‘VAT makes investments tax-free, traders themselves do not pay taxes, they are just intermediaries’ – Roop Khadka’s article

##The various taxes are paid by natural and legal persons as consumers, income earners, and property owners, and most taxes are collected through industrialists, traders, businessmen, employers, etc. In that process, citizens and the government also have to bear the financial, compliance, and collection costs generated by those taxes.

The cost of taxes depends on various factors such as the type of tax, structure, operating procedures, policies, laws, and implementation. The cost of taxes is unproductive and does not contribute to the prosperity of the country. Therefore, the cost of taxes should be minimized through appropriate tax forms, structures, operating procedures, policies, laws, and administration. Among the taxes currently implemented in Nepal, VAT is a broad-based, economically efficient, transparent, flexible and cost-effective tax, and it has the potential to generate more revenue at a lower cost than other taxes.

On the one hand, there is pressure to mobilize additional revenue as the country is struggling to meet even basic expenses from revenue, while on the other hand, it is important to be aware that taxes do not further discourage sluggish economic activities. A VAT policy should be formulated and implemented in the context of these two conflicting needs. In this process, revenue dependence on economic development-friendly taxes should be increased.

Value Added Tax Does Not Unnecessarily Raise Consumer Prices

Although value added tax, customs duty, and excise duty are commodity taxes, their impact on revenue and consumer prices varies. Under the Value Added Tax, the taxpayer can deduct the tax paid on the purchase and import of goods and services necessary for operating his business from the tax collected at the point of sale or can demand a refund of the difference from the government if the tax paid on the purchase and import is more than the tax collected at the point of sale. Therefore, the taxpayer does not have to consider the tax paid on the purchase and import as an investment and apply a profit percentage to it. As a result, the consumer price increases only by the amount of tax due to the Value Added Tax, and the consumer price does not increase by more than the amount of tax.

On the other hand, since there is no provision for tax deduction and tax refund in the customs duty and excise duty system, the customs duty and excise duty paid are considered an investment and applied a profit percentage to the purchase or import price including tax. As a result, the increase in the final consumer price due to it is greater than the amount collected by the government as customs duty and excise duty.

Therefore, since it is economically more efficient or cheaper to collect VAT than customs duty and excise duty, it is an international good practice to impose excise duty only on limited items and to develop VAT as a main source of revenue by reducing the dependence of revenue on customs, which is equally relevant for us. Currently, there is a provision to levy advance income tax in addition to customs duty/agricultural reform duty and excise duty on the import of some agricultural goods. Although the advance income tax is allowed to be deducted by traders from their annual income tax, in practice they collect the advance income tax from the customers by adding customs duty and excise duty to the price of the goods and adding a profit percentage to it. As a result, the increase in consumer prices due to this is much higher than the amount collected by the government from customs duty, excise duty and advance income tax.

For example, suppose “Himalayan Import-Export Company imports agricultural goods worth Rs. 1,000.00 and sells them to wholesalers, wholesalers to retailers, and retailers to consumers, and at each level there is a 25 percent mark-up for the seller’s transportation costs, shop rent, worker wages, and seller’s profit, etc. In such a situation, in the absence of any taxes such as customs duty, excise duty, advance income tax, etc., the value added tax shown in column (2) of Table 2 is Rs. An agricultural commodity with a customs value of Rs. 1,000.00 is sold by the importer for Rs. 1,250.00, while the wholesaler sells it for Rs. 1,562.50 and the retailer for Rs. 1,953.12.

If the Government of Nepal imposes customs duty/agricultural development fee of 10 percent, excise duty of 15 percent and advance income tax of 10 percent on the said commodity, then as mentioned in column (6) of Table 2, the customs duty/agricultural development fee is Rs. 100.00, excise duty of Rs. 165.00 and advance income tax of Rs. 100.00, making a total tax of Rs. 365.00. Since the importer, wholesaler and retailer charge a profit percentage on the purchase price including that tax amount, the selling price of the importer, wholesaler and retailer is Rs. 1706.25, 2132.81 and 2666.02 respectively.

##

##

## Under VAT, the taxpayer is allowed to deduct or claim a refund of the tax paid on purchases and imports, so there is no need to impose a profit percentage on the tax amount like in customs duties and excise duties. This means that the government collects only Rs. 321.19 as VAT, which increases consumer prices, and consumers do not have to pay unnecessary high prices as in customs duties and excise duties. Since VAT can be collected more efficiently, it is possible to collect more revenue at a lower cost than customs duties and excise duties.

Value Added Tax exempts investment.

Value Added Tax is a tax on consumption and the ultimate burden of this tax falls on the final consumers of goods and services. It is not a tax on trade. Yes, this tax is collected from importers, manufacturers, wholesalers and retailers, but they are only the means of collecting this tax. They deduct the tax paid while purchasing or importing goods and services necessary for conducting their business from the tax collected on the sale of their goods or services and remit only the remaining amount to the government. If the tax paid on purchases and imports is more than the tax collected on the sale, they can claim the excess amount back from the government. Due to this, importers, manufacturers, wholesalers and retailers registered for VAT do not have to bear the final burden of VAT and their investments are exempt from the burden of VAT.

The nature of the transaction, the legal status of the seller, the supply chain, the medium and volume of the sale cannot reduce the tax burden on any good or service. The final burden of this tax is proportional to the consumer price in any case. Therefore, VAT is an economically efficient/neutral tax and is called a growth-oriented tax.

Value Added Tax Exempts Exports

#

#

#

#

#

#

###In This means that the taxpayer does not actually have to pay any tax on the export.

On the other hand, the exporter can claim a refund of the tax paid on all goods and services (inputs) related to the exported goods and services, including raw materials, auxiliary raw materials, packaging materials, chemicals, vehicles and their parts, fuel, furniture, stationery, telecommunication services. This will completely free the exporter from the burden of value added tax, which will increase the possibility of promoting exports by making domestic products more competitive in foreign markets. This will increase foreign exchange earnings, improve the trade balance, and increase employment and production. This is shown in Table 4. Suppose a manufacturer imports raw materials worth Rs. 2000, produces finished goods from them, sells them to the exporter for Rs. 4000, and the exporter exports the goods for Rs. 5000.

There is a provision for zero rate of VAT on exports. According to this, the manufacturer adds Rs 260 to the customs, collects Rs 520 VAT on his sales and deducts the VAT paid by him to the customs and remits the remaining Rs 260 to the government. The exporter pays zero rate of tax when exporting goods worth Rs 5000. This means that the exporter does not actually have to pay any tax. However, he can claim back the Rs 520 VAT paid by him when buying the goods from the manufacturer from the government. This makes the exported goods completely free from the burden of VAT.

Table 4: Value Added Tax Burden on Exports

#VAT Makes Illegal Imports Less Attractive and More Difficult

#  

# Value Added Tax is a tax collected at various stages of the production and distribution process and paid by taxpayers on the purchase of goods and services related to their business. Since the tax paid on imports can be deducted, it is less attractive and more difficult to import illegally. Since the importer can deduct the tax paid on his imports from the tax collected on the goods, there is no incentive to commit illegal acts like importing illegally. Similarly, since VAT is levied at different levels, if the tax is not paid at the first level, it is possible to collect it at the later level.

In column (5) of Table 2, in normal circumstances, the customs value is Rs. 1000.00, customs duty 10000 and excise duty 165.00, a total of Rs. 1265.00 including Rs. 13 percent is subject to VAT. However, if the goods are imported illegally, no tax including VAT is levied at the customs point. If the importer sells the goods to a wholesaler at the market price of Rs. 1581 25, VAT is collected at different levels as per Table 5.

Table 5: Status of value added tax collection in case of theftinline_tags_PLACEHOLDER_4

Table 6: Status of VAT collection in case of fifty percent under-invoicing

##VAT is helpful in collecting revenue from the informal sector

## Value Added Tax is also helpful in collecting some revenue from the informal sector. For example, if the VAT is generally effective, most goods and services are subject to VAT at some point, and the informal sector must pay VAT when they consume those goods and services. Thus, even if the informal sector business is not registered for VAT, its purchases are taxed.

Since they are not allowed to deduct tax, the informal sector business will only be taxed on the VAT, which is not that large. On the other hand, if some informal sector people have to do business with VAT registrants, the registrants may demand tax receipts for the purpose of deducting tax, and the informal sector business may be forced to register for VAT. Therefore, VAT is more attractive than other taxes for taxing the informal sector.

Value Added Tax can make the entire revenue collection system more effective

Features such as the catch-up effect, self-policy features and audit trail of Value Added Tax help in increasing not only Value Added Tax but also Customs Duty, Excise Duty and Income Tax revenue collection.

In Value Added Tax, there is a possibility of tax lost at the first level being recovered at the later level (catch-up effect). As shown in Tables 5 and 6 above, if goods are smuggled or under-invoiced, even if VAT revenue is not collected at customs or is collected less, in such a case, since the credit is not received at the later level or is received less, the revenue lost at the first level is recovered at the later level.

Similarly, since it is against the interest of the seller to over-invoice goods and services under VAT and against the interest of the buyer to under-invoice, there is a self-control (self-policy features) element, which reduces the possibility of VAT revenue leakage through under-invoicing.

Not only this, the fact that invoices are issued at different levels under VAT makes it easier to audit.

Due to these various reasons, VAT has become one of the most important and effective revenue mobilization mechanisms in various countries. If the VAT is effective, not only VAT revenue but also customs duty, excise duty and income tax revenue are likely to be mobilized more, and VAT creates an environment that makes the entire tax system more transparent and provides equal opportunities for everyone to do business.

Design and Implementation of Value Added Tax

Since Value Added Tax is an excellent tax from various perspectives, Nepal has also implemented it as a main source of revenue, replacing the existing sales tax, contract tax and hotel tax. BS 2054 BS 1 Marg.

In line with the essence of this tax and international best practices, Nepal had implemented a comprehensive value-added tax system from production to retail level with a consumption-based tax deduction system. Except for limited goods and services exempted by law, all imported and domestically produced goods and services were brought under the tax ambit, the tax rate was fixed at 10 percent, exports were taxed at zero rate, the tax registration limit was set at Rs. 2 million per year for both goods and services, businesses trading below the registration limit could register voluntarily, and it was arranged that the mandatorily registered taxpayers in this tax had to submit tax returns monthly and the voluntarily registered taxpayers had to submit tax returns and pay tax quarterly.

Our Value Added Tax (VAT) formulation was considered good not only as a model in South Asian countries but also at the international level. Tax administrators from various countries including Bangladesh, Zimbabwe, Zambia and others had come to Nepal to study it. Similarly, tax administrators from the Indian state governments of Sikkim and West Bengal were also preparing to come to study Nepal’s Value Added Tax. But unfortunately, due to the blockade imposed by India at that time, their Value Added Tax study tour to Nepal could not be implemented.

The Value Added Tax (VAT) was also successful in practice. This is evident from the fact that the annual average growth rate of revenue has been around 18 percent for more than two decades since the introduction of this tax, with the value added tax revenue accounting for about one-third of the total revenue and the ratio of value added tax revenue to gross domestic product reaching more than 6 percent.

But a few years after the implementation of the VAT, various deviations were caused in this tax. For example, tax exemptions were given to many goods and services based on pressure and inducement from influential people and middlemen. On dozens of items including mobile phones, arrangements were made to allow sellers to keep some part of the VAT collected from consumers. Tax exemptions were made based on the recommendations of various bodies of the Government of Nepal. Arrangements were made to exempt imports of projects run under foreign assistance and security agencies. Separate registration limits were set for goods and services, and a monthly tax period was also set for small vendors who voluntarily registered. This led to many distortions and inconsistencies in the VAT, and the implementation of the tax was weakened.

A series of reforms in value-added tax

In recent years, a series of reforms in value-added tax have begun. In the fiscal year 2060/61, the tax base was expanded by abolishing tax exemptions on more than two hundred goods and services. The tax exemptions given to imports of security agencies were removed. Industries that produce and export tax-exempt goods refunded the tax paid on the purchase of raw materials. Arrangements were made. Taxpayers with annual turnover of up to Rs 10 million were required to submit tax returns and pay taxes once every four months instead of monthly, and to simplify and make effective the system for VAT refunds received by diplomatic missions, it was proposed to automatically refund tax to bank accounts through the Green Channel.

Thus, the campaign started in the fiscal year 2080/81 was continued in the fiscal year 2081/82. This year, the VAT exemption on more than two dozen goods and services was abolished, expanding the tax base. Similarly, when making new agreements on development assistance, instead of providing tax exemption to projects, tax exemption was provided through tax ribbons or clearance. It was made mandatory for VAT registrants to issue invoices through the electronic system. Annually, Rs. Provision was made to link the transactions of all taxpayers with transactions exceeding Rs 250 million to the Central Electronic Monitoring System, and a provision was made to refund 10 percent of the tax paid on the purchase of goods and services purchased by consumers through electronic means. Similarly, in the case of mixed transactions of goods and services, the registration limit was increased from Rs 2 million to Rs 3 million, which reduced the gap in the registration limit set for goods and services.

Thus, while significant reforms were made in the value-added tax through the budgets of the past two years, one or two deviations also appeared like stones in the rice of Basmati rice. In the fiscal year 2080/81, a flat rate tax was imposed on international air tickets, contrary to the principles of value-added tax and international good practice, and a luxury tax was introduced on some luxury goods and services. In the fiscal year 2081/82, in the name of protecting domestic production, vegetables and fruits including potatoes and onions were exempted from VAT for cheap political popularity. Since the exemption of VAT on potatoes and onions etc. means that both domestically produced and imported potatoes and onions are not subject to VAT, domestic production is not protected by VAT exemption. Rather, to increase the production of agricultural products including potatoes and onions, VAT should be imposed, not VAT exemption.

To review the VAT exemption and expand the tax base, the government has decided to introduce a new VAT exemption scheme. It should be continued in 2062/63 and subsequent years, and tax exemptions that are ineffective in achieving the specified objective and have an adverse impact on revenue collection, increase the economic, tax compliance and tax collection costs, and weaken the implementation of the entire tax system, including VAT, should be gradually eliminated, while excise duties and advance income tax imposed on agricultural products including fruits, vegetables, and other items should be reduced.

Such a policy, on the one hand, will make it possible to mobilize more revenue at a lower cost, and on the other hand, consumers will not be unnecessarily burdened with taxes. Therefore, the Ministry of Finance should prepare a detailed schedule for which items the VAT exemptions will be removed and which items the excise duties and advance income tax will be removed within the next three to four years, and a consensus should be reached through extensive discussions with stakeholders, and a national consensus should be reached among political parties. In such a situation, the tendency to impose or remove taxes on the basis of hesitation will end, and certainty will come to the tax system, and the trust of the government in such tax systems will increase.

Similarly, the system of granting VAT exemptions based on the recommendations of various bodies of the Government of Nepal will cause taxpayers to visit various bodies, unnecessarily spend time and resources, compromise, increase costs, and reduce revenue. If tax exemption is required for any goods or services, it should be included in the list of tax exemptions and automatically exempted, and the practice of granting exemptions based on the recommendations of various bodies of the Government of Nepal should be abolished. Since tax refund is an important aspect of VAT, the tax refund system should be simple, easy, transparent, and fast in practice. In this context, especially for exporters, arrangements should be made to automatically refund tax to the taxpayer’s bank account through the green channel or to match it with any other tax liability of the taxpayer, and such a system should be gradually implemented in the case of other taxpayers with good tax participation.

Currently, if the tax paid by a taxpayer other than an exporter on purchases or imports is more than the tax collected on sales, the excess amount is adjusted against the tax liability of the next month and the taxpayer can claim a refund of the excess tax deduction only if the taxpayer has been in a tax withholding situation for four consecutive months. Due to this, taxpayers who cannot deduct tax on time have to face cash flow problems. Instead, there should be a provision that the excess tax deduction amount accumulated in a tax period can be adjusted against other tax liabilities or the exporter can claim a refund in the last month after the tax period ends and the tax refund should be expedited.

Instead of setting separate registration limits for VAT for goods and services, a single registration limit should be set in accordance with international good practice.

Value Added Tax is collected at various levels. Despite the features of this tax such as catch-up effect, self-policing and audit trail, tax collection has not been as effective as expected. In particular, the practice of taking and giving bills, which is the backbone of Value Added Tax, is low. Cash machines are not used at the retail level either.

Since the practice of taking and giving bills plays a major role in effectively implementing Value Added Tax and creating an environment for implementing the entire tax system in a uniform and transparent manner, various promotional and punitive measures should be adopted to create a proper environment for taking and giving bills in the market. The use of cash machines should be made mandatory at the retail level. Market monitoring should discourage illegal imports, create a conducive environment for the right kind of goods in the market, and adopt a zero-tolerance policy regarding the use of fake VAT bills.

(The author is a tax expert, Courtesy of Tax Souvenir 2081)