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VAT System in Bangladesh

Question 1. What are the Advantages and Disadvantages of VAT System?


Answer. Definition of VAT (Value Added Tax): Value Added Tax (VAT) is basically a tax to be levied on the value added by an organization at each stage of its rendering services or producing goods. The VAT is a tax on the final consumption of goods or services and is ultimately borne by the consumer although it is collected at every stage of production or distribution and a tax credit is granted at each stage for tax paid at the earlier stage in the chain of transfer/sale of goods or services till it reaches the final consumer. Introduction of VAT System in Bangladesh: Bangladesh introduced a system of VAT to overcome the existing drawbacks of indirect taxation on July 01, 1991. At the time of introduction, the VAT was applicable only at the import stage, manufacturing stage and service rendering stage. But now it is extended to all levels with wholesale and retails. Advantages of VAT System: Introduction of VAT has some great advantages. The VAT is regarded as a modern and superior tax system. It provides an edge over the earlier excise system as mentioned below: VAT vs. Excise System VAT y y y y y Broad based Single standard rate of 15% No cascading effect of taxes Minimized rate of tax evasion Increased revenue realization y Narrow based y Different rates with some higher rates y Presence of cascading effect y Problem of tax evasion y Unable in mobilizing the increasing need of revenue Excise System

Other important advantages of VAT are: 1. It is a modern and progressive tax system with credit mechanism. 2. This is an audit and account based system minimizing harassment and forcible enforcement. 3. It ensures proportionate low tax incidence for the manufacturers, service renderers and traders. 4. It is a balanced tax system with equity. 5. Uniform rates of VAT boost trade activities and create a favorable atmosphere for the expansion and economy. 6. Helps amassing tax revenues to finance the fund necessary for socio-economic growth of the economy. It has the in-built capacity to raise more tax revenues without distorting the existing tax structure and is yet able to widen the tax-base. 7. Since VAT is mostly based on 100% self-assessment, it reduces the taxpayers hazards to visit tax offices frequently and lead to better tax compliance. 8. With 0% VAT on exports and availability of credit on input tax, it will foster export promotion and help amass foreign exchange wealth. 9. Since there is no tax on tax, price escalation is avoided and will make prices more competitive with the foreign counterparts. This matter is very important in present era of globalization and economic liberalization. 10. The VAT will therefore help common people, traders, industrialists and also the Government. It is indeed a move towards better efficiency, healthy competition and fairness in the taxation system. Disadvantages of VAT System: Despite having the above advantages, the Vat is not free from limitations. Following are the important shortcomings 1. Opponents of the VAT argue that the VAT, like any other consumption-based revenue source, is inherently regressive. Those least able to pay face the highest overall burden disproportionately since they are likely to spend more of their income than the relatively rich person. There is merit in this argument as it believed that the VAT is a broad based tax levied on essential goods. 2. The VAT needs a formal economy where all economic units from importers to retailers document their transactions and maintain accurate records. However, in developing countries, the informal economy covers substantial trading which is not documented and registered.

Moreover, the low literacy rate may also result in poor compliance of the VAT Act and Rules. Therefore the VAT in such countries may fail to achieve its objectives. 3. VAT is supposed to eliminate the cascading effect generated by the traditional tax system. However, in Bangladesh VAT couldn t fully remove the cascading effect. Supplementary duty, customs duty, and other taxes like regulatory duty are added in order to find out the base value. It has recreated the cascading effect to some extent. In addition, various forms of exemptions, truncated base value and tariff value are allowed at different stages of VAT chain. This also creates the cascading effect. 4. Value is supposed to be determined at each stage of transaction. However, the producer in manufacturing stage, avoiding the retail and wholesale stage, can directly sell to customers. The applicable VAT is estimated based on the fixed maximum retail price. This provision disrupts the VAT chain. 5. Truncated Base-value Instead of a flat 15% VAT rate, many effective lower rates are available

6%, 5.5%, 5.0025%, 4.5%, 4%, 3%, 2.25%, 2%. These various forms of rates impede the credit mechanism and disrupt the VAT chain. 6. VAT is too difficult to operate from the position of both the administration and business. a. The administration It is often argued that VAT places a special burden on tax

administration. However, it is worth noting that wherever VAT was introduced one of its effects was the rationalization and simplification of the previous indirect tax system and its administration. Each of the previous indirect taxes such as sales tax and excise duties replaced by VAT had its own rate structure as well as a different tax base and separate administrative procedure. The consolidation and incorporation of numerous indirect taxes into the VAT would simplify the rate structure, tax base, and administration of the indirect tax system, thereby eliminating the overlapping auditing practices that had plagued those systems. b. Business It is true that the VAT is collected from a larger number of firms than under

any form of income tax or single state sales tax; to the typical smaller firms the complexities of the tax and the need for more extensive records (for example, to justify deductions) are likely to prove serious. 7. VAT is inflationary Some businessmen seize almost any opportunity to raise prices, and the

introduction of VAT certainly offers such an opportunity. 8. From the perspective of equity and justice, necessities and small units are exempted from the VAT. Although this reduces administration costs of government and the burden of compliance

on the small units, such exemption narrows the tax base, distorts the system and limits its success. These are some of the major advantages and disadvantages of the VAT system in Bangladesh.

Question 2. What is Value under VAT System? How Can You Determine Value of Goods and Services at Different Stages?
Answer. Definition of Value under VAT System: In VAT system, Value means the value on which the VAT will be calculated or assessed or imposed. It is defined by the amount of extra Value Added to the buying price by the manufacturer or supplier. In other words, Value is the difference between the buying price and the selling price. The following rule is used to determine the amount of Value Added: Value Added = Output Value Input Value = Wages + Rent + Interest + Profit Methods of Calculating Value Addition: Value addition can be calculated using both Direct and Indirect methods. Again, both of these methods can be applied on Additive and Subtractive methods. These methods are discussed in detail in the following paragraphs 1. Direct Additive Method: In this method, all the additive segments such as wages, rent, interest, profit etc. are determined. Then all of them are added and then VAT is calculated on the total amount. Value Addition = t * (Wages + Rent + Interest + Profit); [t = tax rate]

2. Indirect Additive Method: In this method, all the additive segments such as wages, rent, interest, profit etc. are determined. Then VAT is calculated for all segments separately and then those figures are added to determine the total VAT. Value Addition = t * (Wages) + t * (Rent) + t * (Interest) + t * (Profit); [t = tax rate]

3. Direct Subtractive Method: Under this process, value is calculated by determining the difference between the buying price and selling price. Then the VAT is calculated by multiplying the tax rate with the total value addition. Value Addition = t * (Selling Price Buying Price); [t = tax rate]

4. Indirect Subtractive Method: VAT is calculated separately on selling price and buying price. The difference between these two figures is the VAT to be paid at that stage. Value Addition = t * (Selling Price) t x (Buying Price); [t = tax rate]

The Indirect Subtractive Method is the most common method for VAT calculation. VAT Calculation at Different Stages In the following table, the calculation of VAT at different stages has been illustrated. VAT Chain
VAT Stage VAT = t * (Selling Price) t * (Buying Price) VAT applicable Price = tk. 1500 VAT rate = 15% Gross amount = tk. 150 Credit = tk. 0 To be paid = tk. 150 VAT = t * (Selling Price Buying Price) Value Addition = tk. 1000 VAT rate = 15% To be paid = tk. 150 Net VAT under both systems tk. 150

Import/Raw material Stage

Manufacturing Stage

VAT applicable Price = tk. 2000 VAT rate = 15% Gross amount = tk. 225 Credit = tk. 150 To be paid = tk. 75

Value Addition = tk. 500 VAT rate = 15% To be paid = tk. 75

tk. 75

Wholesale Stage

VAT applicable Price = tk. 1000 VAT rate = 15% Gross amount = tk. 300 Credit = tk. 225 To be paid = tk. 75

Value Addition = tk. 500 VAT rate = 15% To be paid = tk. 75

tk. 75

Retail Stage

VAT applicable Price = tk. 2200 VAT rate = 15% Gross amount = tk. 330

Value Addition = tk. 200 VAT rate = 15% To be paid = tk. 30

tk. 30

Credit = tk. 300 To be paid = tk. 30

Total VAT paid by the consumer

Tk. 330

The example shown above can illustrate how VAT is calculated in different stages. Suppose the import price or the price of raw material of a merchandize is tk. 1000. There are four stages between the import of raw material and final consumption of the merchandize. These stages are: y y y y Import/Raw material stage Manufacturing stage Wholesale stage Retail stage

The table shows that 15% VAT is imposed in every stage. Apart from the first stage, every stage has got credit from VAT. This credit amount is the gross amount minus the amount paid in the previous stage. Therefore, starting from the import stage to the retail stage, everyone has paid a total of tk. 330 as VAT. The consumer pays a total price of tk. 2530 (tk. 2200 + tk. 330). In other stages, this amount is deposited in the treasury in a divided manner. Everyone from the importer to the retailer gets a credit equal to the difference between the Input Tax and the Output Tax. The rest is deposited in the treasury. For example, the importer pays tk. 150 as VAT at the import stage. Then he or she collects tk. 225 as VAT while selling it to the manufacturer. From this tk. 225, the importer keeps tk. 150 to him or her as credit and deposits the remaining tk. 75 to the treasury as VAT. This process continues till the retailer as he or she collects tk. 330 from the consumer and keeps tk. 300 as credit and deposits the remaining tk. 30 to the treasury as VAT.

Question 3. What is Duty Drawback? What are the Provisions for Duty Drawback?
Answer.

Definition of Duty Drawback System Duty Drawback in the VAT system is defined as the provision of according a free trade status to export producers by granting them refund on duties and taxes paid on importation of inputs. This provision has been there since the early 1970 s. Initially, it was a system of drawback of actual duties paid under which refund was calculated on the basis of the actual payment made and refunded on a case by case basis. In 1979-80, drawback at Flat Rate system was introduced. Under this system drawback is allowed on the basis of predetermined input coefficient and periodic calculation of the average percentage of value of customs, excise duties and sales tax for a product or product group. The coverage of this system has been expanded over time and 1983-84, drawback payments are allowed to be paid through the exporter s bank in the form of an interest-free 90 day advance. The Notional System of Duty Payments was introduced in 1982-83 for certain fast-moving items such as readymade garments, which enabled the exporter to clear imported inputs without actually paying any duty or sales tax. Item-wise value of imports is recorded and a suspense account for the duties and taxes payable thereon is established. On the production of proof of exports, the liability to pay the amounts in suspense account is removed. In 1987-88, the drawback scheme was extended to indirect exporters using the LC system. Duty Drawback Process The Duty Exemption and Drawback facility provided to exporters by the Bangladesh government enables a business to claim, within six months of exports, the duties and taxes paid on raw materials used in the production process. Apart from imported raw materials, businesses are entitled to duty exemption and drawback on taxes paid on utilities and, in some cases, on the fuel consumed in the production process. Eligible exporters can claim their drawback by filing their claim with the Duty Exemption and Drawback Office (DEDO), which is an agency under the authority of the National Board of Revenue. The Customs Act, 1969 and the VAT Act 1991 governs the process. While Chapter VI of the Customs Act 1969 provides many of the guidelines, since the promulgation of the VAT Act 1991, drawback can also be claimed on inputs under Section 13, Rules 28, 29, 30, 31, 32, 32(a), 33 and 34. Additional SROs that guide the process include SRO 154 (June 9, 2005) and SRO 157 (June 9, 2005).

At DEDO, duty drawback applications are collected in the receipt and dispatch (R/D) section and forwarded to the Director General. DEDO prefers that the applications are sent by mail, since the postmark on the application serves as proof of the application date. Recently, the Duty Exemption and Drawback Office (DEDO) has taken a massive reform plan to expedite its services and resolve misunderstanding between the stakeholders. It has introduced a system under which businessmen will submit all documents at a time seeking duty drawback or exemption. The system for duty drawback will be further simplified and to this end, duty drawback will be fixed at a flat rate on exportable and potentially exportable goods. Exporter will receive duty drawback at a flat rate directly from the relevant commercial banks. The office has also introduced drawback system of Value Added Tax (VAT) in knitwear, shrimp and indirect exports. Provisions for Duty Drawback: Eligible exporters can enjoy this facility under two broad categories a duty exemption or a duty drawback. Under the duty drawback system, exporters get refunds of the duties and indirect taxes they have paid on imported inputs. Duty may be refunded in three ways: a) actual drawback, b) national drawback, and c) flat rate drawback. Due to fewer complications and ease of operation, the flat rate system remains the most preferred method of refund. There are also two other ways of making such refunds: individual and fixed drawback systems. Individual drawback systems refund the duties and indirect taxes paid by the firms, while the fixed drawback systems refund the estimated duties and indirect taxes that enter the cost of production of exports according to a preset schedule. Provisions for duty drawback include: Direct export Deemed export Goods and services which are provided in foreign currencies under the regulation of local and international tender. Goods and services that are supposed to consumed outside Bangladesh in a vessel or airplane. Temporarily imported products which are supposed to be re-exported.

Question 4. Define cottage industry under VAT system. How an owner of a cottage industry can avail cottage benefit?
Answer. Definition of Cottage Industry: Various agencies of the government use different set of definitions with respect to classification of enterprises by size. The 1999 Industrial Policy defined small and cottage industry using both the criteria of employment and fixed assets. This is at variance with the definition used by the BBS. Similarly, the National Board of Revenue (NBR) uses a different definition of "Cottage" enterprise for exemption from Value Added Tax (VAT) and Turnover Tax, which is based on a cut off limit of fixed capital and annual turnover. In the 1999 Industrial Policy, "Cottage Industry" is defined as covering household based units operated mainly with family labor. However, according to National Board of Revenue (NBR), a Cottage Industry is defined as A unit with an annual turnover of less than Taka 2.0 million and with a capital machinery valued up to Taka 3, 00,000 It should be mentioned that in the budget of FY 2010-11, it was recommended to exclude chanachur, juice, energy drinks, cigarette, bidi, gul and zarda from the cottage industries. Cottage Benefit: VAT in Bangladesh gives special treatment to the cottage industries. These industries are fully exempt from VAT or turn over tax. They are also free from VAT formalities. Moreover, the entire export earnings from handicrafts and cottage industries will be exempted from income tax. Availing Cottage Benefit: It is easy to have the benefits of VAT in an economy where it is implemented in a comprehensive form, covering all tiers of production and distribution as well as all economic activities.

In order to get the benefit a cottage industry the owner should adopt the following procedures: The producer of goods, upon fulfilling all the conditions mentioned above, will apply first. The commissioner will appoint one or more tax officers to form an investigation committee in order to check whether all conditions were fulfilled. The appointed investigation officer will physically visit the facility and register a report to the commissioner. If the commissioner is convinced, he or she will pass it to department head. The department head will maintain a list of registered company and inform the local tax authority. The owner of the listed form will keep the company s documents of listing in a visible place. The owner should keep records of monthly transactions and provide a cash memo and keep a memo for himself. Conclusion: The performance of the cottage industry sector calls for special attention because of its labor-intensive character, its focus on catering to the demand of low and medium income consumers and its capacity for import substitution. However, this subsector has been particularly vulnerable to natural disasters and other production snags compared to medium and large scale industries. In addition to that, in terms of indirect taxes, there is virtually no distinction between cottage industries and their large-scale counterparts. Similarly, there is hardly any difference in the treatment of small and cottage industries on the one hand, and large scale manufacturing industries on the other, either with respect to duty on capital machinery or direct taxes. In addition, the tax concessions go more to the benefit of those who supply capital to village producers and in many industries with products which are sold at high prices, a sizeable chunk of the benefits may be appropriated by traders/middlemen. Bangladesh's fiscal policy needs to be particularly tailored to provide support to small and cottage industries by raising the ceiling of exemption limits as regards taxation, and by lowering the VAT rates.

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