the concerns raised by Mr. Ahmed can be largely met with the establishment of proper procedures, not at the level of principal legislation, i.e., law. This is true with regard to both current and the new VAT law. Automation of the VAT procedures can give relief to the VAT-payers in many matters mentioned above. Reforming VAT regime calls for these.     
Dr. Md. Abdur Rouf is Director, Central Intelligence Cell and Deputy Project Director, VAT Online Project, National Board of Revenue (NBR).
roufcus@yahoo.com