Simplifying VAT

By Uditha Jayasinghe

Delays in Value Added Tax (VAT) can cause serious cash flow challenges to both the Government and the private sector. Taking this into consideration, the 2011 Budget outlined a fresh process to ensure that VAT payments are processed faster and established a new unit under the Inland Revenue Department (IRD) to achieve this end.

On Tuesday (10 May) the Joint Apparel Associations Federation (JAAF) organised a seminar to educate the industry on the new changes and how the new paperwork should be handled.

Addressing the gathering, IRD Deputy Commissioner General Mallika Samarasekera noted that the delays in VAT refunds were largely due to the painstaking investigation process that needs to take place before money is released. She attributed this to the VAT scam that revealed millions of rupees being paid out to non-existing businesses and insisted that extra procedures had been put in place to prevent this from being repeated.

“VAT refunds are a vulnerable point in any country – developed as well as the developing,” she said, adding that the despite the new regulations there were still instances of errant traders trying to mislead the IRD.

“This simplified VAT scheme was introduced to reduce the processing period and make payments in four weeks. Earlier it could take up to a year and it was gradually realised that since this created significant cash flow issues to companies, our competitiveness in the global market was being reduced. Moreover, there are massive development projects undertaken by the Government with the help of foreign funders that need swift payment. Therefore, taking all these points into consideration, the simplified VAT scheme was introduced.”

Insisting that developed nations face the same challenge, Samarasekera remarked that a special programme started over one-and-a-half-years ago to reduce backlogged VAT payments had reduced the amount to 5,000 claims but non-response to claims had forced the IRD to audit several companies, extending the delay.

“We have realised that few companies are aware of the documents that are needed for the VAT submissions and often compile accounts only when they are pressured to do so.”

The USA has calculated that VAT repayment losses account for 15.8% of total fraud and non-fraud tax omissions in that country and Samarasekera observed that this gave some idea of the extent of the losses.

“The 2011 Budget expanded VAT suspensions, this scheme is similar to what was introduced in 2005 and appropriate changes have been made to laws and circulars. We appeal to all companies to assist us in making this new process work.”

VAT Deputy Commissioner Deepani Herath who heads the new simplified VAT division, delivering the presentation to explain the new scheme, stated that they were working with limited resources but that the process would assure speed.

“All the applications are available online to download. When the application is handed over to the peon in the VAT department, he will note down the time. This will ensure that the process is completed within a certain period of time.”

The applications will be evaluated with two assessors before being crosschecked with the database. It will then be released with the signature of Herath and certificates will be given to denote the stage of the process. In the SVAT-01 form the companies have to give two addresses to further prove authenticity. She then went on to explain each of the forms in detail.

Industry perspective

How the simplified VAT scheme will impact the apparel industry was explained by JAAF Secretary General M.P.T Cooray.

VAT is based on a destination principle. In other words, VAT is chargeable where the supply is affected for the value addition takes place. However, VAT is a neutral tax as far as exports are concerned. Hence exports were zero rated and input VAT is to be refunded. Thereby domestic distortions arising from the VAT system is removed as far as exports are concerned. Resultantly imported inputs for export processing, including that of VAT applicable on areas such as capital equipment, were either differed or excluded.

Because of this principle the import substitution of inputs for export processing could have been hampered if this principle is continued to apply. In this scenario the tendency to import would be higher than procuring from the domestic market because of the incidences of VAT liability of such local input purchases, importance of the concept of suspended VAT emerges at this point.

“This rationale for introducing a suspended VAT scheme for local suppliers therefore becomes an essential prerequisite for the achievement of the objectives of creating value added exports within the economic growth agenda of the country. So we the industry lobbied for introducing the basic rationale of a level playing field for domestically manufactured inputs with that of imported inputs and we continue to lobby to remove the cascading efforts of domestic indirect taxation which is harmful for local value addition,” he said.

Implementation issues of SVAT

Regulatory authorities were introduced – the Textile Quota Board (TOB) for apparel and the Export Development Board (EDB) for other exporters. Cooray asserted that the apparel industry was able to convince the authorities to put the suspended VAT scheme under the TOB because that was the only agency which had all the details of the industry.

The TOB registration process evolved from initially only allowing RCA (input and intermediate goods manufacturers supplying more than 5l% of their turnover to export oriented garment manufacturers), MEX (finished garment manufacturers, who export directly or through BOI Trading House). BTH (BOl registered Trading Houses) to the scheme. Later others, such as value-added service providers, were added to the scheme.

According to Cooray, multiple issues arose from this scheme. In a matter of three to five years the system was subject to numerous challenges, however all those were best handled by a Technical Committee comprising of representatives from the Inland Revenue, BOl, Customs and JAAF and the systems were updated in an amicable consultative process.

For example, the documentation system was migrated from dual party declaration to single party declaration and reverted back to dual party declaration. Efforts were purely to see how best the industry could be facilitated while protecting national interest. But, since it was a new system a number of issues were there.

Firstly, due to changes in the administration, the system failed and the monitoring Technical Committee mechanisms did not function. This resulted in delays in reconciliation, non-submission of documents by the parties causing significant delays in finalising the VAT refunds. The department was saddled with these issues. But no answers could be found.

In the latter part of 2010, a joint effort was made by JAAF, the Ministry of Finance, Department of Inland Revenue and TOB to resolve these issues and due to best cooperation among all parties, the problem could be settled to a great extent, he said.

“In this process, the JAAF found basic weaknesses in the systems and the policy framework. Among that, the serious issues was that the system was not capable of penalising the parties who have not lived up to the legal requirements but instead the parties who had met all requirements were not getting their due refunds and were almost about to be assessed.”

In turn the local suppliers were agitated. In the final analysis, the deficiency in the suspended VAT system is creating all these issues. Namely, the earlier S-VAT scheme was limited only to direct inputs of goods and services for manufacturing and exporting and did not recognise many other payments which could not be suspended either by the TQB or by the EDB resulting in accumulation of refundable VAT.

“The root cause being that the system, although it recognised the eligibility of the entities, was designed on an activity-based scheme rather than an entity. For example, the scheme recognised particular types of supplies and not the suppliers or the buyers identified by the TQB or the EDB.”

The result was a cash flow burden both to the industry and to the Government. “In fact it has been said that if collected tax is to be refunded, what then is the purpose of collection? Having realised these difficulties, we made a proposal to introduce a cashless, paper-based VAT system as far as the exporters are concerned. The exporters include deemed exporters as well. Deemed exporters include any company supplying more than 51% of their turnover to an exporter.”

Accordingly, JAAF in its budget proposal in October 2010 proposed that all expenses incurred in the process of export be brought under the suspended VAT scheme which was accepted and included in the National Budget in November 2011 and implementation commenced in April 2011.

Changes in the new S-VAT

Firstly the system shifted from cash payments to a paper-based system. Secondly, the identification of eligible company became the pivotal point in place of a specific activity, identification of an eligible company to procure goods and services on a suspended VAT basis.

“The eligible companies include exporters, indirect exporters and value-added service providers. Any of these companies, if proved to the satisfaction of the Commissioner General of Inland Revenue, that they are exporting directly or indirectly with more than 51% of its turnover, then they can procure any local input on a suspended VAT basis without spending a cent. Further, any supplier supplying to any such eligible entity is required to register with the Department of Inland Revenue as an eligible supplier. Depending on the volume of exports, either direct or indirect, a purchaser can be a supplier or vice versa.”

The significance of the scheme is that the total export procurement and supplies are well and truly brought under the formalised VAT system while removing cash flow burden to the export industry, cash flow burden to the government and more or less minimising the propensity of fraudulent activity as far as supplies to export sector are concerned, Cooray reiterated.

“The success of this scheme will depend on a number of factors. First, the ability of the industry to be compliant with the system. Second, the ability of the Department of Inland Revenue (DIR) to monitor. Hence, we believe electronic document is an important element which we believe will be implemented by the DIR in a progressive manner. We, the industry, believe that this is one of the most outstanding trade facilitation measures introduced by the Government to ensure the realisation of the export objectives of value-added economy.”

He urged all the stakeholders to work together as a public private partnership to mature trade facilitation measures not only to a level of cashless system but also of paperless electronic documentary mechanism.

Pix by Upul Abayasekera