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Toward a Functioning Anti-Fraud Program in Value

Added Taxation

Tuan Minh LeThe World Bank

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Basics of VAT

• Consumption tax levied at each stage of production-distribution.

• Common VAT type: consumption-based, destination principle.

• Credit invoice method of collection.• Zero rated v. exemptions. • Administration costs not trivial.• Compliance costs typically high for small

businesses.

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Types of VAT related revenue leakage

• Under-collection of VAT payable from traders.

• Over-payment of VAT refunds.

VAT revenue leakage risk mapping(Ref.: Keong, 2005)

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Non-registered Traders VAT registered Traders

Under-accounting of output VAT Over-claiming of input VAT

Under-collection of VAT Over-payment of VAT refund

VAT Revenue Leakage Risk

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NON-REGISTERED TRADERS

Imports

• Under-declaration of import VAT• Failure to pay import VAT

VAT Registration

• Failure to register

Sales

• unauthorized collection of VAT

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VAT-REGISTERED TRADERS

VAT registration• Fraudulent registration

• Fraudulent de-registration

Standard-rated suppliesOutput VAT collected but not remittedFailure to collect or under-collection of VAT

Imports by traders with input VAT restrictionUnder-declaration of import VATFailure to pay import VAT

Reduced rate/zero-rated suppliesOver-declaration of exports/zero-rated suppliesStandard-rated supplies treated as reduced rate/zero-rated suppliesAvoidance schemes to qualify for reduced rate/zero-rating

Input VATFictitious purchasesDisallowed expensesPurchases attributableto exempt supplies

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Considerations in designing an anti-fraud program

• Risk of VAT fraud.• Compliance costs.• Administrative costs.

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Principles for VAT productivity

• Simplicity and transparency.• Balancing of effective enforcement and

good taxpayer service.• Fair treatment of taxpayers to avoid

splitting and growth of informal sector.

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Anti-fraud strategies:VAT design (1)

• VAT registration and de-registration– Level of threshold:

» Wide range: 0-$700,000. » Even in developed countries: Demark: $1500;

Japan: $200,000.» Uniform v. multiple thresholds.» Voluntary registration: allowed for most countries,

but not all (e,g., Norway, Spain, Sweden).» Introduction of presumptive taxation.

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Anti-fraud strategies:VAT design (2)

– Voluntary registration—require firms to:» Keep sales and purchases records.» Maintain account with a financial institution.» Possess fixed place to run business » Not fly by night! Setting minimum number of years

for VAT traders to remain in VAT if registered voluntarily.

» Sell almost exclusively to VAT registrants.

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Anti-fraud strategies:VAT design (3)

– Set high turnover threshold at introduction of VAT and consider lowering it over time.

– Provide for claw-back of VAT claimed when traders deregister from VAT.

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Anti-fraud strategies:VAT design (4)

• Refund v. carry forwards– Reliable major exporters should get immediate refunds.– Others get excess credits carried forward within mandatory time

limit.

• Specific approaches to reduce level of refund claims– Import relief scheme for major exporters

• Examples: Singapore’s Major Exporter Scheme. • Free trade zones/duty suspension regimes.

– Deferring accounting of VAT on imported capital goods– Zero-rating of supplies to exporters (e.g., Ireland, Italy, Algeria,

Morocco, Tunisia, South Korea, Azerbaijan, Albania.)

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Anti-fraud strategies:VAT design (5)

• VAT rate structure– Multiple rates inherently complex.– Ineffective to resolve equity issues.– Prone to avoidance and evasion.

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Anti-fraud strategies:VAT design (6)

• VAT exemption- Cascading or shrinking base.- Ineffective in achieving targeted equity.- Inefficient.- Apportionment of input values required

firms producing both exempt and taxable outputs.

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VAT refund treatments (1)

• Stakes high: – Refund claims up to 50% of gross VAT collection.– Major source of tension between taxpayers and administration. – Vietnam: 6-month delayed refunds cost 28c/$1 and 5c/$1

investment in PV term for export apparel and leather shoes manufacturing projects, respectively (Le, 2003).

• Why refund delay common in developing world:– Frauds and inefficient refund processing system.– Incentives for meeting revenue targets.– Insufficient funds to refund.

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VAT refund treatments (2)

• Specific approaches to refunds: Harrison and Krelove (2005)– Zero-rated supplies to exporters.– Large scale cross-checking of invoices.– Certification of refund claims by CPAs.– Preferential treatment of good compliers.– Purchases paid through banking system.– VAT bank accounts.– Deferment of VAT on capital goods.

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VAT refund treatments (3)

• Risk management approach– Most appropriate in reducing compliance and

administration costs.– Most effective: protect VAT revenue base and

minimize refund delays.– Gold/Silver/others schemes based on history of:

• tax compliance.• exports.• account keeping.• audit of records.

– Using 3rd party information, especially information exchange between Customs and tax.

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Related issue: Required use of cash registers

• Purpose: Counter non-compliance.• Not panacea—not effective without credible

enforcement mechanisms.– Traders may not use (even in U.S. bars, restaurants,

and small establishments).– Traders may enter lower sales values.– Insufficient information for sales taxation administration

(for administration, 4 types of records needed: (1) records of total sales; (2) purchase invoices; (3) annual inventory data; and (4) evidence to support deductions—but cash register does not tell all!)

– High compliance costs to small businesses.

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Balancing acts…VAT from administration’s and taxpayers’

perspectives– Multiple types of fraud by traders.– Multiple types of abuse and corrupt behavior by tax

collectors.• Arbitrarily raise assessments either to fulfill collection

targets or to create opportunities for bribery.• Demand bribery for expediting approval of refunds.• Perform repeated audits or unduly lengthy audits.• Perform repeated or unnecessary queries on traders.• Be reluctant to provide clarifications to traders’ inquiries.

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Protection of taxpayers

• To provide legal protection for traders, legislation should provide traders with:– Rights to appeal.– Entitlement to interest due to delayed refunds.– Confidentiality of traders’ data.– Rights to deny access to tax officers at unreasonable time and at

residential premises of traders unless search warrant provided.• Tax administration:

– Establish effective compliance program.– Improve quality of taxpayer service.– Engage major stakeholders and community participation in tax

administration arrangements.

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FAD suggested model of best practice (Harrison and Krelove. 2005)

– Keep number of VAT payers at manageable level.– Keep proper control of VAT registration.– Make sufficient funds available for legitimate refund claims.– Process refunds within reasonable statutory period.– Pay interest on late refunds.– Offset VAT refunds against other tax arrears.– Refund promptly to exporters with sound compliance history.– Audit VAT refund claims as part of wider audit program.– Provide appropriate sanctions against refund claim frauds.– Establish transparent and functioning appeal system.– Improve taxpayer service.

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References• Brondolo, John, and Carlos Silvani. 1996. Selected Issues in

Administering the VAT: Cross-Checking Invoices and Controlling Refunds to Exporters. Mimeo.

• Harrison, Graham, and Russell Krelove. 2005. VAT Refunds: A Review of Country Experience. IMF Working Paper WP/05/218. November 2005.

• Keong, Kor Bing. 2005. Anti-Fraud Measures and Issues to be Considered by Governments in the Implementation of a Value Added Tax System. Paper commissioned by the World Bank.

• Le, Minh Tuan. 2003. Analysis of Tax and Trade Incentives for Foreign Direct Investment: The Case of Vietnam. Ph.D. Thesis. Kennedy School of Government, Harvard University.

• Le, Minh Tuan. 2003. Value Added Taxation: Mechanism, Design, and Policy Issues. Paper Presented for the World Bank course on Practical Issues of Tax Policy in Developing Countries.