VAT compromise signals hope
By Christopher Ram
April 18, 2005
Despite rejecting a call by the Private Sector Commission of Guyana (PSC) for a suspension of the passage of Bill # 3 of 2005, the Value Added Tax Bill, to allow for consultations by the Government with stakeholders generally and the PSC in particular, the National Assembly arrived at a compromise which was unanimously approved at its second reading. The National Assembly agreed to take the Bill to Select Committee during whose deliberation the PSC and other bodies would be permitted to make its case for such changes to the Bill as they consider appropriate. The deliberations of the National Assembly are usually discussed with cynicism but on this most fundamental piece of tax legislation, the members rose to the occasion with a debate that was quite informative and, taken as a whole, reasonably balanced. There were a few incorrect statements due perhaps to a lack of understanding; omission of others such as any reference to the fact that there is no such thing as a uniform VAT system or to the fact that the largest economy in the world (USA) does not have a VAT and the second largest (Japan) has a VAT that is considered quite unique; the impact of the introduction of VAT on the cost of living and the lack of emphasis on the complexities of the tax and the substantial opportunities for fraud such as a trader charging VAT on fake invoices which are not recorded or accounted for to the authorities or making improper claims for refunds.
Two issues I believe were not adequately addressed are the ability of the Guyana Revenue Authority to administer the VAT given its existing responsibilities and the human resource constraints facing every entity in Guyana and the failure of the Bill to zero rate basic food items as is done in all the CARICOM countries which have VAT.
Today's Business Page once again looks at the subject having re-published late last year a three part article first published in 1993. The basis of today's article which continues next week is a presentation made by the writer at a Luncheon Presentation sponsored by the Guyana Manufacturing and Services Association Limited (GMA) on last Tuesday April 12.
Value Added Tax and tax reform
I had expressed pessimism about any compromise from the majority party since there is a long outstanding commitment given by the Government of Guyana to the IMF for the introduction of VAT by July 2006. In the document dated July 7, 2004 in which the commitment is given, the introduction of VAT is stated 'to advance tax reform consistent with VAT implementation by 2006'. In truth, VAT has been on and off the agenda for over twelve years although the current administration appears to have argued against it in 1993 in response to a call by Professor Clive Thomas for the Government to give it consideration. To that extent, I consider that the private sector must accept part responsibility for the obvious lack of information, preparation and discussion on what is considered the most innovative tax system to have been introduced anywhere in the world over the past century. VAT now operates in about 140 countries with the majority having introduced the tax over the past quarter of a century.
The trouble with tax changes even when they are no more than tinkering is to shroud them in the cloak of tax reform. Really meaningful and serious tax reform requires the simultaneous review of all existing taxes, with all the stakeholders. In particular, the introduction of VAT - an expenditure tax - should be accompanied by a reduction of taxes on income. Whether such issues can be raised in the Committee stage of the Bill is an open question but if the atmosphere of compromise persists, there is no reason why the parties cannot agree to include this as it deals with the tax modeling that is necessary to determine the rate of the VAT which is still to be decided.
Before I move into the substantive issue and particularly since the tax we are told is being introduced to advance tax reform, let me mention a few areas where the cries for reform have been all but ignored.
Tax Reform Issues
- Differential tax rates - commercial v non- commercial company
- un-incorporated vs. incorporated business
- Tax Evasion (estimate by the Commissioner General of billions lost through evasion).
- Company Group relief
- The turnover tax
- Income tax threshold far too low and should be radically increased
- Corporation tax should be more in line with personal taxes
- The imposition of a withholding tax on those multi-million dollar contracts whose contribution to the State seems negligible.
- A statutory review of the decision in the Bata Shoe Company Case
- The penal duties on incorporation of companies.
- Apparently unreasonable and unjustifiable remissions and exemptions.
It is a fair chance that the country loses as much again via tax holidays, which are closely guarded secrets, and exemptions for some type of businesses. In other words, we probably remit or forgive as much as three times the annual taxes paid by companies.
Apart from considerations of equity such generosity with funds otherwise due to the state seems to make no economic sense particularly in the context of the weak performance of the economy over the same period as the real GDP growth shows.The question which arises is are these free lunches since they do not contribute to economic growth as the following figures show?
Year Amount Real GDP Growth
2003 15.771 (0.6)
2002 15.486 1.4%
2001 16.331 2.3%
2000 13.200 (1.4)
1999 7.537 3.0%
There must also be some concern that personal taxes now contribute as much to the coffers of the state as companies do. When we consider the meagre - some would say mean - allowance for individuals, the lack of equity in the personal tax system is further exposed.
If the IMF, as drivers of our economic and fiscal policies, was serious about tax reform including such basic concepts as efficiency, equity, transparency and certainty, then it should be rooting for those concerns to be addressed rather than for the introduction of another tax for which the country is by all accounts hardly prepared. The IMF cannot be unaware that the last major piece of 'tax reform' it proposed and embodied in the Fiscal Enactment Amendment Act #15 of 2003 is still to be properly implemented. I should mention as well that the flip side of the tax reform debate is expenditure management - a topic that demands equally serious attention.
The world going Vat - but not the USA
VAT operates in 136 out of 186 countries although only nine out of the 27 countries with a population of less than one million have the tax. One of the first countries outside of Europe to have introduced it was our giant neighbour Brazil back in the sixties while Caricom neighbours Trinidad, Barbados and Jamaica have been more recent converts. VAT exists in every country in Europe and in Canada but significantly not in the USA.
Interestingly, only five countries have ever removed an existing VAT and of these, three have reintroduced the tax. Two Caricom countries, Grenada (introduced 1986, dismantled shortly thereafter) and Belize (introduced 1996, removed 1999) have held out. The numbers do not necessarily reflect the efficacy of VAT since the tax is also largely driven by the IMF which believes in its inherent virtues, the principal of which is that it assists in the better allocation of resources. That argument may indeed hold true for the private sector but is it equally applicable to governments? In other words, do governments take such factors into account when deciding on their expenditure priorities?
Questions and issues
In the introduction of such revolutionary concepts, some critical issues and questions should be addressed. Here are some sample questions drawn from a paper presented by Professor Richard Bird, the world's leading authority on taxation in developing countries at the First Global International Tax Dialogue Conference on VAT held in Rome last month. In my view these are issues which ought to have been addressed prior to the plunge and it does not seem too late for them to be given consideration. In that regard I am particularly disappointed that with VAT being so important to this country at this stage, the Government did not seize the opportunity to participate in this conference which brought some of the world's top VAT experts together for two days. Think of the missed networking and knowledge opportunities!
1. What are the principal objectives for the introduction of VAT?
2. What is the best model of VAT appropriate to this country?
3. Is the IMF-favoured VAT with a low rate and very few exceptions the option which this country will pursue?
4. What does tax-neutral mean in the context of rate-setting? Is it neutral for all or will there be losers and winners?
5. What are the revenue implications for Guyana of trade liberalisation including CSME and the FTAA and to what extent will the proposed system respond to the anticipated revenue problems?
6. How effective is the proposed system in economic, equity, and administrative terms and what are the alternatives which have been considered and discarded?
7. How relevant is the proposed system to the particular circumstances of Guyana with a culture of evasion, a large informal cash economy, widespread smuggling and a low level of compliance?
8. Given the performance of the GRA since the merger of the Customs and the Inland Revenue and the problems currently experienced with administering the existing taxes, can it assume additional responsibilities and administer VAT sufficiently well to make the introduction of the tax worthwhile?
9. Is VAT the efficient, simple, revenue-raiser as some claim or as others argue so inequitable in its application as to exacerbate social and political tensions?
10. Will VAT provide a way to tap the informal sector or does it instead tend to drive even more into that sector?
11. Since VAT represents a fundamental shift from taxing income to expenditure, will income and corporation taxes be reduced and if so when?
12. Does the government see this as the end product of tax reform or should it be part of simultaneous, wider tax reform?
13. To what extent, if any, does the proposed system benefit from the experiences of other CARICOM countries and have we sent any of our people for training in any of those countries?
14. Why the haste to introduce VAT when all evidence from around the world tells us that effective implementation cannot be achieved in the timeframe which has been imposed?
15. Since the business sector carries the principal responsibility for the collection of the VAT would the government respond favourably to a request from the sector for more time before the implementation?
How it works
The Draft legislation proposes the repeal of a number of indirect taxes including Consumption Tax, the Travel Voucher Tax, the Hotel Accommodation Tax and the laws relating to service tax, premium tax purchase tax, entertainment tax and telephone tax. These will all be replaced by VAT and welcomed by manufacturers who hopefully will find the likely reduced rate a spur to the sector. In the GMA presentation, I had noted that while the VAT will extend to the bottling of juice, aerated and alcoholic drinks, it is a fair bet that excise and higher taxes on alcoholic beverages, cigarettes and luxury items will remain. In fact on the day of the Parliamentary Debate, Bill # 4 of 2005 Excise Tax Bill was circulated. The objective of the Bill was stated in its Explanatory Memorandum as to 'ensure that the yield under the proposed new system (VAT + Excise Tax) would approximate the revenue collection under the current system'. (Editor's note: this bill has been sent to a Select Committee).
The essence of a VAT is that it is charged on a wide range of transactions, with a mechanism for offsetting tax paid on inputs/purchases against tax charged on outputs/sales. What makes VAT so different is that it seeks to tax expenditure and in theory at least the citizen can choose the simple device of forgoing the expenditure if she wants to avoid the tax. The fear is however that unlike those countries which reduced personal taxes and reduced corporate tax rates on the introduction of VAT, there is every indication that we will maintain personal income tax and corporation tax at their high rates which make evasion worthwhile. The tax/GDP ratio which is already very high may quite likely rise, not only taking money from the private and domestic sector but operating as a deterrent to badly needed growth. It would be a major disappointment if the Government fails to appreciate this point in its haste to deal with VAT and VAT alone!
There does appear to be an intention that the combined effect of the VAT and the new Excise Tax will be revenue neutral. But can anyone confidently state that the tax will be revenue-neutral and at the same time say that the rate(s) have not yet been determined? Or respond to a representation for a category of item to be classified as zero-rated rather than exempt? Have the authorities been collecting and analysing data to enable them to do this type of modelling to determine the best structure for a Guyana VAT? We have had years to do this type of serious economic modelling and vague promises that the tax will be revenue neutral is either ill-informed or is based on information which should be shared with the public.
Two to one
Consistent with similar legislation, the Act provides for taxable, zero-rated and exempt categories. Zero rating allows the removal of the effects of VAT usually from a particular good or service - usually for social or economic reasons - and permits a claim for a refund of input VAT i.e. VAT suffered on its purchases even though it has no output VAT i.e. VAT charged on sales. My reading of the Bill suggests that such a credit only becomes a refund until after six months, which can play havoc with an entity's cash flows - a fact that is often lost on the administrators of existing direct taxes. And is it fair that refunds due attract interest at the rate of 1% per month while unpaid taxes attract interest at 2% per month?
On the other hand, since no tax can be charged on exempt items and since there is no refund of the tax suffered on purchases, the seller will simply pass the cost of his input VAT to the consumer. This is why it is so important that certain categories of items are classified as zero-rated rather than exempt. When Trinidad introduced VAT in 1990 prescription drugs, unprocessed food such as flour, bread, milk and margarine, live animals, livestock feed, seed fertilizers and farm machinery were zero-rated. This list has substantially increased since 1990. My understanding of the Guyana Bill is that these items are not zero-rated and will therefore attract VAT with the obvious implications for the cost of living and consequences for the poor.
Another issue of practical significance, is whether the tax is paid on the accruals or cash basis? Let us take a quick and simple example. Company A pays VAT on its purchases for March amounting to $20,000 and has fully settled its bills. It gives extended credit on sales on which VAT of $35,000 is charged. However, its customers paid only on invoice with VAT of $13,000. Is the law going to insist that Company A pay over $15,000 (output VAT of $35,000 less input VAT of $20,000) or that the Company recognize a VAT refund of $7,000 ($20,000 -$13,000). This is an issue with practical cash flow implications particularly for those companies which grant extended credit such as hire-purchase companies which I understand have not been consulted on the Bill.
The stretch factor
At a time when the GRA is still trying to cope with the merger of the two principal revenue-collecting agencies, it seems at best a major risk to impose on it such another responsibility. The present Commissioner General is on record as lamenting the billions of tax revenues under existing laws which go uncollected each year. Is it not far more logical that the additional resources being made available by the Government and lending institutions to the GRA be concentrated towards collecting these taxes, rather than deploying the existing resources towards a new and more challenging tax?
I have the greatest sympathy for the GRA and its staff who operate in what sometimes appears to be an unreceptive if not hostile environment with little understanding, co-operation or empathy from its stakeholders. I believe however that the GRA has not yet justified the billions which have been invested in it. Indeed ,if we use the indicator of revenue collected for every dollar spent, the yield on every dollar spent has dropped by a troublingly large factor. Is VAT likely to make the situation better or worse?
The GRA is singularly vulnerable in never having had a single year's report tabled in Parliament as required by law. Is this the mark of 'transparency and governance', to use the words of the IMF document referred to earlier?
The Bill provides for appeals to the Commissioner General, a VAT Board of Review and a judge in Chambers. The courts are overloaded and may have little time for VAT and the best recourse will be the CG and the Board of Review.
Is the training and the expertise available to address the multitude of challenges which are likely to arise in the first few years of VAT? I am concerned that currently and in contravention of the Income Tax Act there is no Board of Review. What is there to comfort us that the GRA and the Minister of Finance would be more diligent with respect to the VAT Board of Review for which there is even less expertise?
To be continued
Business Page today concludes its three-part article on Value Added Tax, the bill which the PNCR convinced the government should be taken to a select committee for further consideration. It will be recalled that the Private Sector Commission had asked for a delay citing inadequate consultation. VAT is due to be introduced in July 2006 following the registration exercise which will begin in May 2006.
Back to Bird
This piece begins by drawing from Professor Bird's paper presented at the First Global International Tax Dialogue Conference on VAT held in Rome last month. Professor Bird has for years been considered the world's foremost authority on taxation in developing and transitional economies. His book, Readings on Taxation in Developing Countries with Oliver Oldman and published by Johns Hopkins is still one of the most widely read books by those interested in the economics of development.
Professor Bird notes that in developing and transitional economies (DTE), VAT is invariably among the most important sources of government revenue, but that this creates problems for those countries as they become dependent on VAT and hence more vulnerable to potential problems.
Rates are often changed not on any rational basis, but entirely to meet revenue needs. On the other hand, zero-rating and exemptions become the vehicle through which some sectors win favour. Our legislation must therefore guard against any politicization of the VAT.
Despite the herd mentality which drives increasing numbers of countries to introduce VAT, the tax does not always work well in many DTE, principally because some are simply not ready for 'self-assessment.' If proof be needed, we show each year how unprepared for self-assessment the country is. If we are not ready for self-assessment for income and corporation tax purposes, can we be ready for self-assessment for VAT and if not, as Professor Bird asks, can such a country have a VAT at all? And, if it does (as many already do), is the best VAT for it always the same as the 'model' implicitly set out as a standard in most of the literature?'
The debate in Parliament seemed to have assumed that there is such an animal as a uniform, standardized VAT. That is not correct and VAT like other taxes is subject to 'the NOSFA principle' - No One Size Fits All.' That the Bill is imported from some unstated country is clear when the definition section (s 2) refers to 'memorandum, articles of association' - terms that are now obsolete under the Companies Act, 1991.
Experience in DTE suggests that the oft-cited '18-24 months' needed for successful VAT implementation vastly understates the nature and time-scale of the task in many countries. According to Professor Bird, some countries "that adopt a VAT must sometimes, for better or worse, take what may be called the 'big bang' approach - a short lead time with the consequences addressed later." Experience has shown that when this happens, it has seldom worked out well, which is probably one reason he stresses for the need to follow the 'normal' time schedule. When one hears of the eleventh-hour consultation now taking place it is hard to escape the conclusion that the government is allowing itself - once again - to be pushed in a direction and at a pace which this environment cannot sustain.
VAT is a particularly complex and costly tax to comply with and administer, and is consequently ill-suited to developing countries. VAT revenues are higher - all else being equal - in countries with higher literacy rates and hence presumably with better administrative capacities.
In the presence of a substantial 'informal' sector, a tax like VAT that falls on the formal sector acts to deter the growth and development of the economy as a whole. Indeed, one recent study (Hines 2004) concludes that increasing consumption taxes definitely fosters the expansion of the hidden economy as more businesses go outside the formal structure.
I now turn to some other relevant issues taken from the Background Paper presented at the same conference at which Prof Bird presented his paper.
How many rates of VAT?
Standard advice has been for a single-rate VAT (other than a zero rate for exports only). Rates vary from 5% in Singapore and Nigeria to 25% in Sweden with a multitude of rates within this range across the world. In Barbados, Jamaica and Trinidad & Tobago, the VAT rate is 15%, having started at 10 per cent.
Guyana is yet to set the rate(s) which will apply. This should be a function of the answers to the questions posed earlier in this brief presentation.
The standard advice is also for a short list of exemptions, limited to basic health, education, and financial services. Systematically documenting worldwide practice in this area is difficult, but the proliferation of exemptions in VATs in practice is an increasingly common concern. Politicians have been all too willing to grant special treatment to their friends which explains some of the anomalies in the present tax system. Are we likely to see this pattern continue under VAT?
The level of the threshold at which registration for the VAT becomes compulsory is a critical choice in the design and implementation of the VAT. Experience suggests that many countries have tended to set the threshold too low, putting themselves in considerable difficulty when their tax administration is found to be insufficiently developed to administer a large VAT population. Indeed, in both Ghana and Malta an initially low threshold was one of the primary reasons for the failure of their first VAT.
The appeal of a high threshold stems from the empirical regularity that a relatively small proportion of firms typically accounts for a very large proportion of potential VAT revenue. A high threshold thus economizes on scarce administrative resourc-es at little cost in revenue.
In Guyana we have had considerable difficulties with setting thresholds whether under the Companies Act for purposes of the audit requirement or for purposes of the presumptive tax under the 2003 Fiscal Amendment Act. We need to think this one through.
Modern tax systems and their administration are built on the principle of 'voluntary compliance,' meaning that taxpayers are expected to comply with their basic tax obligations with only limited intervention by revenue officials. Which Guyanese would put their hands on their chest and swear that there is such a culture in Guyana?
In many countries, especially developing and in transition, audit performance is reported to be a particularly poor aspect of VAT administration. With false claims for refunds a major threat, an efficient audit system is absolutely vital. Here again, our performance has been very weak as too many (non-)taxpayers get away with millions because of the absence of basic auditing skills in the Revenue Department.
No recipe for
Countries with well- designed VATs that have been properly implemented are likely to face fewer compliance problems in the longer-term.
Experience shows that it takes 18-24 months to implement a VAT effectively. Key to success is a sound policy design (a single rate, few exemptions and high threshold), simple laws and procedures, an appropriately structured and resourced administration, and compliance strategies based on a balanced mix of education and assistance programmes, and risk-based audit programmes.
To state that this is no simple piece of legislation is an understatement. It is long, complex and confusing. One section has twenty-one subsections. Another defines a supply of services as including anything done including "refraining from or tolerating an activity"! Experience has shown that even the simplest and least complex law soon becomes subject to myriad amendments, with all its innocence soon lost. We need to avoid that danger.
The Commissioner General has frighteningly wide powers including "issuing an order in writing" and "at any time entering any house or premises described in the order authorising the distress proceedings." Was this discussed with the legal profession? We need to be mindful that insensitivity on the part of the administrators has led to major problems in some countries.
I closed my GMA presentation by asking a further couple of questions which I now repeat. Can, or should we implement a 'full' VAT immediately or should we grow into one over time? If the choice is really a 'bad' VAT adequately administered or a 'good' VAT poorly administered, which is better? Or is this a false choice? And what about a bad VAT badly administered?
There is confidence that the select committee will take an enlightened approach, taking all concerns on board and not considering itself hidebound to any unrealistic deadline. Let us give ourselves enough time and get it right.