The way VAT works
Since VAT (Value Added Tax) is imposed on imported goods and domestic supply as well, it is considered as trade neutral. 15 per cent VAT is imposed on duty paid value (DPV) of imported product and thus effective rate comes to 16.5 per cent while the customs duty on the imported product is 10 per cent. In case of taxable supply, 15 per cent VAT is imposed on the price of the manufactured goods in our country. There are truncated value base VAT rates and tariff value for various types of goods and services which are fixed by the National Board of Revenue (NBR), considering the impact of VAT on prices of goods, cost of living, and assistance to local industries.
From the perspective of the buyers it is a tax on the purchase price, whereas, from the sellers point of view, it is a tax only on the "value added" to a product, material or service, at the stage of its manufacture or distribution. It is collected fractionally, via a system of partial payments, whereby taxable persons deduct the amount of tax they have paid to other taxable person on purchases for their business activities. This mechanism ensures that the tax is neutral regardless of how many transactions are involved. However, the way the VAT works can be described by taking an example.
For example, importers import a good for a value of taka 100 Tk. He paid VAT to the customs. VAT will be charged on the duty paid value. Therefore, he will pay 15 per cent VAT on DPV of 110 Tk totalling Tk 16.50. Importer charges for a value of144 Tk which includes process cost and profit.
He applies the VAT at 15 per cent on the value taka 144 Tk and VAT comes to taka 21.60 (144*0.15=21.60). Importer sells the goods to producer for taka 165.60 (144.00+21.60=165.60). Therefore, difference between the output tax taka 21.60 and input tax credit taka 16.50 (VAT paid to customs) is taka 5.10, the tax liability of importer. Importer could also get same result by multiplying the margin (144-110)*0.15=5.10.
Producer charges the value for a good of taka 208.66 which includes process cost and profit. He applies the VAT at 15 per cent on the value taka 208.66 and VAT comes to taka 31.30 (208.66*0.15=31.30). Producer sells the goods to wholesaler for taka 239.95 (208.66+31.30=239.95). Therefore, difference between the output tax taka 31.30 and input tax credit taka 21.60 (VAT paid to importer) is 9.70 taka, the tax liability of producer. Producer could also get same result by multiplying the margin (208.66-144)*0.15=9.70.
Wholesaler charges the value for a good of taka 262.91 and applies the VAT at 15 per cent on the value (262.91*0.15=39.44) by which VAT comes to taka 39.44. Producer sells the goods to wholesaler for 302.35 (262.91+39.44=302.35). Therefore, difference between the output tax 39.44 taka and input tax credit 31.30 (VAT paid to producer) is 8.14 taka. Wholesaler could also get same result by multiplying the margin (262.91-208.66)*0.15=8.14.
Retailer charges the good for a value of taka 317.46 and applies the VAT at 15 per cent on the value (317.46*0.15=47.62), by which VAT comes to taka 47.62. Retailer sells the goods to consumer for taka 365.08 (317.46+47.62=365.08). Therefore, difference between the output tax 47.62 taka (VAT collected from consumer) and input tax credit 39.44 taka (VAT paid to wholesaler) is 8.18 taka. Retailer could also get same result by multiplying the margin (317.46-262.91)*0.15=8.18.
Government will get the taka 8.18 from retailer and remaining taka 39.44 from importer, producer and wholesaler as VAT. Importer imports raw material and producer purchases that raw material from importer. Producer produces goods by that imported raw material. Then produced goods are being sold to wholesaler. After that, wholesaler sold the goods to retailer. In every stage, some value is added and tax is imposed on this value addition. This is the manufacturing process from imported raw material to produce goods. Thus VAT works and finally whole of the VAT is paid by the consumer. The tax on consumers is 15 per cent.
So far it is seen that operation of input tax credit mechanism reduces the tax burden of consumer. In order to avail credit the only required document is tax invoice. But in case of import, the bill of entry shall be considered as tax invoice. In order to protect the consumer and producer, there has been provision of rebated rate, truncated base and tariff value in present VAT act which was started since 1991.
These provisions create a number of rates which hinders the operation of input tax credit mechanism and consequently have been withdrawn in the new VAT act 2012 may be implemented since July 2019. There would be multiple rates of VAT in new VAT act on the basis of business people demand. Under this circumstance, provisions to operate input tax credit mechanism can be made to protect the consumer from high priced goods if there are multiple rates of VAT. It is found that there are five different rates of VAT at Maharashtra in India, while this rate differs from state to state. VAT on essential commodities, gold, silver, specified goods, liqueur and all other goods such as nil, 1.2 per cent, 5 per cent, 20 per cent and 12.5 per cent respectively.
The writer is former member, Bangladesh Tariff Commission, Ministry of Commerce