The concept of Value Added Tax (VAT) emerged in Europe in the 1920s because of the need for eliminating 'tax on tax' and shifting the tax burden of this genre of the consumption tax upon the ultimate consumer. In the mid-1930s, VAT was introduced in France in a limited scale and in the 1950s, France expanded VAT to all levels, i.e. import, manufacturing, wholesale and retail.
Meanwhile, following the end of the World War II and decolonisation of Asian, African and Latin American colonies, the European countries felt the need for regional cooperation that was absent for centuries and with this objective they formed the European Economic Community (EEC) to harness potentials for regional integration aiming at their common development. It was felt that harmonisation of physical and economic infrastructures as well as regulations were necessary for effective regional integration.
VAT, which was proved to be useful upon its implementation in France, was then considered a better system of taxation on consumption; so, it was recommended to all members of the EEC to implement it soon. Thus, VAT quickly expanded in Europe. Meanwhile, the International Monetary Fund (IMF) and the World Bank (WB) accepted the idea of VAT and started seeking for its implementation aiming at tax reforms in the countries seeking IMF and WB loans. In this way, VAT quickly expanded throughout the globe and today 166 countries are practicing VAT in various forms.
VAT was developed as a preventive measure against tax on tax. Governments need to collect revenue in a convenient manner, no matter from where the tax money it is generated. Governments throughout history have fixed different bases for different taxes. For instance, income is the base of income tax. Use of road by vehicle is the base of road tax. Houses, factories, buildings, establishments are the bases of holding tax, Import is the base of import tax. In some countries, there is inheritance tax where inheritance of parental property is the base.
It is time to rethink the VAT theory in line with lowest possible single rate and widest possible coverage as well as to ensure things such as eliminating unnecessary accounts, removing input tax credit and doling out a portion of the collected tax to the poor.
Value addition while selling goods and services is the base of Value Added Tax. It is commonly believed that tax cannot be the base of any tax. We do not find such a notion in our VAT law or in the constitution. Though widely desired, tax on tax could not have been completely eliminated anywhere. Import tax is currently being added with the cost of the goods before sale. So, the notion of tax on tax is still there though there should not be an additional tax levied on the same tax, i.e. no VAT on VAT, no Supplementary Duty on Supplementary Duty etc.
If a government cannot collect tax on the base of tax, then it shall try to find some other ways to collect taxes. Ultimately, people will have to pay tax in one form or the other. So, we do not find any harm in collecting tax on the basis of tax if it is easier. After all, simplification is an important pillar of the taxation system.
The other day, in a gathering of accountants, one said that VAT means a vast accounting task. In our country, VAT accounting has become more complex than general accounting. A business is supposed to comply with all relevant laws of the land, i.e. company law, tax law, labor law, environment law etc.
Among them, VAT law demands maintenance of more accounts compared to all other laws. Justification of keeping so many accounts for 'VAT purpose' has been described as checking the propriety of 'input tax credit' which was introduced to prevent tax on tax.
As mentioned earlier, tax on tax cannot be completely prevented. In an effort to remove tax on tax, maintenance of huge amounts of bank accounts has made the VAT system unbearably complex, laborious, time-consuming and costly for which businesses are being compelled to hire consultants and in some cases, are even choosing non-compliance and evasion. Maintenance of so many accounts for VAT purposes has put big dents in the country's 'ease of doing business' performance.
If taxes can be easily collected on a base where another tax is marginally included, we find no harm in that. After all, tax has to be paid by the people in some form. Maintenance of multiple accounts for ensuring input tax credit in order to remove tax on tax appears to be unnecessary in an age when proper automation can guarantee the trails.
Tax should be collected in the simplest possible way. Simplicity demands less accounts. Our present VAT system demands more accounts mainly to ensure availing the proper amount of input tax credit by the tax-payer. Input tax credit has been designed to remove tax on the base of tax, though after performing all these strenuous exercises, people are paying the tax at some other places.
Things have become unnecessarily complex, widespread application and retention of collected tax has become challenging because a large portion of the paid tax is taken back by the tax-payers as input tax credit.
In my opinion, the solution lies in the basic premise of VAT – lowest possible single rate and widest possible coverage. If the rate of the tax is the lowest, then demand for input tax credit shall not rise, it shall be easier for people to pay tax.
Single rate shall draw tax equally from the rich and the poor. So, a portion of the collected tax shall be given back to the poor as safety net packages to ensure equity and justice. It is time to rethink the Value Added Tax (VAT) theory in line with lowest possible single rate and widest possible coverage as well as to ensure things such as eliminating unnecessary accounts, removing input tax credit and doling out a portion of the collected tax to the poor. Thus, more revenue can be collected and administration of VAT can be made simpler.
Dr. Md. Abdur Rouf is a VAT expert, currently working as Director General, Customs Intelligence and Investigation Directorate. He can be reached at: firstname.lastname@example.org.
Disclaimer: The views and opinions expressed in this article are those of the authors and do not necessarily reflect the opinions and views of The Business Standard.