Study On The Forms Of Vat And Tax Finance Essay - Free Essay Example

Introduction VAT is a broad-based tax imposed on the expenditure of consumers when they purchase goods and enjoy services. It is collected on behalf by businesses which are registered to charge the tax in stages on the value added from the manufacturing to retail level. The businesses in turn account for the tax so collected at the end of every month. It is not all goods and services that attract VAT. Some are exempted under the law (e.g. commercial rental establishment, dwelling, the rendering of financial service, the provision of transport, etc). For this reason, when consumers purchase such commodities or enjoy these services, they are not required to pay VAT. Registration for VAT is obligatory for all manufacturers, wholesalers, importers and service providers irrespective of business turnover. Registration of businesses in the retail category however, depends on a qualifying threshold of Eth birr 500,000 annual turnover or sales. The VAT Law (Proclamation No 285/2002) also permits voluntary registration if the person regularly supply or render service at least 75% to registered persons. It makes possible for businesses to benefit from the advantages which VAT registration offers. To qualify for voluntary registration, a business must have a fixed place for conducting business, keep proper accounting records and be able to file regular and reliable tax returns. The administration of VAT has not been with out challenges, in Ethiopia starting from registration to its administration and compliance VAT has got its own strength and weakness this paper is trying to discuss on it and propose solutions to those weaknesses. 1. Registration The VAT proclamation stipulates that for the registration of persons to qualify to charge the tax, they must at least make taxable transactions of not less than Eth birr 500,000 within the year. This provision in the Law makes few persons eligible for registration to charge VAT. To avoid registration for VAT most businesses deliberately understate their sales or may split up businesses to avoid meeting the registration requirements. Consequently, there are pockets of businesses that may not be registered. This makes these businesses more attractive to customers because their prices are not VAT inclusive, putting VAT registered businesses at a disadvantage. The registration threshold specified in the VAT Law is so high that businesses with the same category but under reported annual turnover will fall under different price set up. In addition to that some businesses that meet the registration requirements may not be well organized and structured to operate the VAT. The VAT req uirements of basic record keeping may not be met. Due to the low levels of literacy, business men and women may possess the business acumen and may informally operate the business without necessarily keeping business records for the purpose of the tax. The VAT Service has continuously engaged taxpayers and businesses in educational programs which inform them about their obligations. These have been carried out with the view to helping traders understand the complexities of the tax system so that they can co-operate with tax authorities. Also, businesses are asked for their input in formulating special schemes to improve tax collection. This collaboration has been so successful that some key members of the trade associations are made part of formulation of new policies on tax educational drives. Some of these programs are seminars, facility visits, visits by VAT officers and education on the offences and sanctions in the VAT Law. Officers also attend meeting of trade associations in order to educate them and also to answer questions on the problems they face. 2. Tax Invoices A pervasive feature of the VAT system is the specially designated invoice. VAT invoice authorized by the VAT Service, the government agency that oversees the administration of the VAT. In Ethiopia, any charge of VAT must be accompanied by a VAT invoice. The law makes it an offence for VAT registered businesses not to issue the VAT invoice when they make taxable supplies. There are two situations where a registered supplier may be relieved of the obligation to issue a VAT invoice, the first involves retail sales to unregistered persons, according to the directive by the authority to be provided that a receipt or simplified form of VAT invoice other than formal VAT invoice, and the other one is waiving the registered persons obligation to issue any VAT invoice covering cash sales if the total amount does not exceeding Birr 10. VAT invoices leave an audit trail that assist not only in curbing tax evasion but also in monitoring activities of registered persons. They also provide a valuable source of information for use by other tax types. The right to claim input taxes, checks both over and under invoicing and limits the activities of smugglers who would normally have disposed of their goods in bulk to VAT registered persons. Businesses in the retail sector are selective in the issuance of the approved VAT invoice, preferring instead to issue their own invoice and thereby avoiding the tax. This problem is so pervasive that it is more unusual for a customer to be issued with an unauthorized invoice than with the approved invoice. Associated with this problem is the challenge of charging VAT on supplies made. Businesses in the retail sector who deal directly with consumers find the additional VAT charge a burden and whenever possible avoid charging VAT making their prices lower. The VAT Electronic Cash Register (ECR) is a specially designated wireless portable terminal which aids in simple VAT transactions and returns submission for businesses and it wa s started to introduce and implement for the last two years. The ECR can issue a VAT invoice in a short time with only basic information about the transaction. The terminal also keeps a record of all sales therefore eliminating the need to keep special records of sales. The ECR also addresses the need to issue VAT invoices with every transaction because it automatically issues a receipt for every sale and keeps a dealer receipt for confirmation. In addition, it has the ability to file returns electronically when the accounting period is over, thereby eliminating challenges associated with return completion and filing. Therefore this project should have to get a serious attention to implement through out business transaction to overcome the problems arise from avoiding VAT invoice. 3. VAT return form Following registration for VAT, all tax payers are required to submit a VAT return every month VAT data is based on the VAT return form. In addition to the tax payer identifiers (name, TIN, VAT number and the tax period), the form requires the tax payer to provide information in 23 defined boxes. Of these 23 boxes only 8 boxes are supposed to contain primary data relating to sales and purchases for the period. The remaining 15 boxes are designed to include computed figures. The actual VAT data base however includes at least three additional fields which are not shown on the VAT form used to generate reports and records. These boxes are for use by the tax assessment officers and should not be accessible by data encoders. Since VAT is based almost exclusively on self-assessment, the primary data on input and out put declared by the tax payer is rarely queried at this stage of the process. During tax audit stage, however, the primary data which defines the extent of VAT liability a re queried and this may result in additional assessment. There is considerable scope for improving and simplifying the VAT form. As noted above, the tax payer is required to provide primary data in only 8 boxes. The distinction between some boxes is negligible especially since they are subject to the same rate of VAT. Some are also redundant and should remove. Data entered in these boxes are never validated, and in any case is re computed by the system. The form also lacks a basic ledger approach. Ideally, credit brought forward from an earlier tax period should be the first item of a VAT return. Tax computation, where possible, should be simplified. Taking these issues in to consideration, a much simpler VAT return form that can be provide the tax payer information on one side of a single page and easy to check is proposed. The existing form, being spread over two sides of a page is more difficult to be visually checked for consistency. 4. Tax payable for the tax period The tax payable is the difference between tax charged on taxable transactions under article 7 (commonly referred to us out put tax), and the allowable tax creditable under article 21 (commonly referred to us input tax or input credit). The tax payable on import of goods generally is paid at the time of the import independent of any VAT return, whether or not the importer is also a registered person. For imports of certain services, tax is payable by the customer as a reverse taxation. Registered persons must file returns and pay tax on monthly returns basis. Any net tax payable for the tax period generally must be paid by the due date of the return for that period. If the registered persons deductible input tax for the tax period exceeds the out put tax payable for that period, the excess is subject to refund. Due to the low levels of literacy among businesses in this category, non submission of returns is rampant. These businesses find it time consuming and an imposition to fill and submit VAT returns. Linked to this problem is the inaccurate completion of the VAT returns. In order to comply with the tax laws, these businesses may fill in the return forms differently from actual transactions carried out. Businesses in the retail sector find it difficult to account for and pay the VAT due because of cash flow challenges and lack of proper records. VAT charged and collected may not be recorded and so at the end of the accounting period, accounting for the tax sometimes proves to be difficult. Coupled with this problem is the submission of repayment returns to avoid paying tax due. Repayment returns are returns that show the business in a credit position. It is the policy of the VAT Service to encourage voluntary compliance with the VAT law in order to create an enabling environment for the collection of the tax. However, the VAT proclamation makes provision for sanctions for various offences and accordingly the Service has not hesitated to prosecut e recalcitrant persons who go contrary to the Law as a last resort. For some categories of businesses, the formulation of special schemes and educational programs has failed to make them comply with the VAT Law. They repeatedly flout tax laws by failing to issue the prescribed invoice, not submitting returns and not paying the VAT due. When these offences occur repeatedly then the sanctions are applied. Some the sanctions are penalties, interests, court fines and prison terms and distress actions. 5. Tax credit and Tax Refund VAT is the difference between output tax and input tax. The tax paid for the merchandise and Capital goods at the time of purchase/import/production are subject to be deducted from the tax collected from the sale of goods and services. If such input taxes are not offset from output tax within five month, and if the taxpayer is continuously in credit position for at least five months, such the taxpayers can claim refund of such unadjusted input tax. Regular exporters are entitled to claim refund on the monthly basis. Input tax credit and tax refund system is a beauty of VAT. Some criminal type taxpayers have been issuing false invoices to the fraudulent taxpayers collusively that have resulted in phony refund and exaggerate input tax claims on the one hand, and suppressed local sales and inflated export on the other hand. The self policing features of VAT system have not yet been realistic in Ethiopia in terms of check and balance between sellers and buyers. In order to halt s uch fake refund claims, ERCA has recently adopted a policy that mandatory to enter all purchase bills of such claimants to cross verify data, and to generate miss matched report that will help to investigate the transaction trail of the taxpayers involved. Moreover, the taxpayers who have higher credit balance over the years and who have claimed tax refund have a possibility to be selected for the audit and investigation on a priority basis. 6. VAT Audit The basic audit selection methodology is risk management. Risk management requires the need to strike a balance between applying effective controls to protect revenue while ensuring that compliant taxpayers are not over-burdened with compliance costs and requirements. Theres need therefore for a comprehensive strategy and program that applies risk-management principles, coupled with critical taxpayer services and compliance initiatives. This will require identifying major risks and prescribing ways and means by which these risks will be addressed together with the criteria for evaluating progress in reducing the identified risks. The process of audit planning shall start with the preparation, prior to commencement of the audit activity, of a written plan containing; (I) a list of prioritized risks and issues identified; (ii) The data needed to test those areas of risk; and (iii) A list of interview questions for inquiries with the taxpayer, and/or their authorized repre sentative. Risk Management application in tax will be as per the Standard Integrated Government Tax Administration System (SIGTAS) Audit Risk selectivity criteria. Risk Management consists of a comprehensive approach to determine potential non-compliance areas and allocate resources accordingly. Tax auditors are secondary assessors. Primary assessors are the taxpayers themselves. Due to poor information and resource base, Ethiopians tax auditors are not capable enough to detect tax evasion and in many cases, they are unsuccessful to bring the tax defaulters within the law. Private sector is getting smarter day by day as compared to the public sector; hence there is low probability of being penalized for the cause of tax evasion due to improper application in the selection of taxpayers for audit and investigation and poor individual as well as organizational capability of the tax authority. ERCA is facing some difficulties in making VAT system institutionalized. The quality of services and audit and investigation has been questioned time and again in terms of tax yield and procedures to be followed due to in efficient auditors with poor technological backup. Businesses do not attach importance to communicating material changes in business to the VAT Service. Issues such as discontinuation of business, change in location or address, changes in ownership are not communicated to relevant tax authorities. This results in misclassification of businesses and creates difficulties when there is the need to audit or correspond with the business. Tax officials are not been so effective to enforce stringently on rampant non-compliances. ERCA has been striving to invest in an integrated information network and data bank among Custom Department and Revenue Investigation and other government organization to enhance organizational capability E-filing system and Risk Engine Module has to be institutionalized to reap its benefits. 7. Administrative Capability of ERCA Ethiopia has been deliberately and consistently adopted tax reform program to strengthen regulative and administrative capability of the tax administration. The then Value Added Tax Department and other tax collection branch offices were merged to domestic tax branch offices, and integrate the data base of VAT for the purpose of income tax assessment, submission of tax identification number and other tax administration facility. Recently ERCA is restructured in light with changing demography of taxpayers, varied nature of business, and growing demand of services to the taxpayer. Reforms in hardware factors like policy formulation, law enactment, infrastructure development, and organizational restructuring are abundant, but reforms in software factors like system improvement, culture development, skill enhancement, attitude and behavioral changes in human resources is lacking in Ethiopian tax administration. In short, the professionalism is lacking in tax administration as compar ed to the revenue risks. Some of the high risk area in terms of revenue leakage and non-compliance are service sector, proprietorship firm, and consultancy and professional service oriented firms. Taxpayers commit financial crimes through non-registering of their business, under disclosing of income, under reporting of their transaction, and under payment of their taxes. ERCA has been able to figure out the problem and the vulnerable areas, Hence, the next initiatives will be to handle such problems properly along with desired professionalism. ERCA should continue its reform endeavors in the days to come. The newly introduced performance based system Balanced Score Card (BSC) has a high bearing on the overall productivity of ERCA and it has been effective in motivating and making employees accountable to their performances. Conclusion There are some issues and challenges to be dealt with. Continuation of existing Balanced Score Card (BSC) , and the development of positive image of tax administration in the society have also been the challenging tasks before ERCA has been striving to deal with such challenges and been focusing on taxpayer education and consumer awareness campaign. Apart from this, procedural simplification in filing of return, payment of taxes, and assessment of taxes are also agenda for reform. Scaling up investment for ICT sophistication, transformation from manual operating system to e-system, organizational restructuring and reengineering of ERCA, separation of tax audit and investigation from enforcement service, decentralization of service delivery mechanism and establishment of separate Human Resource Development (HRD) Section to focus on enhancing the capability and integrity of auditors are some initiatives taken by ERCA. The informal retail sector is one part of the VAT administra tion that poses a lot of challenges to the VAT Service in its effort to administer the tax. However, this sector also holds a lot of promise for the economic growth of the country, in that it is the small retail shop that would ultimately grow to become the big wholesale or manufacturing business. Supporting these businesses to grow by assisting them to account for the tax and to keep proper business records will help them also collect more revenue for the state. Ultimately the VAT system could be described as a self-assessment system that depends on registered persons to collect the tax from consumers and account for it to the VAT Service within a month of collection of the tax with minimum paper work and interference from the Tax Authorities. However, when a sector like the informal retail sector is concerned the system has to be designed to suit their peculiarities.