The single standard rate of VAT was set at 10 percent at the outset and was subsequently increased to 13 percent in 2005. In Nepal, VAT is calculated on invoice credit mechanism in which the registered taxpayer, de jure taxpayer, collects VAT from the consumers, de facto taxpayers. We have embraced ‘destination principle’ that imposes tax on the taxable transaction within the jurisdiction of Nepal.
All Imports are taxed and exports are zero-rated to support export of domestically produced goods and services through tax credits and tax refund mechanisms.
VAT has completed its 14 years today. During that time it has witnessed many ups and downs. It has become the backbone of internal revenue as it surpassed customs duties from fiscal year 2002/03 and now stands as the largest contributor to state coffer. At the time of its introduction, only 2,045 taxpayers converted from the old sales tax regime to VAT, but by the end of FY 2010/11, the number of VAT registrations had reached 97,664, registering a staggering annual growth of 126.42 percent.
But the registered taxpayers have not contributed enough to meet the expected level of tax generation. By the end of FY 2010/11, around 49 percent tax returns were credit returns, accounting for mammoth credit of Rs. 109 billions; only around 18 percent, worth Rs. 19 billions, were debit returns; followed by 33 percent zero returns. The credit volume is soaring alarmingly (5.62 times the debit amount payable to the treasury and 1.73 times total VAT collection for the year). Another 21.25 percent taxpayers are not filing their returns.
Although VAT comprises 35.92 percent of total tax revenue for FY 2010/11, improving compliance among taxpayers has been tough. Most of the taxpayers are as yet not interested in issuing tax invoices at market prices. A sizeable amount of tax is vanishing through tax avoidance and evasion. The problem has been further aggravated due to weak law enforcement, by both the customs and Inland Revenue administration.
Some criminal-minded taxpayers have been in collusion with fraudulent taxpayers resulting in fake input tax and refund claims. Tax refund has turned out to be a means that fraudulent taxpayers use to get back money from the treasury by preparing forged tax invoices and export documents.
Though Inland Revenue Department (IRD) achieved notable success in reducing VAT dues last year, a big chunk of the dues is yet to be collected. The taxpayers desist from paying up either by delaying the payment or through an appeal to the Revenue Tribunal. IRD has figured out the problem areas of the system. Now it has to buckle down to tackle such problems deftly and show the desired level of professionalism.
There is where the new performance based incentive system (PBIS) comes in. It is expected to have a significant impact on enhancing the overall productivity of IRD. It has already been effective in motivating employees and making them accountable.
The government has encouraged the use of printers and electronic cash machines for the preparation of tax invoice, but the taxpayers have been loath to adopt them. Additionally, the tax administration has launched Tax Enforcement Campaign Year to intensify tax enforcement, but the effect has been minimal. Given its poor enforcement capability, Nepal´s porous border has bred illegal and fraudulent economic activities.
The customers are largely oblivious of VAT system. They are indifference and do not even bother to ask for bills at the time purchases. The ill-intentioned taxpayers cash in on the ignorance of such customers.
IRD has been pursuing a two-pronged strategy, namely enhancing service delivery to lure taxpayers towards tax administration and administering stringent legal actions against tax dodgers. Establishment of Taxpayers Service Offices (TSOs) at the doorstep of the taxpayers will focus on registration, taxpayer education, tax collection, market survey and monitoring to enhance service quality.
On the other side, the IROs have an inbuilt system to detect phony transactions. IRD has been slow on taxpayer education and consumer awareness campaign. This has to change.
Apart from this, procedural simplification through application of e-based system, scaling up investment for ICT sophistication, restructuring and reengineering of the organization, decentralization of service delivery, and centralization and specialization of audit and investigation are some of the lofty goals of the Inland Revenue Department.
Policy changes are vital at the moment. The gargantuan exemption list must be trimmed down to reduce distortion in the system and to increase tax base with a single minimal tax rate. Multiple rates system is neither error-free nor is it administratively feasible for both taxpayers and tax administration.
A policy of increasing the threshold and introduction of annual turnover tax for the non-registered taxpayer could be a viable option for structural reforms in VAT administration. The ever-changing nature and dynamics of service business is also the VAT administration could look into.
The most challenging aspect of VAT is to address no-billing and under-billing conditions. For this, the custom administration should enforce the law to buy all the goods declared undervalued and simultaneously, the IRD should purchase under-invoiced goods. And no fraudulent taxpayer should be shielded from legal action.
The tax administration and business community that were once at loggerheads over the introduction of VAT are now on the same boat. They need to continue working together for the effective implementation of the VAT regime.
Koirala is director, Inland Revenue Department (IRD)
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