No tax aroused a controversy as complex and deep as the present VAT increase – Bandula
Posted on October 5th, 2016

“VAT was introduced in 2002 by the then United National Front government. At that time the income from this tax was Rs. 66 billion. When Mahinda Rajapaksa was voted out of power after the end of 2014, the revenue generated from VAT was Rs. 275 billion – a fourfold increase. However that was achieved without hartals and demonstrations.”

Opposition parliamentarian Bandula Gunawardena recently published a book on the Value Added Tax. In this interview, The Island staffer C. A. Chandraprema speaks to Gunawardena about the current controversy surrounding the VAT increase on the cards.

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Q. Do you remember any other instance where a tax aroused as much controversy as the VAT increase that is on the cards now?

A. In my experience, no single tax aroused a controversy as complex and deep as the dispute over the present VAT increase. VAT was introduced in 2002 by the then United National Front government. At that time the income from this tax was Rs. 66 billion. When Mahinda Rajapaksa was voted out of power after early last year, the revenue generated from VAT was Rs. 275 billion – a fourfold increase.

However that was achieved without hartals and demonstrations. It is true that at times the VAT rate had gone up to 20%. But that VAT rate was charged only on luxury goods. There were several VAT rates below that which were applied to other goods and services. Those days it was not just one rate for everything. This time the VAT on the telecommunications industry has been imposed on top of the existing telecommunications levy. Even during the Rajapaksa era, there was a VAT on the wholesale and retail trade but only applicable to the largest establishments with a turnover exceeding Rs. one billion a year. As soon as the present government came into power, this threshold for the wholesale and retail trade was reduced to 400 million a year. Then in the budget for 2016, the VAT on the wholesale and retail trade was abolished. However, in July, the VAT on the wholesale and retail trade was re-imposed at 15% with the threshold brought down to just 12 million a year. After mass protests and hartals by the wholesale and retail trade they have increased the threshold to Rs. 50 million. This is plain insanity.

Q. In a way the present government has acknowledged that imposing VAT on the wholesale and retail trade is not advisable which is why they abolished it in the original budget for 2016 …

A. Yes, because they acknowledged that point they abolished the VAT on the wholesale and retail trade altogether. In fact, the revenue estimates for the 2016 budget had stated that the income from VAT in the year 2016 would be reduced by Rs. 25 billion. That was what Parliament was told. Now they are trying to do something else.

Q. If you take VAT as a way of earning revenue for the government, how does it compare with the old Goods and Services Tax and the Business Turnover Tax?

A. We introduced the VAT in 2002 in a context where there was a general consensus in the world that the previous taxes had a cascading effect with taxes being imposed on taxes. If the turnover of a business is 500 million and the cost of the inputs was 450 million, VAT will have to be paid only on Rs. 50 million. But, the Business Turnover Tax would have to be paid on the 500 as well as the 450 that went to produce it. That was why the GST was introduced. The GST is similar to VAT. In 2002 it was after combining the defence levy and the GST that VAT was introduced.

Q. Though the VAT may be imposed on other sectors, many people think that it should not be imposed on the wholesale and retail trade. What are your views on this?

A. One of the main reasons for that is because we don’t have a proper system of accounting. The invoices that are necessary to be able to deduct input VAT paid are often not available. Besides, the retailers will have to maintain two sets of books, one for goods which are subject to VAT and another for goods that are not subject to VAT. Another person will have to be employed for this purpose. The basic principle in taxation is that it should be simple.

In developed countries like Canada and Singapore the entire tax system has been computerised. The reason why there was that great VAT fraud in Sri Lanka some time ago was because of our inability to keep track of things due to the lack of a proper accounting system. That is why in countries like ours, the better policy would be to retain VAT at the level of the formal economy with it being imposed on the importer or manufacturer and leaving it at that without going further down the chain.

Q. I have been told by a retailer that due to the structure of the trade in this country, when the VAT is imposed on the wholesale and retail trade, VAT is paid by everybody down the line and each time the goods change hands, the VAT paid by the level above is passed on to the level below resulting in a VAT burden which will have to be borne by the consumer well above the original 15% intended. He told me that what often happened was that when an importer brings goods into the country, he sold it to Pettah merchants after paying the 15% VAT. Then the Pettah merchant keeps a small profit and sold it to the van and lorry delivery service. He claimed the 15% input VAT he paid to the importer and paid VAT only on his profit. But the VAT he paid on his profit was also passed on to the delivery service. When the delivery service sold the goods to the retailer, once again VAT was paid by the delivery service on their profits and this too was passed on to the retailer who in turn paid VAT on his profit and passed on the whole thing to the consumer and by the time the goods reach the end user, due to the number of times the goods had changed hands, the 15% VAT may have caused a rise in the price of the goods by much more than the original 15%. What do you think?

A. That may happen in certain instances. It is because of these complexities that certain items like rice, milk powder and sugar have a different kind of tax called the special commodities levy. It should be noted that even though the government says that such essential items have been exempted from VAT, there is a different tax on such goods. The special commodity levy is charged also from produce like potatoes, onions, sprats, dhal etcetera. These essential items which have been taxed under a separate scheme will have to be separated from the goods on which VAT is payable. Then the VAT paid on the inputs should be deducted from the VAT paid by the retailer and to keep track of all this, a bookkeeper will have to be employed. When we were in power, we discontinued about 15,000 small scale VAT files because the cost of administering those VAT files was greater than the revenue generated by them.

Q. Now that the VAT liable threshold has been increased to Rs. 138,000 a day, most retailers have dropped out of the VAT net. However the problem is that a shop that goes just above that threshold will get caught in the VAT net whereas a shop that is just below will escape. One trader who had got caught to the VAT net when the threshold was brought down to Rs. 400 million a year told a gathering of traders that his neighbour who did about 380 million worth of business a year did not have to pay VAT because he fell below the threshold. The same problem will apply to the traders who are just above and just below the threshold of Rs. 138,000 a day. People will be tempted to scale down their operations or to split up existing businesses so as to escape the net. Don’t you think so?

A. That again is why VAT should be charged only on the topmost levels of the wholesale and retail trade. The government should let it remain at the present 100 million a quarter (400 million a year) level. Further, they should not charge VAT on the health services and on telecommunication services.

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