Business Page –  VAT compromise give hope Part 2

Sunday, April 24th, 2005

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