Reforms Necessary in Nepalese VAT Law
Value Added Tax (‘VAT’) was first introduced in France in 1954 and today, it has been implemented worldwide with tremendous success. In Nepal, after intense debate and deliberation, it was implemented first in 1997. However, it is felt that its positive impacts are yet to be fully realised even after almost 14 years of implementation. The main problem that the government is facing each year is lack of compliance by all taxpayers due to various reasons. In this article, a brief attempt has been made to analyse the radical changes those are required in Nepalese VAT laws with the changes on the ways the business and trades are carried in modern times.
First, to start with the positive impact that VAT laws brings is taxation at every stage of supply chain and credit to taxes paid on inputs and on input services. Therefore, the foremost good factor that VAT laws bring is the removal of cascading effects. The term cascading effects refer to ‘tax on tax’. Therefore, VAT shuts door for multiple taxation, thereby removing cascading effects in supply chain as every buyer and seller will be entitled to avail input tax credits and adjust its credit with its output tax liability. In principle, we have understood VAT laws to be so.
However, in practice, not necessarily the implementation of VAT laws always removes cascading effects. Therefore, we need to have an effective and good VAT law that alone brings the intended consequences to the tax payers. In practice, what has been observed is the concept called ‘exemption of taxes’ on ‘exempted goods and services’ which act as a barrier to smooth supply chain. Mainly, the essential goods and services, for example rice, pulses, flour, fresh fish, kerosene, salt, health services, contraceptives, medicine etc. are exempted from payment of VAT on a simple rationale that these commodities and services are essential for human survival and imposition of taxes will increase the price of these products thereby making it inaccessible and expensive for poor citizen of our poor country. Morally and ethically too, this sounds a great welfare measure taken by the state. But, in practice and in a world which is full of profit making enterprises, this rationale does not work so greatly as think it to be. We can understand the tax exemption behind the agricultural products like wheat, paddy, flour etc. and agricultural tools, shovels, etc. But, Nepalese VAT law even exempts taxes on air travel, gold and silver, mobile phone set etc. which is beyond anyone’s understanding and these types of exemptions have only accentuated the obstacles to smooth supply chain.
While the output goods and services are exempted from the payment of taxes for those goods mentioned in Schedule – I of VAT on its output side, it may not be so in case of input goods/services. Therefore, a vendor who purchases raw materials and services, and manufactures an exempted product, say medicine, cannot utilise its input taxes that it has paid on inputs. Its input tax credit will go to become a sunk cost. In this situation, the only options available to the manufacturer/seller would be to add up the cost of taxes paid in inputs in its final outputs and pass that cost to the customer if manufacturer/seller has to keep its business running. Therefore, while declaring certain goods/services as exempted goods/services, the government is not doing any yeoman’s service to its citizens except those few essential goods.
Keeping goods and services exempt will also have another round of disadvantages – that is to the vendor which buys these exempted products and services, utilizes these input goods and services for manufacture and sells its outputs which are taxable in nature. In this case, this vendor will not have any input tax credit and has to collect the tax amount from the public/customers, which will only increases the price of these products.
Internationally, it has always been a moral dilemma among legislators/governments to frame effective VAT laws containing provisions that leave entire supply chain unaffected. Since revenue and fiscal laws stand on the different footing than other laws, they are enacted as per the economic and fiscal needs of the nation unlike other general laws which may be enacted to curb one or the other evils. Government will also make use of tax laws to control the flow of goods and services as per demand of the country on the prevailing economic condition. Therefore, though it may be desirable not to have ‘exempted products/services’ at all, but practicality, does not allow this to happen. This is fully understandable. Having said so and being fully aware of the government’s constraints, the challenges posed by exempted goods and services in supply chain is not that difficult to address if genuine efforts are made and willingness are shown by the government.
Arguably, the easy and effective ways to curb the threat posed by exempt products/services are to make them taxable by declaring the rate of tax at Zero Percentage for these products/services. This is internationally known as ‘Zero – rated goods/services’. Our Nepalese VAT law has already enumerated this concept but only few categories of items and transactions find place in Zero-rated list.
Currently, the exports are Zero – rated which is in consonance with international tax principle that only the products/services be exported and not the taxes so that our products become competitive in international markets. Other Zero rated transactions in the list are the supplies made to industries located at Special Economic Zone (SEZ), battery used in solar power generation and manufactured by domestic manufacturers etc. The need of the hour is to reduce the number of items/services and transactions currently mentioned at Annexure – I of VAT and move them to Annexure – II so that exempt products would be converted to taxable one, i.e. to convert them to ‘Zero-rated’ goods/services.
By introducing the concept of ‘Zero – rated’ for maximum number of goods and services, the goods and services would get taxable life – making inputs utilised for producing these zero rated goods creditable. Though there may not still be output tax liability, the vendor would be able to use the credits that it has accumulated while producing/distributing ‘Zero – Rated Goods’. Therefore, the expansion of this concept in VAT laws will make a good impact on the business community and ultimately, the impact will be felt by the consumers. A small effort from government side can make a big difference!
Another possible remedy that can be injected to streamline the credit mechanism would be rather than making these products exempt, a small VAT should be imposed on them. In Nepal, currently, there are only two VAT rates – 0% and 13%. In this context, a middle path can be found making majority of currently exempt products taxable, say at the rate of 1%-3%. Though imposition of tax may make these products little more expensive and may not go well with ‘people – centric!’ political class but we must understand that imposition of tax at small rate will not be so burdensome on us- the public and on the other, and helps not to snap the supply chain.
From the point of collection of revenue too, mostly these products are relatively inelastic and therefore, will not have any impacts on their demand. There would be more positives to the economy in the long run with these measures which may not at first glance, look so populist. This second prescription is recommended only when government is unable to declare exempt goods as ‘Zero – rated’ having constraints due to other economic factors. Whatever government does, however, should be for giving impetus to economic development and should propel our economy to forward direction.
© Rajib Dahal. The Author is an Advocate and can be reached by posting your comments in this blog.