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The Impact Study of VAT in Bangladesh

Report On

The Impact Study of VAT in

Bangladesh

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Taxation one of the major sources of public revenue to meet a country's revenue and

development expenditures with a view to accomplishing some economic and social

objectives, such as redistribution of income, price stabilization and discouraging harmful

consumption. It supplements other sources of public finance such as issuance of currency

notes and coins, charging for public goods and services and borrowings. The term 'tax'

has been derived from the French word taxe and etymologically, the Latin word taxare is

related to the term 'tax', which means 'to charge'. Tax is 'a contribution exacted by the

state'. It is a nonpenal but compulsory and unrequited transfer of resources from the

private to the public sector, levied on the basis of predetermined criteria.

Background of the ReportThis report entitled “The Impact Study of VAT in Bangladesh” is a fundamental

requirement for the completion of the course FRL-403. The main purpose of this report is

to extract the information of the Value Added Tax practiced in Bangladesh. Under the

instruction and guidance of the course instructor Professor Feroz Iqbal Faruque, we have

taken the initiative to conduct the research and prepare this report with much precision

and by being completely unbiased.

ObjectiveThe general objective of this report is to provide a synopsis of how Value Added Tax is

practiced in our country and related consequences. It is also required for the completion

of this course. Beside the general objective, the objectives behind this report are given

below:



Primary Objective:

The primary objective of the report is—

To analyze on the issue “The Impact Study of VAT in Bangladesh”.

To disclose the precise scenario of the “The Impact Study of VAT in

Bangladesh”.

To analyze and recommend on the mentioned issues.

Secondary Objective:

The secondary objective to prepare this report is—

To fulfill the requirements of our course FRL-403.

To have a clear understanding about the activity of specific descriptive research

technique that is personal interview.

To gather experience and knowledge of doing a professional report.

Scope of the Study:This research study will cover the topic “The Impact Study of VAT in Bangladesh” and

its related issues. It also includes recommendations against the selected issues. This

report can be used as a secondary source for further purposes.

Sources of Information:To fulfill the objective of this report collection of relevant, accurate, standardized and

needful information was required. To make this report reliable we have collected data

from both primary sources and secondary sources. Special consideration was given so

that chances of biasness could not arise. The sources used were:



Primary Sources:

Primary data is defined as data, which originates as a result of that particular

investigation. We have collected primary data through depth Inter with various people.

The primary data related to “The Impact Study of VAT in Bangladesh” was collected

from the audiences by the method of personal interview that we conducted. Both

structured and unstructured questions were constructed to extract the primary data.

Secondary Sources:

Secondary data represents the data which are made by others but it is useful for another

purpose or research. As a part of collecting data from secondary sources, we have

referred different books of Tax and VAT. We collected our data from the magazine, news

paper, libraries and also from the websites.

Limitations:No study is beyond any limitations. While doing this research study we had to face some

difficulties. The limitations of the research activities are as follows—

We did not have so much experience for conducting research and preparing the

report very frequently, though we are in learning position.

In depth interview some participants were unenthusiastic to provide enough

information.

There was no current information related to Bangladesh on the Website.

There was lack of precise information; both primary and secondary.

There was not enough time to analyze the selected issues.

Our resources (such as, human resource, financial resource, etc) were limited. So

it was hard for us to prepare a professional report with our limited resources.



MethodologyThis report covers the different aspects and activities that are required for the collection

of VAT by the Govt. However, the report is prepared based upon the information

collected from several persons and organizations who are involved in the relevant

business like dealing with VATable goods and services, the researcher’s own judgments

and also from the Internet. Some surveys have been conducted and some interviews were

taken. The findings are strictly structured upon information provided by these sources

and some secondary sources. The focus here is on presentation of facts as discovered.



1.0. Introduction

Value Added Tax is emerging as an effective tool of taxation in the hands of

Governments internationally. In fact more than 100 countries around the world have

accepted this as a way of taxation on commercial activities. Our neighboring countries

like India, Bhutan, Nepal and Pakistan have already recognized VAT. Developed

countries including Australia, United States, USSR, and UK have already introduced

VAT successfully.

The origin of Value Added Tax (VAT) can be traced as far back as the writings of F Von

Siemens, who proposed it in 1918 as a substitute for the then newly established German

turnover tax. Since then numerous economists have recommended it in different contexts.

Also, various committees have examined the tax in great detail. However, for its

rejuvenation, the tax owes much to Maurice Faure and Carl Shoup. The recent evolution

of VAT can be considered as the most important fiscal innovation of the present century1.

VAT was first introduced in France in 1954. With the imposition of Taxe sur la Valeur

Adjoutee, France become the first European country to implement VAT on an extensive

scale. It was not, however, at first a complete system of VAT, since it applied only to

transactions entered into by manufacturers and wholesalers. It was supplemented by a

separate tax on services (Tax sur les Prestations de Services). In addition, there were

special excises (Taxes uniques) which were levied on services and distribution in lieu of

the taxes sur les presentations de services.

2.0. Value Added Tax (VAT)

Value Added Tax, or VAT, is levied on top of the cost of a product or service and

generates revenue for a government. Value Added Tax, popularly known as ‘VAT’, is a



special type of indirect tax in which a sum of money is levied at a particular stage in the

sale of a product or service.

In 1954, the value added tax system was initiated by the then joint director of the tax

authority of France, Maurice Laure. VAT came into effect for the first time on 10th April,

1954. From its inception, the value added tax system was imposed on all major sectors of

a country. Once instituted, it was immediately clear that revenues collected from the

VAT system constituted a substantial share of the government’s revenue in the economy.

Not surprisingly, due to the ease of payment and ready comprehensibility, the value

added tax system has been adopted by different nations across the world.

Value Added Tax (VAT) a percentage tax on the value added of a commodity or service

as each constituent stage of its production and distribution is completed. VAT may be

classified in three ways:

(i) On the basis of coverage of stages - throughout the production and distribution

stages, or confined to limited stages - manufacturing plus wholesale, or

wholesale plus retail;

(ii) On the basis of the method of calculation - tax credit method, subtraction

method, and addition method; and

(iii) On the basis of tax treatment of final-product capital goods such as

machinery, equipment, and supplies - the consumption form, the income form,

and the product variety.

Thus the three broad types of VAT are the gross national product (GNP) type, income

type and consumption type. A consumption type VAT is an indirect tax. An income type

or a GNP type VAT might be considered as a direct tax but a commodity tax cannot be

considered so. Consumption type VAT is also considered as an alternative form of 'sales

tax'.



VAT is intended to be levied – or charged – whenever there is some value addition to raw

material. The taxpayers on the other hand, will get credit for the amount of tax paid off at

the stages of procurement. The value added tax system has proven to be effective in

avoiding problems that normally might arise out of the double taxation of goods and

services. The value added tax system is designed to address various problems associated

with the conventional sales tax system. In sales tax, there is no provision for input tax

credit, which means that the end consumer may pay tax on an input that has already been

taxed previously. This is known as cascading and leads to increases consumer tax and

price levels, which increases the rate of evasion and can be detrimental to economic

growth. The value added tax system deals with these problems quite efficiently. As VAT

is imposed on value addition – at every single stage – there is no incidence of cascading.

In this way, the final consumers bear the burden of paying value added tax. This system

involves absolute transparency at every stage of taxation, thereby making the tax system

quite comprehensible and simple.

The value added tax system allows for input tax credit, or ITC, on the amount of tax

levied at the preceding stage of the value addition chain. The allowance for ITC is

normally appropriated from the value added tax liability imposed on the following stage

of the sale of the product.

3.0. VAT in Bangladesh

The main components of indirect tax in Bangladesh are Value Added Tax (VAT),

Supplementary Duty and Excise Duty. VAT is imposed on producer, manufacturer,

importer, exporter or service render under the Value Added Tax Act, 1991, on goods or

specified services, at the rate of 15% at every stage of transfer. VAT paid against the

input is adjustable against the VAT on output to be collected from the buyers and the net

sum stands payable on delivery of goods or specified services to the VAT authority.

Exemption is allowed to certain goods or service or certain taxpayers. All cottage



industries, except those producing particular products, are exempted from VAT. But,

manufacturer, producer or service render (other than cottage entrepreneurs), whose

annual turnover does not exceed Taka 1.5 million are required to pay Turnover Tax at the

rate of 2.5 per cent in lieu of 15 per cent VAT. This limit is too low for small industries.

As a result, small industries are subjected to the same 15 per cent VAT as their large-

scale counterparts. In addition, supplementary duty is imposed at variable rates on certain

categories of consumption goods across all size categories. Finally, excise duty applies to

a limited number of items irrespective of size classification.

3.1. National Board of Revenue (NBR): The Tax Central

Collection Authority

The National Board of Revenue (NBR) is the central authority for tax administration in

Bangladesh. It was established by President's Order No. 76 of 1972. Administratively, it

is under the Internal Resources Division (IRD) of the Ministry of Finance (MoF). MoF

has 3 Divisions, headed by 3 permanent Secretaries to the Government, namely, the

Finance Division the Internal Resources Division (IRD) and the Economic Relations

Division (ERD). The Secretary, IRD is the ex-officio Chairman of NBR.

NBR is responsible for formulation and continuous re-appraisal of tax-policies and tax-

laws, negotiating tax treaties with foreign governments and participating in inter-

ministerial deliberations on economic issues having a bearing on fiscal policies and tax

administration. The main responsibility of NBR is to collect domestic revenue primarily,

Import Duties and Taxes, VAT and Income Tax for the government. Other

responsibilities include administration of all matters related to taxes, duties and other

revenue producing fees. Under the overall control of IRD, NBR administers the Excise,



VAT, Customs and Income-Tax services consisting of 3434 officers of various grades

and 10195 supporting staff positions (Approved set up as on 09 Feb., 2000 AD).

National Board of Revenue (NBR) is the apex authority of the government responsible

for collecting tax revenue, administering taxation administration and framing taxation

policies and laws for the government. The main responsibility of NBR is to mobilize

domestic resources through collection of Import Duties, VAT, Excise and Income Tax for

the Government. NBR through its different taxation sources collects more than 95% of

the tax revenue for the government.

NBR was created by a Presidential Order in the year 1972 and placed under Internal

Resource Division (IRD) of Ministry of Finance. Secretary of IRD acts as the Chairman

of NBR. Four Members (top position of the hierarchy) of NBR from Direct Tax wing and

four Members from Indirect taxation wing assist the chairman in executive, legislative

and policy matters.



3.2. Introduction of VAT in Bangladesh

In April 1979, the Taxation Enquiry Commission (TEC) officially took up the issue of

introducing VAT in Bangladesh as an alternate to sales tax. Until 1982, sales tax was

being collected under the Sales Tax Act 1951, which was replaced by the Sales Tax

Ordinance 1982 with effect from 1 July 1982. The World Bank played the pioneering

role in introduction of VAT in Bangladesh. A World Bank Mission visited Bangladesh

for preparing an agenda for tax reform in Bangladesh in December 1986. The mission

submitted its final report on 15 October 1989. The report recommended the introduction

of a manufacturing-cum-import stage VAT at a single standard rate within three years.

Thereafter, a Bangladesh Tax Mission visited India, Indonesia, the Philippines and

Thailand during 13 November - 04 December 1989. The Mission submitted its report in

January 1990. The government discussed the issues relating to introduction of VAT with

all related private and public agencies including the various leading Chambers of

Commerce and Industry from time to time. The government prepared the Value Added

Tax Act 1990 (Draft) in June 1990.

Final version of the Value Added Tax Act was promulgated 31 May 1991 as a

Presidential Ordinance with eight sections (relating to registration under VAT system and

the appointment and powers of VAT authorities). It was made effective from 2 June

1991. The Value Added Tax Bill 1991 was introduced in the Parliament on 1 July 1991

and the Parliament passed it on 9 July 1991. With the Presidential assent to the bill on the

next day it came into effect as The Value Added Tax Act 1991. The VAT Act 1991

replaced the Business Turnover Tax Ordinance 1982 and the Sales Tax Ordinance 1982

with effect from 1 July 1991. It imposed VAT @ 15% on importer or supplier (producer)

of taxable goods and provider of taxable services having annual turnover of Tk 1.5

million or more. It imposed Turnover Tax (TT) @ 2% (currently 4%) on supplier of

taxable goods and provider of taxable services having annual turnover of less than Tk 1.5

million (Tk 2 million at present). The new law imposed VAT at zero-rate on export sales

of any goods and services, brought excise duties on most goods under the VAT net, and



imposed Supplementary Duty (SD) @ 10% to 85% on goods and services which are

luxurious and non-essential and are socially undesirable.

The objectives behind introducing VAT in Bangladesh were to-

(a) Bring transparency in the taxation system;

(b) Prohibit cascading taxation at different stages of production;

(c) Consolidate the tax administration;

(d) Activate the overall economy by mobilizing more internal resources; and

(e) Bring a consistency in the tax-GDP ratio.

VAT introduced in Bangladesh in its initial form was a sort of consumption tax (by

allowing purchase of capital goods as input), which extended its coverage up to the level

of import, production or manufacture and service-rendering but not to export (which is

zero-rated), wholesale or retail level. Since the financial year 1996-97, VAT in

Bangladesh has become a broad-based consumption expenditure tax by covering the

wholesale and retail levels. VAT is imposed on the following goods and services: all

goods imported in Bangladesh except those mentioned in the First Schedule of the VAT

Act; all goods supplied except those mentioned in the First Schedule of the VAT Act; and

all services provided in Bangladesh except those mentioned in the Second Schedule of

the VAT Act.

The standard tax rate for VAT has been fixed all along at 15% (for taxable goods and

services). The adoption of truncated value-bases caused multiplicity of practical tax rates,

but VAT rate is a single, flat or uniform one. The rate of turnover tax (TT) is also

uniform at 4% (2% up to 11 June 1997). But the rates of supplementary duty (SD) are

multiple. At the beginning (FY 1991-92), there were five different rates which ranged

from 10% to 85%. Next rates were eleven in number and ranged from 5% to 350%. For



FY 2000-01, there are 31 different rates that ranged from 2.5% as on coffee to 350% as

on cigarettes.

The computation of actual value-addition requires detailed recording of payments for

goods/services bought, which is not properly done in Bangladesh. To ease the

administrative steps for taxation of services, in specified cases, a 'truncated value-base'

was fixed with the option of waiving 'input tax credit'. Under the VAT system, tax points

depend on the stage of production and distribution. For goods imported by any importer,

VAT is to be paid at the time of paying import duty under the Customs Act 1969.

For goods produced or manufactured or imported, purchased, acquired, or otherwise

collected by any registered persons in the course of business operation or expansion,

VAT is to be paid at the time of one of the following activities whichever occurs first:

(a) when the goods are delivered or supplied;

(b) when an invoice relating to the supply of goods is given;

(c) When any goods are used personally or given for use to another person; and

(d) When the price is received in part or full.

For services rendered by any registered persons in the course of business operation or

expansion, VAT is to be paid at the time of one of the following activities whichever

occurs first:

(a) When the services are rendered;

(b) When an invoice relating to the rendering of service is given; and

(c) When the price is received in part or full. For goods or class of goods for which the

NBR has ordered through the official Gazette notification to use stamp or banderole

or special sign or mark having security system of specified value on package or

carrier or container of the goods, VAT is to be considered as paid equivalent to the

value of the stamp or banderole or special sign or mark used.



For services rendered by construction firms, indenting firms, travel agencies, motor

garages and workshops, and dockyards and other services determined by the official

Gazette notification, VAT is to be paid as withholding tax and VAT is collected,

deducted and deposited by the receiver of the services or the persons paying the price or

commission as the case may be. For any other goods and class of goods or services, VAT

is to be paid at the time as indicated in the NBR rule.

Taxation remains a poor tool of government revenue collection in Bangladesh. Taxes to

GDP (gross domestic ratio) ratios are usually not high in South Asia. But in case of

Bangladesh the figure is alarmingly low - only a little higher than 9%, while the average

for South Asian countries is 11%, the developing countries more than 15%, the

industrialized countries 30%, and high income countries 24%. The introduction of VAT

contributed significantly to raise the tax revenue collection in Bangladesh. The joint

contribution of sales tax and excise duty to in the increase of total tax was Tk 696.9

million (28.8% of total increase) in 1979-80 and Tk 3.9 billion (44.8% of total increase)

in 1989-90. In absolute volume, the annual increase in revenue from VAT and excise

duty is more than the previous annual increase in revenue from sales tax and excise duty.

However, in relative term, the share of sales tax and excise duty in total tax in the 1980s

was almost similar to the share of VAT and excise duties in that under the VAT regime.

The share of VAT as a per cent of different indicators (internal trade tax, external trade

tax, indirect tax, total tax, total GDP and non-agricultural GDP) has usually an increasing

trend and the shares are significant. On an average, around 75% of total tax come from

indirect taxes, and more than a half of the indirect taxes is collected in the form of VAT.

The scope of VAT mainly covers the 'non-agricultural sector' but with a standard tax rate

of 15% the share of VAT as a percent of 'non-agricultural GDP' is only 3% to 4%.

VAT was introduced in Bangladesh as a consumption tax and allowed the full deduction

of 'machinery' as an input from the 'output value' (sale proceeds of taxable goods and

services) to compute the tax-base (i.e., value added). Although the initial coverage was

up to import and production stages, the VAT-net is now expanded to wholesale and retail



stages. Initially, the number of VAT taxable services were 25 (under 21 Heading

numbers), but now the number is theoretically unlimited, although for practical purposes

this number is kept limited to 70 services under 57 heading numbers for which the scope

is defined. Goods other than primary unprocessed agricultural products and food items

listed in the First Schedule of the VAT Act (live animals or poultry, human or animal

hair, parts of animal body or animal products, parts of plant, green or dried vegetables,

fruits, unprocessed spices, food items, oil seeds, natural gums or like products, wood,

uncared wool or cotton, and raw jute, etc) are subject to VAT. Thus almost the whole

economy falls under the VAT-net and as a consumption tax, VAT is supposed to

streamline the economic activities with corrective measures by applying supplementary

duty.

3.3. VAT & Its Necessity

VAT is a multi-point tax system but without the effect of double taxation. Tax is

chargeable at rate prescribed at each point of sale. In Valued Added Taxation system, the

tax is calculated at different points of production and distribution of a commodity. It is

collected in installment on the basis of value added at each point of production and

distribution. Since an input is taxed only once VAT avoids the cascading effect, which is

the chief demirt of a generalized system of taxation i.e. excise and sales tax.

There are several objectives associated with VAT, foremost being its revenue raising

quality, due to inclusion of items such as wages, interest, profits etc. in its base. It shall

also bring in more discipline in the indirect tax regime. It is also imperative that VAT

will take care of the demerits of the existing system.



3.4. Value Added Tax Features in Bangladesh

The main features of VAT in Bangladesh are as follows:

1. VAT is imposed on goods and services at import stage, manufacturing, wholesale

and retails levels;

2. A uniform VAT rate of 15 percent is applicable for both goods and services;

3. 15 percent VAT is applicable for all business or industrial units with an annual

turnover of Taka 2 million and above;

4. Turnover tax at the rate of 4 percent is leviable where annual turnover is less than

Taka 2 million;

5. VAT is applicable to all domestic products and services with some exemptions;

6. VAT is payable at the time of supply of goods and services;



7. Tax paid on inputs is creditable/adjustable against output tax;

8. Export is exempt;

9. Cottage industries (defined as a unit with an annual turnover of less than Taka 2

million and with a capital machinery valued up to Taka 3,00,000) are exempt

from VAT;

10. Tax returns are to be submitted on monthly or quarterly or half yearly basis as

notified by the Government.

11. Supplementary Duty (SD) is imposed at local and import stage under the VAT

Act, 1991. Existing statutory SD rates are as follows:

A. On goods: 20%, 35%, 65%, 100%, 250% & 350%

B. On services: 10%, 15% & 35%.

Cigarettes, natural gas and petroleum products which were the major sources of excise

duties, initially were kept beyond VAT net work. In 1992-93 these items were brought

under VAT. It may be mentioned that at present manually made cigarettes (known as

Biri), part of textile items & services rendered by commercial banks are still under excise

system. The primary requirement under VAT system in Bangladesh is to have

registration numbers by all taxable persons from the local VAT authorities.

Such registrations are compulsory for each location of a business. The taxable persons are

to apply in a specific form to the VAT authority if their annual turnover exceeds 1.5

million taka. The taxpayers are given a registration number through a specific certificate.

The registration certificate contains along with other information the activity codes in

which the person is related.

The registration numbers are used by the taxpayers in their business transactions.

Registrations are done free of cost and are not subject to renewal. Any person whose

annual turnover is less than 1.5 million taka or any person outside VAT may also apply

for registration voluntarily. Any registration may be cancelled if the person discontinues

his business or if his annual turnover is found to be less than 1.5 million taka.



Under the VAT system in Bangladesh all tax payers are required to maintain books of

accounts regarding purchases, sales, raw materials, finished products etc. They are also to

maintain an account current book to help them to determine the amount of VAT due and

the amount actually paid for taxable goods. Payments of taxes are made through

adjustments in the account current book. Credit available for input taxes and refund

against export can be used to settle the liability for output tax.

The value of imported goods for levy and collection of VAT is considered to be the

assessable value for levy of custom duties plus other duties and taxes. While for domestic

goods, this value is consideration (the money value) at which the goods are supplied by

the manufacturer, this value includes all costs, charges, commission, duties and taxes

except the VAT amount. On the other hand, the gross receipts are considered to be the

basis for determining the VAT liability for services in general. But in special cases, some

narrow base values instead of gross value are taken into account for VAT calculation.

Again in some cases, tariff values are fixed as base value for determining VAT.

Each tax payer is required to issue a tax invoice, as proof of payment of VAT, for each

supply of goods or services. However, the importers are not required to issue any tax

invoice. But when importers sell their goods they may issue a supplementary tax invoice

to a VAT registered person. VAT on imported goods is to be paid by the importers at the

time when the customs duties on it are paid. In other words, VAT at import stage is paid

before clearance of goods. But for the local manufactured goods VAT is payable at the

time of supply of goods and services. Each registered supplier of goods or services is

eligible to take instant credit of the VAT paid on inputs. The payments of VAT for goods

(output tax) are made through adjustment in the account current book.

Taxpayers are to keep sufficient balance in their credit in the current account book either

through deposition of money to the Govt. treasury or through their input tax credit.

System have also been introduced to collect taxes on certain services like Construction,

Motor Garages & Workshops, Printing, Indentors, etc. at the source point of payment.



Each taxpayer is to submit a tax return for each tax period (each calendar month) within

20 days of a month following the tax period. The VAT authorities examine the returns,

and enter the data into the computer. All exports of goods & services are zero rated under

VAT system. Moreover, all input taxes (VAT, Customs duty, Excise duty etc) paid on the

inputs used for manufacturing the exported goods is refundable. Such input taxes against

export are refunded either in actual or on a flat rate basis. Refund claims of input taxes

are dealt with by a Duty Exemption and Drawback Office (DEDO).

Value added tax system in Bangladesh gives special treatment to the small firms. Under

the system, small manufacturers and services whose annual turnover is less than 1.5

million taka is exempt from VAT but they are to pay turnover tax @ 2 per cent. Such

turnover tax can be paid either at a time or on quarterly basis. But they are not entitled to

get credit benefit of their input taxes.

Moreover, a small firm whose annual turnover is less than 1.5 million taka and whose

investment in capital machineries only during a particular year does not exceed 300,000

taka are treated as a cottage industry and is fully exempt from VAT or turn over tax. They

are also free from VAT formalities. It is easy to have the benefits of VAT in an economy

where it is implemented in a comprehensive form covering all tiers of production and

distribution as well as to all economic activities.

The single stage VAT in Bangladesh has undoubtedly widened the tax base as compared

to excise or sales tax system and has brought a favorable result in collection of taxes but

it had limited further results due to some limitation and distortion in its application.

3.5. Value Added Tax (VAT) Wing

Value Added Tax (VAT) was first introduced in Bangladesh in the year 1991 by partially

replacing the Excise Duty and wholly the sales tax at the import stage. In Bangladesh,



only a single rate of VAT 15% is prevailing. However in some cases base value for VAT

is truncated.

3.6. VAT Administration

VAT administration is one of the three wings of National Board of Revenue (NBR).

Under the direct supervision and control of the Chairman NBR, Member (VAT) of NBR

works as the head of operational and administrative activities of VAT administration. At

present there are eight VAT Commissionerates all over Bangladesh each headed by a

Commissioner of VAT.

The Commissionerates are Dhaka (south), Dhaka (North), Rajshahi, Jessore, Khulna,

Sylhet Chittagong, and VAT Large Taxpayers’ Unit (LTU). Each VAT

Commissionerates has five to eight divisions which are headed by Divisional Officers

who may be Deputy Commissioners or Assistant Commissioners. Under each VAT

Division there are two to five circles which are headed by Superintendents. These circles

are the basic building block of VAT administration. However, the head of each VAT



division plays the most significant role for VAT collection and administration in the field

level. Commissioners, Additional Commissioners, Joint Commissioners usually monitor

and supervise the functions of VAT circles.

3.7. VAT Mechanism

VAT system in Bangladesh operates under the legal framework of Value Added Tax Act

1991 and Value Added Tax Rules 1991 made under Value Added Tax Act 1991. As per

VAT Act at a flat rate of 15% is chargeable on all goods and services imported in

Bangladesh and on all goods and services produced in Bangladesh at every stage when

the title of the goods and services of the concerned transaction is transferred. However

there is exception for certain the goods and services listed in the first schedule and second

schedule of VAT act 1991 respectively. The exempted items are basic agricultural

products, live animals and animal products, education, books, magazines, newspapers,

postal services and passengers and goods transportation services etc.

Besides, according to the law, any person engaged in the business of goods and services

subject to VAT having yearly sale of less than Taka two million has to pay Turn-over

Tax (TT) instead of VAT, at the rate of 4% on the amount of the yearly sale. Any person

doing the business in goods and services subject to VAT has to pay VAT under self

clearance procedure.

The person is required to comply with following procedures prior to clearing goods and

services from taxpayer’s premises:

Get registered with VAT authority, collect Business Identification Number (BIN)

which is referred in all matters relating to VAT.

Submit value declaration – the basis for imposing VAT i.e. price per unit on which

rate of VAT to be charged- and get it approved of VAT authority (basically

Divisional Officer).



Maintain prescribed books and record.

3.8. VAT Collection Trends

VAT at this moment, is the most dominating revenue sources of the government. In

FY2005, VAT revenues constituted 36% of the total tax revenue and 27% of the total

revenue collection, making it to be the largest piece of the tax revenue pie. VAT

collection is growing very rapidly over the last decade. In FY 2005 VAT achieved an

impressive 23.7% growth.

Table 1: VAT Collection Scenario

(Figures: Billion Taka and Percentile) FY2001 FY2002 FY2003 FY2004 FY2005

VAT Collection 61.32 69.6 80.71 85.75 106.05

Growth in VAT Collection 13.6 13.5 16.0 6.2 23.7

VAT collection as percentile

of total revenue

25.4 25.2 25.9 24.2 27.1

Total revenue receipt 241.7 276.7 311.19 354 392



4.0. Tax Expenditures in Bangladesh

4.1. Introduction

In recent years, the study of tax expenditures has gained increased importance in the

literature of public policy, particularly in developing and transition economies. Such studies

are primarily concerned with reduction in tax liabilities resulting from various tax preferences

such as preferential tax rates, exemptions, deductions, rebates, deferrals, credits, etc. These

measures are often used as part of an efficient tax policy in order to achieve certain

fiscal/social objectives, e.g., generating revenue at socially efficient and equitable level that

minimizes its disincentive effects on economic activities, reducing pressure on public sector

borrowing and substituting direct government expenditures (Cavalcanti and Li, 2000; Tanzi

and Zee, 2000). These incentives may also be viewed as subsidy payments or government

spending towards preferred taxpayers channelled through the existing tax system, besides

direct expenditures of the government. Thus, it is necessary for a government to analyse tax

expenditure accounting on a regular basis for maintaining efficiency, accountability and

fiscal transparency of the country.

Tax expenditure measures are tax provisions, liabilities or concessions that fall outside a

benchmark tax system. Tax expenditures may take a variety of forms such as tax exemptions,



deductions, exclusions, allowances, credits, deferrals, relief, etc (OECD, 1996 and WB,

2003).

Tax holidays and tax free zones are also examples of tax expenditures subject to specific

periods and geographical areas (Swift 2006). Technically, tax expenditures may be defined as

the gap between potential tax revenue, which does not contain tax provisions, and net tax

revenue or tax revenue received. However, application of the definitions of tax expenditures

differs among countries.

The establishment of an efficient and effective tax system by giving special attention to tax

preferences plays an important role for a developing economy like Bangladesh, which faces

constraints to requisite revenue generation due to lower domestic tax bases and increased

integration with the world economy. The analysis of tax expenditure accounting is necessary

broadly from two perspectives: first, it gives an indication about potential areas for further

revenue generation; and second, it gives additional information about actual budget

expenditures of the government that is not reflected in spending program of the budget

documents. This policy note attempts to analyze the concept and size of tax expenditures in

the context of Bangladesh with special references to India and Pakistan for FY05. It also

finds the necessity to re-examine a few existing tax expenditure measures in Bangladesh.

4.2. Existing Tax Expenditure Measures in Bangladesh

The tax system of Bangladesh includes several tax expenditure measures under the broad

headings of direct taxes and indirect taxes. These provisions, introduced with the enactment

of the tax law, have been subject to changes from time to time. The major policy objectives

behind the tax expenditure measures in Bangladesh are to accelerate the process of

industrialization, to attract foreign currency through increasing exports and foreign direct

investment (FDI) and to ensure social security and welfare of low and modest income groups.

Tax expenditure measures exist in sectors such as Public Services, Agriculture, Labour and

Employment Affairs, Transport and Communication and Social Security and Welfare, etc.



Tax Expenditure Measures under Direct TaxesVarious tax expenditure measures exist for corporate and personal income taxpayers under

the existing income tax law. These are summarized below.

Corporate Income Tax

Tax holiday facility is allowed to newly set-up industrial undertakings, physical infrastructure

facilities and tourism industry subject to certain specified conditions in order to promote

industrialization and employment generation. Exemptions and deductions are applicable to

incomes from firms in Export Processing Zone (EPZ), 50 per cent of income for export

earnings, power generation companies, computer software businesses, agriculture-related

industry, micro credit for NGOs, local government, welfare activities, etc. In particular,

concessionary rate is allowed at the rate 20 per cent for those who do not enjoy tax holiday or

accelerated depreciation, 15 per cent for textile and jute industries and 25 per cent for local

authority, etc. Accelerated depreciation is allowed at the rate 100 per cent for new firms.

Personal Income Tax

Exemptions and deductions are admissible to individual incomes from agriculture-related

activities, income of foreign technicians in EPZs, remuneration of diplomats and foreign

employees of an embassy, income of an indigenous person of Hill Tracts region as

individuals, income from specified savings instruments, etc. In addition, 15 per cent tax

rebate is allowed on investment in provident fund, Deposit Pension Scheme (DPS),

insurance, shares, bonds, etc.

Tax Expenditure Measures in Indirect TaxesUnder the various acts of indirect taxes, exemptions and deductions are given in the area of

customs duty, supplementary duty and Value-Added Tax (VAT).

Customs and Supplementary Duty



Exemptions are granted to local industrial units of a few specific sectors, viz. EPZ

enterprises, power generation companies, poultry and dairy farms, etc. Concessionary rates

are applicable to agro-processing, textile and leather industry, educational institutions,

hospitals, privileged persons, etc. Incentives are also given to those sectors, which are

complying with the international and bilateral agreements and conventions.

Value–Added Tax

Goods and services exempted from VAT include food and agricultural products, animal

products, poultry sector, agriculture inputs, basic services for living, social welfare services,

culture related services, finance and financial activities related services, transport services,

personal services, etc.

5.0. VAT System in Bangladesh

As mentioned earlier, Bangladesh introduced the VAT as a radical reform in the indirect

tax system. The then government tried to familiarize people with this new tax system and

to make the reform successful. Before judging the success of this reform, some important

issues should be discussed.

5.1. Revenue and Tax Structure in Bangladesh

A. Revenue StructureTotal internal resource generation of a country consists of tax and non-tax revenues.

National performance, therefore, regarding mobilization of internal resources may be

assed by relating the overall tax and non-tax revenue to national income and comparing

these ratios over time. Table 2 gives a picture of the revenue structure of the country.



Table 2

Revenue Structure of Bangladesh, 1972/73 – 1990/91 (per cent)

Year Total Revenue / GDP Tax Revenue / Total Revenue

72/73 – 74/75 5.2 83.0

75/76 – 79/80 8.8 85.3

80/81 – 84/85 9.2 84.0

85/86 – 87/88 9.0 83.9

88/89 – 90/91* 9.3 83.3

As indicated, the revenue GDP ratio rose from a low of 5.2 per cent in the early seventies

to 8.8 per cent in the late seventies and then increased only marginally and remained at

less than 10 per cent even in 1988/89 – 1990/91. Also tax receipts accounted, as table 2

shows, for more than eighty per cent of the total revenue earning of the country during

this period. Thus, it is evident that the internal resources generation effort of the country

is low and the loan’s share of it is borne by the tax revenue.

a) Tax Revenue

National Board of Revenue (NBR), under Ministry of Finance is the apex authority of the

government for collecting tax revenue. In FY 2005 government collected 77.8% of revenue

through NBR sources. Import duty together with supplementary duty is still cater the largest share

of tax revenue for the government. Value Added Tax (VAT) is second largest source followed by

Income Tax. In FY 2005 VAT accounted for 36% of total NBR tax revenue where share of

Income Tax was only 19%. These figures reveal the fact that government is largely dependant on

indirect tax sources.



Government also collects tax, duty and fees through different central government and local

government organizations. Non judicial stamps, interest, dividends, profits, are few other major

sources of government revenue.

Table 3: Tax and Non Tax Revenue Collection by Major Heads

Billion Taka

NBR Tax Revenue FY2001 FY2002 FY2003 FY2004 FY2005

Income tax 36.0 41.0 47.9 52.7 58.5

VAT 61.3 69.6 80.7 85.8 106.1

Import duty 47.7 53.5 58.8 73.0 80.0

Excise duty 2.8 3.0 3.1 1.7 1.5

Supplementary tax 33.6 38.5 43.9 54.3 56.0

Other tax and duty 1.6 1.7 3.2 3.1 3.0

Total NBR tax 183.0 207.3 237.5 270.5 305.0

Non NBR tax Revenue

Narcotics duty 0.40 0.30 0.35 0.40 0.45

Vehicle tax 1.44 1.45 2.25 2.41 2.67

Land revenue 2.14 2.14 2.06 2.59 3.26

Non judicial stamp 7.92 8.11 7.34 7.10 8.12

Total Non NBR tax 11.90 12.00 12.00 12.50 14.50



revenue

Non Tax Revenue

Dividend and Profits 7.74 11.62 8.32 10.54 11.65

Interest 5.50 4.49 7.25 7.50 6.36

Administrative fees 10.22 8.72 7.79 9.64 9.88

Service fees 2.56 2.74 4.72 4.82 4.33

Non commercial sales 2.13 2.52 2.96 3.10 2.64

Railroads -1.34 3.90 4.15 4.53 4.79

Telegraph and Telephone board

12.60 16.03 16.00 17.02 16.50

Other non tax revenue 7.42 7.38 10.51 13.85 16.35

Total non tax receipts 46.83 57.40 61.70 71.00 72.50

Total revenue receipt 241.73 276.70 311.19 354.00 392.00



b) Government Receipts

Tax revenue is the main source of the government revenue. Tax revenue accounts for about 80

percent of total government revenue. In FY 1996-97, revenue/GDP ratio was 9.62 percent, which

rose to 10.21 percent in FY2001-02. In FY 2006-07 the revenue/GDP rose to 10.58 percent.

Table 4 shows tax and non-tax revenue receipts and tax-GDP ratio during the period from

FY1996-97 to FY2006-07.

Table 4: Revenue Receipts

(In crore

Tk.)

Particulars 1996-

1997

1997-

1998

1998-

1999

1999-

2000

2000-

2001

2001-

2002

2002-

2003

2003-

2004

2004-

2005

2005-

2006

2006-

2007

Total Revenue 17385 19020 19767 20074 24342 27893 31120 35400 39200 44868 49472

Tax Revenue 14261 15390 16167 16079 19778 21332 24950 28300 31950 36175 39247

Non-tax Revenue 3124 3630 3600 3995 4564 6561 6170 7100 7250 8693 10225

As percentage of Gross Domestic Products (GDP)

Total Revenue 9.62 9.5 9.0 8.47 9.6 10.21 10.35 10.63 10.57 10.79 10.58

Tax Revenue 7.89 7.69 7.36 6.78 7.8 7.81 8.30 8.5 8.62 8.70 8.40

Non-tax Revenue 1.73 1.81 1.64 1.69 1.8 2.4 2.05 2.13 1.96 2.09 2.19

Source: National Board of Revenue, Finance Division and BBS. Figures are based on revised budget.



(c) Tax ManagementDetermination of tax policy of the government and its implementation are reposed on the

National Board of Revenue (NBR). During FY 2006-07, various steps were taken to rationalize

direct and indirect taxes to achieve accelerated economic growth aimed at reducing poverty,

infusing more dynamism in the agriculture sector, expansion of export-oriented industries and

exports, development of domestic industries, enhancing industrial productivity and creation of

employment opportunities.

Measures under Direct and Indirect Tax System for FY 2006-07Measures under Direct Tax system

Limit for tax exempt-income for individual assesses has been increased from Tk. 1,20,000.00 to

1,50,000.00

For self occupied housing property, interest expense against house building loan up to Tk.

20,00,000.00 is to be treated as deductible expenses

Collection of Advance Income Tax (AIT) from credit card bill abolished

Introduction of Universal Self-Assessment System

Deduction of the amount of penalty for non-submission of income tax return.

Income tax investment rebate for non-resident Bangladeshis introduced

Deadline for depositing of AIT extended from I week to 3 weeks

Like woven and knit garments, collection of AIT at the rate of 0.25% from the sale proceeds of

any good or commodity exported at source level

Tax exemption on Zero Coupon Bonds

Abolition of upfront AIT from the Treasury bill and Treasury bond issued by the government

Threshold limit for paying AIT increased from Tk. 2,00,000.00 to 3,00,000.00

Deduction of AIT at the rate of 10% from trustee fee and deduction of AIT at the rate of 7.5%



from freight forward agency commission

Tax Holiday for Solar Energy Plants

Tax exemption period for agricultural industries extended up to 30 June 2008

Exemption facilities for inward remittances in Bangladesh for foreign nationals withdrawn

In case of jute and textile industries rebated tax at the rate of 15% extended up to 30 June 2008

Special tax rate of 15% for diamond cutting & polishing industries introduced

Transfer of capital for new assesses availing and self-assessment system restricted to prevent tax

evasion

10% tax rebate allowed in case of assesses paying tax at the highest rate of 25% and showing 10%

higher income than the previous year

Minimum tax rate for companies introduced by inserting a new section 16cc

New sections of laws introduced for courier services, cash incentives for exports and credit card

Bangladesh has so far signed agreements with 25 countries to avoid double taxation

Measures under Indirect Tax System

Customs Duty

Four tier duty structure and the highest duty rate of 25% of last fiscal year (FY06) remained

unchanged in fiscal year 2006-07. However, customs duty on intermediate goods and basic raw

materials reduced from 13% to 12% and from 6% to 5% in fiscal year 2006-07

Six-tier supplementary duty rates of 20%, 35%, 65%, 100%, 250% and 350% prevailing in the last

fiscal year reviewed. Number of tiers remained unchanged, while two slabs @ 20% and 35%

reduced to 15% and 25% respectively

Tax incidence on sugar in FY2006-07 reduced. Specific duty at the rate of Tk. 2250.00/MT

imposed on raw-sugar, while Tk. 5000.00/MT imposed on refined sugar in FY 2006-07

Specific duty on mobile phone reduced from Tk. 300.00 to Tk. 200.00 per set

Import duty and taxes exempted from capital machinery and raw materials for poultry industries

Customs duty rate reduced in some raw materials for plastic, melamine and electronics industries

in FY 2006-07

Some reforms initiated in the Customs Act to mitigate container congestion at port

Value Added Tax (VAT)



(a) In order to ensure quicker disposal of appeal cases, the time limit reduced from one year to

nine months for Commissioner, Customs, Excise & VAT (Appeal) and VAT Appellate Tribunal

(b) A provision introduced for taxpayers to get any VAT documents by providing certain fees

(c) The time limit for submitting challan/invoice (musuk- 11) extended from 72 hours to 3 (three)

working days.

(d) In the VAT Act, there is a provision for imposition of a minimum fine ranging from an amount

equal to the amount of tax evaded to a maximum of two and a half times of tax evaded. It is

binding for VAT officials to impose a minimum penalty equal to the amount of tax evaded even

for minor offences. In order to remove this inconsistency, the amount of fine and penalty

reduced in FY2006-07 to a minimum of half and maximum of the twice evaded tax. On the

other hand, in case of relative minor irregularities the amount of fine and penalty reduced to a

minimum of Tk. 5,000 from Tk. 10,000 and for minor offences to Tk. 20,000.00 from Tk.

25,000.00

VAT exempted on some new items at import and production stages. The items include sugar,

petroleum bitumen (in drum and bulk), waste paper, synthetic staple fiber, synthetic filament tow

at the import stage and chimney for using kerosene lantern at the production stage

With a view to increasing domestic revenue, VAT network expanded in FY2006-07 by

introducing some new goods and services under the VAT. These are as follows:

(a) VAT on smart card and infusion set at import stage withdrawn

(b) VAT exemption on land development agencies withdrawn and imposed @1.5%

VAT imposed on some services for expanding VAT base. These are:

(1) black and white photo studios,

(2) graphic designers,

(3) cellular fixed wireless telephone (a portable telephone set with antenna, which can be

connected with mobile and land telephone system)

To encourage the development of telecommunication sector, tax reduced from Tk 900 to Tk 800

for each cellular mobile phone connection to ensure availability of telecommunication facilities to

the people at an affordable price

To encourage the development of local dairy industries, supplementary duty withdrawn from local

production on packed powder milk sold in packs of 2.5kg and over



To remove distortion and to ensure equity among taxpayers, exemptions were withdrawn from

turnover tax on some services, such as,- residential hotel, decorator and caterer, community center,

beauty parlour, shipping agent, air-conditioned bus and railway service and transmitting

advertisement through satellite channels under VAT system

Source: NBR

(d) Revenue Collection ActivitiesAnalysis of revenue collection activities for FY2006-07 by categories shows that the bulk

of revenue collection comes from value added tax (VAT). Income tax occupies the

second place in the row. Next positions are held by import duties, supplementary duty,

other taxes and excise duty. Overall, the share of VAT in the total revenue collection is

gradually increasing. It may be mention that for the first time, income occupies second

position over import duties.

In FY 2004-05, the total revenue collection under NBR amounted to Tk. 29988.66 crore.

The collection was Tk. 3795.76 crore higher than that of the previous fiscal year showing

14.49 percent growth. In FY 2005-06, total revenue collection stood at Tk.33987.04

crore, which was Tk. 3998.38 crore or 13.33 percent higher than that of the previous year.

In FY 2006-07, total revenue collection stood at Tk. 37030.79 crore, which was Tk.

3043.75 crore or 8.96 percent higher than the collection of the previous year. Item-wise

tax collection from FY2004-05 to FY 2006-07 is presented in Table 5.

Table 5: Item wise Revenue Collection

(In crore Taka)

Items of Revenue Collection FY 2004-05 FY 2005-06 FY 2006-07

Import Duty 7910.04 7825.43 8161.02



VAT (at import level) 5347.06 5885.65 6292.65

Supplementary Duty (at import level) 1853.50 1563.42 1188

Total 15110.60 15274.50 15641.67

Excise Duty 143.91 161.15 183.78

VAT (Local) 5106.35 6472.52 7445.83

Supplementary Duty (Local) 3702.94 4665.77 4775.58

Total 8953.20 11299.44 12405.19

Income Tax 5672.30 7141.56 8668.91

Other taxes and duties 252.56 271.54 315.02

Grand Total 29988.66 33987.04 37030.79

Source: National Board of Revenue (NBR).

Table 6: Item-wise Revenue Collection for FY 2006-07

Supplementary Duty 16.1%

Excise Duty 0.5%

VAT 37.1%

Other taxes and duties 0.9%

Import Duty 22.0%

Income Tax 23.4%



B. Tax Structure

The tax structure in the country consists of both direct (income tax, gift tax, land

development tax, non-judicial stamp, registration, immovable property tax, etc) and

indirect (customs duty, excise duty, motor vehicle tax, narcotics and liquor duty, VAT,

SD, foreign travel tax, TT, electricity duty, advertisement tax, etc) taxes. Since direct

taxes represent only about 19% of total taxes, tax-structure is heavily dependent on

indirect taxes, which are usually of regressive nature. Of the direct taxes, around 69%

come from income tax, 19% from non-judicial stamp, 5.7% from land revenue, 5.6%

from registration and balance from gift tax and other direct taxes.

Indirect taxes (representing 81% of total taxes), on the other hand, are mainly import-

dependent. Around 67% of indirect taxes are collected at import stage by customs

authorities as customs duty (38.0% of indirect tax or 30.7% of total tax), VAT (24.3% of

indirect tax or 19.6% of total tax), and SD (4.7% of indirect tax or 3.8% of total tax).

Balance of indirect taxes (representing around 26.64% of total taxes) include taxes

collected on domestic production, consumption or transactions such as VAT (11.4%), SD

(11.6%), excise duty (1.5%), foreign travel tax (0.7%), electricity duty (0.6%), motor



vehicle tax (0.7%), narcotics duty (0.2%), TT (0.03%), air ticket tax (0.01%) and

advertisement tax (0.001%). Public revenue also comes from non-tax receipts such as

surplus of sector corporations, financial institutions, railways, postal department,

telegraph and telephone, judicial stamp, etc, and these non-tax revenues represent around

19% of total revenues.

1. Direct Taxes

Income Taxes

Other direct taxes

2. Indirect Taxes

Taxes on foreign trade

i) Import Duty

ii) Export Duty

iii) Sales (import) Taxes

iv) Other Customs Taxes

Taxes on domestic goods and services

i) Taxes on domestic goods

ia) Excise Duties

ib) Sales(domestic)tax

ii) Tax on domestic services

(a) Direct Tax



Direct tax in Bangladesh comprises taxes on income and taxes on property. Table 7shows

that the percentage of direct tax in total tax revenue increased from 16.5 per cent in the

early seventies to 22.70 per cent in 1988/89 – 90/91.

Table: 7

Tax Structure of Bangladesh, 1972/73 – 1990/91

(Percentage of total tax)

Tax Head / Period 72/73 –

74/75

75/76 –

79/80

80/81 –

84/85

85/86 –

87/88

88/89 –

90/91

1. Direct Tax 16.5 18.0 19.7 22.3 22.70

a. Income Tax 7.6 12.6 13.7 15.0 -----

b. Other Direct Tax 8.9 5.4 6.0 7.3 -----

2. Indirect Tax 83.5 82.0 80.0 77.7 77.30

a. Foreign Trade Taxes 43.8 55.9 56.0 52.1 -----

(i) Import Duty 32.8 37.4 38.9 38.2 -----

(ii) Export Duty 0.6 2.2 1.0 0.0 -----

(iii) Sales Tax 9.6 15.9 15.5 13.2 11.86

(iv) Other Customs Tax 0.8 0.4 0.6 0.7 -----

b. Taxes on Domestic

Goods & Services

39.6 25.5 24.0 25.6 -----

I. Taxes in Domestic

Goods

36.5 24.2 23.5 25.1 -----

Ia. Exercise Tax 31.8 22.2 23.2 25.1 -----

Ib. Sales/ Domestic Tax 4.7 2.0 0.3 0.0 -----

II. Taxes on Domestic

Services

3.2 1.2 0.5 0.5 -----



Therefore, revenue earnings from the individual income tax have been very low. The

major reason for such a low tax collection from individual income tax is the very narrow

tax base. Less than 0.5 per cent of the population is covered in the tax net.

(b) Indirect Tax

Although the contribution of indirect taxes as a proportion of total tax yield has been

declining over the years. It still bears the lion’s share in overall tax receipts of the country

by accounting for more than three quarters of the overall tax yield. Indirect taxes may

broadly be divided into taxes on domestic goods and services and taxes on foreign trade.

(c) Taxes on Domestic Goods and Services

Table shows that the share of the taxes on domestic goods and services remained stable at

around a quarter of total tax revenue after falling from a high of 39.6 per cent in the early

seventies. The sales tax on domestic goods does not exist any more. In fact, as table 2

shows, excise taxes accounted for almost the entire revenue yield form this source which

stands at a quarter of total tax receipts of the country.

Another interesting feature of taxes on domestic goods and services is that only a few

items generate the total tax yield for excise taxes. In fact, only four items namely-

tobacco, petroleum, petroleum gas and jute manufacture accounted for more than 70 per

cent of total excise tax yield of Bangladesh in 1984/85. These findings thus clearly

indicate that taxes on domestic goods and services are low and the base is also very

narrow.

(d) Taxes on Foreign Trade

Foreign trade tax has continued to play a dominant role in the tax structure of Bangladesh

over the years. Table shows that it has accounted for more than 50 per cent of the total

tax yield of the country in recent years.

(e) Others



Excise Duty

Excise duty is currently imposed in Bangladesh under the Excise and Salt Act 1944

introduced to levy and collect duties of excise on domestically manufactured goods

and also to salt. Before introducing VAT since July 1991, the excise constituted the

second largest source of revenue for the government (about 22% of total revenue), but

out of 99 excisable items, 74 were shifted under VAT in 1991-92. The goods and

services subject to excise duty are listed with the tax rates in the First Schedule of the

Excise and Salt Act 1944, which now include BIDI , cloth and cloth goods, and bank

services. Narcotics duty continued to be collected from all kinds of produced alcohol

at rates specified in the Second Schedule of the Narcotics Control Act 1990 and

alcohol products are not subject to excise duty or VAT.

Sales Tax

The first sales tax was introduced in the former Central Provinces of India in 1938. In

Bengal, sales tax was adopted in 1941. In 1948, sales tax was transferred as a central

tax under the General Sales Tax Act of 1948. The Sales Tax Act 1951 came into force

on 1 July 1951 by repealing the Pakistan General Sales Tax Act of 1948. Until 1982,

sales tax was being collected under the 1951 Act, which was replaced by the Sales

Tax Ordinance 1982.

The VAT law was promulgated by repealing the Business Turnover Tax Ordinance

1982 and the Sales Tax Ordinance 1982 with effect from 1 July 1991 by imposing

three types of taxes, viz, VAT, SD and TT. Now VAT is being imposed at 15% on

'value added' at import and all production and distribution stages of taxable goods and

services and collected from VAT-registered persons having annual turnover of Tk 2

million or more. In case of annual turnover of less than Tk 2 million, TT is imposed

at 4% on gross turnover.

Goods and services, which are luxurious, non-essential and socially undesirable, are

subject to SD at rates ranging from 2.5% to 350%. Exports are subject to imposition

of VAT at zero-rated, ie, VAT paid at pre-export stages is refunded to the exporters.


http://banglapedia.org/HT/B_0507.HTM


The VAT authority has also been collecting another tax called 'infrastructure

development surcharge' at the rate of 2.5% since 1997-98 on the value of goods

produced in Bangladesh as specified by the government in this regard.

Income Tax

Income tax was first introduced in the subcontinent by the British in 1860 to make up

the revenue deficit caused by the SEPOY REVOLT , 1857. After independence of

Bangladesh, income tax was made effective under the Income Tax Act 1922 passed

on the basis of the recommendations of the All-India Income Tax Committee

appointed in 1921. Currently, income tax has been imposed under the Income Tax

Ordinance 1984 (ITO) promulgated on the basis of recommendations of the Final

Report of the Taxation Enquiry Commission submitted in April 1979. Income

taxpayers (assessees) are classified as individuals, partnership firms, Hindu undivided

families (HUF), associations of persons (AOP), companies (publicly traded and

private), local authorities, and other artificial juridical persons. Tax rates and scope of

taxable income differ on the basis of residential status of an assessee (resident or non-

resident).

5.2. Tax Return

Taxpayers can submit tax return under 'self-assessment' or 'normal' scheme. In the

classified income tax return, an assessee has to show his/her total taxable income under 9

heads of domestic income and 1 head of foreign income. Individuals having limited

income from salary, wages and/or self-employment can use a one-page tax return to be

submitted only under 'self-assessment' scheme, where only 3 heads of income are to be

shown - 2 heads for domestic 'salary' income (gross and taxable) and other head for all

other domestic/foreign incomes. Tax-base for income taxation is 'annual total income'

computed with consideration of a number of 'exclusions' provided in Part-A, Sixth

Schedule of the ITO.


http://banglapedia.org/HT/S_0209.HTM


5.3. Corporate TaxCorporate tax rates for industrial companies whose shares are publicly traded is 35% and

the rate of those whose shares are not publicly traded is 40%

Deduction of VAT at Source:

The authority for deducting VAT at source has been given to the Government, Semi-

Government, Autonomous Organizations, Non-Government Organization (NGOs), Bank,

Insurance or Limited Company. The services on which deduction at source applicable are

listed in the following page:

Head # Service Code #

Service Provider Rate of Deduction

(%)

S 003 S 003.10 Garage and workshop of motor car

4.5%

S 003.20 Dockyard 4.5%

S 004 S 004.00 Construction Contactor/Sangstha

4.5%

S 007 S 007.00 Advertisement Organization: Government, Semi-Government, Autonomous Body, Nationalized

4.5%



Bank and Insurance Sector

Private Organization, Non-Government Sangstha (NGO), Private Bank & Insurance, Limited Company, Any Sangstha or Person

9%

Others 15%

S 008 S 008.10 Printing firm/organizations 4.5%

S 020 S 020.00 Survey Sangstha 15%

S 032 S 032.00 Consultancy and Supervisory Firm

4.5%

S 033 S 033.00 Lessee 15%

S 034 S 034.00 Audit and Accounting Firm 4.5%

S 037 S 037.00 Procurement Service Provider 2.25%

S 048 S 048.00 Transport Contactor:

For carrying Petrol and Petroleum goods

2.25%

Others 4.5%

S 049 S 049.00 Transport rent provided 4.5%

S 053 S 053.00 Participants of Board Meeting 15%

S 060 S 060.00 Buyer of Auction Goods 1.5%

S 065 S 065.00 House clearing and maintenance organization

2.25%

S 066 S 066.00 Lottery ticket seller 15%

5.4. The Tax Structure for Individual Tax Payers

If an individual has been in Bangladesh for a period/period totaling 182 days or more in

the income year, he/she is considered a resident. In case an individual has been in the



country for 90 days in the income year and 365 days in four years preceding this year,

he/she will also be considered a resident.

Each individual is entitled to an investment tax credit of 15 percent of the total income or

Tk 100,000 whichever is less. Incomes from small and cottage industries are entitled to a

5 to 10 per cent tax rebate depending on the production volume.

On the first Tk. 165,000.00 of total income - no tax obligation

On the next Tk. 275,000.00 of total income - 10%



On the balance of total income - 25%

5.5. Tax Holiday Tax holiday is allowed to industries subject to the relevant rules and procedures set by the

National board of Revenue (NBR) for the following period according to the location of

the establishment.

In Dhaka and chittagong Divisions (excluding 3 hill districts): 5 years. In other divisions

(including 3 hill districts of chittagong Division): 7 years.

The period of such tax holiday will be calculated from the month of commencement of

commercial production. The eligibility of tax holiday to be determined by the NBR and

the time of the commencement of commercial production is certified by the respective

sponsoring agencies. The industrial establishment should be registered under the

companies Act. 1994.

Tax holiday facility can be availed by industries coming into commercial production

within 30 June 2000 A.D.


http://www.nbr-bd.org/

http://www.nbr-bd.org/


5.6. Other Tax Incentives in Bangladesh

Other tax incentives:

Exemption of tax on interest of foreign loan.

Exemption of tax on Royalty/Technical know-how.

Tax exemption on capital gains. Avoidance of double taxation.

Liberal investment allowance for tax assessment.

An accelerated depreciation instead of a tax holiday of a tax holiday is allowed at the rate

of 80 per cent of the actual cost of the machinery or plant from the year the plant starts

production and 20 per cent for the following year provided the industry is located within

a "developed area". The depreciation is 10 per cent if the industry is set up in a location

considered less than a "developed area".

5.7. Tax Rates on Other Companies

Tax rates on income of all other companies including banks, financial institutions,

insurance companies and local authorities are 45%.

Investment requirement by companies enjoying tax holiday: Companies enjoying tax

holidays are required to invest only 25% to 30% of their income in other activities as per

rule of N.B.R.

5.8. Turnover Tax

Persons other than those specified by National Board of Revenue (NBR) through official

gazette notification, who produce taxable goods or provide taxable services but not



required to register under section 15 of the Value Added Tax Act, 1991, and having

annual turnover of less than Tk. 20 lacs shall have to enlist with the superintendent and to

pay 4% as turnover tax in advance.

Following restrictions apply to persons enlisted for turnover tax payments:

a) Persons enlisted for turnover tax cannot pay tax on the basis of tariff or truncated

value

b) They cannot obtain input rebate and VAT registered persons purchasing from

turnover taxed persons on the basis of tax challan cannot also obtain input rebate.

An application for enlisting has to be made to the superintendent of concerned local VAT

office, in form ‘Mushak-6’. The superintendent is satisfied on the turnover declared by

the applicant shall issue an enlistment certificate in form ‘Mushak-8’.

Records to be Maintained

Persons enlisted shall maintain accounts of daily buy-sale transactions in form’Mushak-

17A’ and shall also preserve number wise sale cash memo including enlistment number.

Further, declaration of turnover, challan of treasury deposit, returns etc. shall have to be

preserved for at least 4 years.

Deduction of Turnover Tax

Turnover tax can not be deducted at source against supply of goods or services. However,

it is to be ensured through presentation of treasury challan and certificate about deposit of

due tax in advance for the concerned tax period.

Tax Period for Turnover Tax

Tax period can be annual, quarterly, or monthly. It fully depends on the convenience of

the Turnover tax enlisted person to choose his tax period and mention the same while



declaring annual turnover in form ‘Mushak-2B’ on the basis of his own selection, enlisted

person shall have to submit return to the concerned circle.

Payment of Turnover Tax

In the case of annual declaration, within 30 days of declaration of turnover and for

quarterly or monthly declaration within 15 days of such declaration tax calculated @4%

on the turnover declared, shall have to deposited to the treasury and the return together

with the main copy of treasury challan have to be submitted to the concerned circle in

form ‘Mushal-3’. Tax is payable from the date of enlistment and in absence of any

transaction in any tax period for any reason, tax has to be paid.

Turnover tax is payable in advance within certain days of the commencement of tax

period. Default to pay in due time may attract a penalty not exceeding Tk. 5000 and 2%

of additional tax for each month as additional tax.

Claming of Drawback

Any registered or enlisted person is entitled to drawback against export from duty

exemption and drawback office (DEDO).

6.0. Tax Structure: Institutions and the Reality

Internal resource is the key for sustenance and development for a nation. Revenue

collection scenario in Bangladesh is not yet reached to any impressive stature. For very

poor Tax-GDP ratio, government has to finance growing budget deficit through

substantive amount of foreign loans and public debts. In FY 2005, Tax GDP ratio was

8.7, while Revenue GDP ratio stood at 10.64. These figures indicate the poorest

performance even among the South East Asian subcontinent countries. However, for



substantive growth in tax revenue collections, in the recent years, Tax-GDP ratio is

increasing steadily.

Table 8: Revenue-GDP Ratio

FY2001 FY 2002 FY 2003 FY 2004 FY 2005

Revenue as percentage of

GDP

9.6 10.21 10.35 10.63 10.64

Tax revenue as percentage of

GDP

7.8 7.8 8.3 8.5 8.7

Tax revenue constitutes more than 80% of government revenue receipts. National Board

of Revenue (NBR), the authority for collecting tax revenues, registered impressive tax

collection growth during the recent years. Over the last few years tax revenue form NBR

grew steadily, while growth in non tax revenue sources remained stagnant.



7.0. Necessity of Tax Reform in Bangladesh

For socio-economic and infrastructural development in Bangladesh, the importance of an

increase in domestic revenue is well recognized. Since more than 80 per cent of total

revenue comes from taxes, restructuring the tax system by introducing the VAT was thus

critical.

Bangladesh relies on heavily on trade taxes. But studies of the tax structure of certain

developing countries suggest that the economic cost of trade taxes is much higher than

domestic consumption taxes. The trade taxes lead to the creation of inefficient domestic

industries by penalizing exports.

The tax structure (before introducing the VAT) was inelastic, unresponsive to the growth

in overall economic activity. Taxes on agricultural income and property incomes are

negligible and poorly administered.

Therefore, in order to ensure self reliant growth and reduce external dependence, the

domestic resource mobilization efforts in Bangladesh have to be graded up. Although tax



revenues account for more than 80 per cent of total revenue in Bangladesh, the tax efforts

i.e. tax-GDP ratio in Bangladesh was only 7.2 per cent in 1985/86 which is far from

satisfactory, from the point of view of tax collection, even by an Asian Standard.

So to keep pace with the ever growing public expenditure (which is required to meet

public needs) and make the resources available for development efforts, there is no

substitute for a comprehensive tax reform. Such a reform should aim at raising revenue as

well as eliminating the tax induced distortions in the structure of the economy. The

introduction of the VAT is the center-piece of this reform effort.

8.0. Why the VAT is Preferred for Bangladesh

The reasons for preferences of the VAT for Bangladesh are: it has more advantages than

disadvantages compared to other taxes. Moreover, the tax structure prior to July 1991. In

Bangladesh was highly defective which is, more or less, discussed above. Tax evasion

was widespread particularly among the rich. The tax structure was also discriminatory

against export and biased towards inefficiency. The tax system was also inequitable and

there were large scale allegation of corruption.

Moreover, there was more than one rate in the tax system which would result in

economic inefficiency and administrative complicacy. The cascading effect of the

indirect taxes would increase the production costs, induce the producers to evade taxes

and generate some problems which have been discussed earlier. It would also reduce the

consumer’s welfare through the price-rise.

Therefore, due to intrinsic problems of the indirect tax system, revenue collection of the

government was never satisfactory. To overcome this deficiency and to make the indirect

tax system more dynamic and fruitful, the VAT has been introduced.



9.0. The Salient Features of the VAT in Bangladesh

A. Policy IssueConsumption Type, Destination Principle and Invoice Method.

The VAT that has been introduced in Bangladesh is of the consumption type (as

opposed to the income or gross product type) under which the VAT shall amount

to a tax on the consumer goods only leaving out capital goods. This has been done

to ensure neutrality with regard to the choice of techniques. With regard to the

regime for international trade, the destination principle (as opposed to the origin

principle) has been adopted, under which a VAT taxes all value added, at home

and abroad, in relation to goods that have as their destination the consumers of

Bangladesh. Under this system exports are zero rated and imports are subject to

VAT. The destination principle is compatible with the consumption type of VAT.

The other reasons for adopting the destination principle are that it emphasizes

employment more than consumption and ensures neutral treatment of imported

and domestic goods by taxing imports and domestic goods going into domestic

consumption at the same rate. In a country like Bangladesh where the exchange

rate does not adjust quickly and the factor prices are also not flexible, the

destination principle has to be favored. In respect of the method by which a tax

paying firm may compute its tax liability, the invoice or tax credit method (as

opposed to the account based method) has been adopted in Bangladesh in view of

its compatibility with a consumption destination type of VAT. The tax credit

method avoids the direct calculation of value added, instead, the tax rate is

applied to a component of value added (output and inputs) and the resultant tax

liabilities are subtracted to get the final net tax payable. Its other advantages are

that the tax liability is attached to the transaction and the invoice becomes the

crucial documentary evidence and that it creates a good audit trail. Further, any



tax period (monthly or quarterly) can be used under this method, while the

account based VAT would focus on the annual profit and loss account.

B. Import-cum Manufacturing and ServicesWith regard to the tax on goods, the VAT in Bangladesh was restricted to the

import and manufacturing stage since the accounting system at the other levels of

operation is weak. Certain selected services (mentioned in the 2nd schedule to the

VAT Act, 1991 where financial services are not included) have also been brought

under the VAT system. This would mean relatively few registered traders, clearly

identifiable taxable commodities and a less complex administration. The

disadvantages here are that the revenue base is relatively small implying a higher

rate of tax and those firms in collusion with wholesalers or retailers might

understate the true value of sales and thus cause erosion of VAT revenue. In

1996-97 fiscal budget measures retail level has come under VAT and now only

nine groups of goods are VATable at retail sale. In future the retail level VAT will

be expanding.

C. Single RateThe standard rate of value added tax (VAT) is 15 percent. However, tax-payers

whose annual turnover is lower than taka 2000,000 pay a turnover tax at 4 per

cent instead of a VAT at 15 per cent. In addition, supplementary duty at 10 per

cent to 85 per cent is imposed on specific luxuries, unnecessary and socially

undesirable goods and services. It is zero rated for goods exported. In addition, all

input taxes, if inputs are used for exported commodities, would be rebated. There

are reduced rates of nine percent, five percent, 4.5 percent, 2.25 percent, 1.5

percent and zero percent which apply to, for example, certain categories of

advertisement (nine percent), the supply of electricity (five percent), engineering

services, security services, services rendered by construction contractors, audit

and accounting firms, consultants, printing press, architects, interior and graphic

designers (4.5 percent), supplies of goods and services through participation in a



tender/quotation and for pathological laboratory work, supplies of goods and

services by hospitals and petroleum carriers, maintenance and cleaning of

building floors/premises (2.25 percent), trading services, land development and

construction of apartments, retail sales of furniture (1.5 percent) and exports of

goods and services (zero percent). Supplies of certain goods and services are

exempt from VAT, for example, certain food items (such as meat, fish, potatoes,

vegetable and fruits), jute and jute goods and social welfare, cultural, training,

rehabilitation services and agricultural development.

D. Exemptions and ExclusionsSome imported commodities, specific excisable goods and services, agricultural

insecticides and pesticides, books, newspapers, journals, periodicals, yarn and

textiles, educational items, scientific equipment imported by educational

institutions, aluminum utensils, primary agricultural produce and milling of rice,

wheat and pulses are exempt from the VAT. To derive the maximum benefits

from VAT as non-cascading, efficient and buoyant revenue raising tax system,

exemptions and exclusions should be kept at the minimum. Exemptions not only

cause erosion of the tax base requiring imposition of higher rate to generate a

given amount of revenue, they introduce cascading by bringing about breaks in

the credit chains something the VAT is designed precisely to avoid. Exemptions

necessitate extra record keeping to separate the taxable from the exempt sales.

Further, the distinction between what is exempt and what is taxed is often tenors

or arbitrary. The use of exemptions can introduce ambiguity into the structure of

tax rates by making the effective tax rate on a commodity a function of the

structure of production, rendering the rate irrelevant. As a matter of principle,

exemptions under VAT are not justified except on overriding administrative

expediency or equity grounds. In fact distributive goals would be better achieved

if there exists necessary capacity to administer a comprehensive transfer system.



E. Treatment of Small FirmsIn Bangladesh, for administrative and record keeping reasons, small forms have

been kept outside the purview of the VAT. Specific industries with installed

capital machinery valued at Taka 300,000 or below are exempt from the VAT.

For administrative and record keeping reasons, small firms have been kept outside

the purview of the VAT in Bangladesh. There are two bases for exempting the

small firms. Specified industries with installed capital machinery valued below

Taka three lacs and with annual turnover below Taka fifteen lacs, are exempt

from VAT. Secondly, all manufacturers or services renderers having turnover

below Taka fifteen lacs are exempt from VAT. This way of exempting economic

activities from the purview of VAT is not however free from problems. There is

the potential danger of under reporting sales or understating the value of capital

machineries. The borderline cases are also hard to deal with. This also creates

competitive imbalance, since the exempted firms have artificial price advantage

over the taxable firms leading to market distortions.

F. ServiceCertain selected services were brought under the VAT system in Bangladesh

during the introduction of the system in 1991. A few more services have also been

added to the list in 1992 and in 1996. Since organized manufacturing accounts for

only 15 percent of value added in Bangladesh, in order to have a meaningfully

broad based VAT, it is essential to expand the VAT system to cover as large an

area of services as possible. But although the total value added by services is quite

high in Bangladesh (about 40 percent) only a small proportion of this value added

could come under the potential VAT base.

Services like education, public administration, and health would certainly remain

outside the tax net leaving only 15-20 percent of total value added in service

sectors that could be covered under VAT. The services however belong to the

difficult tax area. It is difficult to define the service sector precisely and to

measure its output. The location or time of supply or consumption of services is



often elusive or even meaningless. Since the service sector is characterized by

high value added than in the stage of production, it is immediately susceptible to

evasion as well. Again, the predominance of labor intensive production in service

limits economies of scale thus leading to the creation of a large number of

difficult to tax small service renderers. Nevertheless, for distributional, efficiency

and welfare reasons services should be brought under the VAT net as far as

possible. Further efforts in base expansion would therefore lie principally in this

direction.

G. Broader CoverageThe VAT in Bangladesh has a broader coverage compared with the bases of taxes

it has replaced. All goods except those mentioned in the First Schedule to the

VAT Act 1991 are subject to VAT (some more items have, however, been

declared exempt by specific notifications). Theoretically, a tax that has

consumption as its base has the desired property of being elastic. Since

consumption is the largest component of GDP or value added, increase in revenue

is expected to keep pace with the GDP growth. With regard to the services also,

the VAT base is larger than the excise base it has replaced.

H. Treatment of ExportExports are zero rated under the VAT system in Bangladesh. This implies that

there would be no VAT on exports. In addition, all input taxes (VAT, customs

duty, excise duty etc.) would be rebated. Under the VAT system, it would be

possible to determine the hidden taxes with more confidence. As such, the rebate

procedure would be more efficient and the amount rebated would approximate the

actual input tax content of any export consignment.

I. Operational Issues



a. Taxability

Except those goods and services specifically exempted by notification, all

imported or domestic goods and all services are subject to the VAT. In the case

of imports, the importer and in the case of domestic supply, the manufacturer –

supplier is liable to pay the VAT. In case of a service, it is the service supplier

who is liable to pay the VAT (VAT Act 1991).

b. Time and Manner of Payment

At the import stage, the VAT is leviable and payable before the clearance of the

imported goods from customs. In the case of domestic supply, although the

payment of the VAT takes place at the time of clearance of the goods from the

production premises (Rules 23 of the VAT Rules 1991), the liability could be

born earlier [section 6(2) of the VAT Act, 1991]. Similarly, although the

liability is generated earlier [section 6(3) of the VAT Act 1991], the VAT on

services can be deposited into the treasury any time before the submission of the

monthly return.

c. Input Tax Credit

A registered tax-payer is eligible to take instant credit of the VAT paid on

inputs against the VAT payable on outputs (section 9 of the VAT Act 1991).

For access to the credit against the VAT on domestic supplies or services, one

needs to have in his possession the VAT paid invoice in the case of

domestically produced intermediate inputs / raw materials and the Bill of entry

in the case of imported inputs (Rule 20 of the VAT Rules 1991).

d. Registration

For the ease of administrating all procedure or suppliers of vatable goods or

services or traders or importers of goods or exporters of goods or services shall

have to be registered with the concerned divisional VAT office. The office

allocates a particular number to each of the procedures, suppliers, importers or

exporters or traders to identify as a VAT payer and this is registration. The



certificate in which it is communicated (Mushak-8) is called registration

certificate.

Compulsory Registration

Concerned divisional VAT office can register and inform a person under section

15(4), when he does not apply for registration though required by law to do so.

He shall be deemed to be registered from the day condition for his registration

becomes apparent. In orther words, he would be liable to pay output VAT after

allowable adjustment of input tax not from the day of actual registration, but

from the day he fulfills the condition for compulsory registration.

Importers or exporters of any goods (other than listed for turnover tax and

within the scope of cottage industry) producers, traders and suppliers of vatable

goods or services must be registered as a compulsory requirement.

Only one registration is necessary when more than one taxable goods are

supplied or services provided or imported or exported from the place of

production of vatable goods or supply of services.

Self- Registration

For producers or suppliers of vatable goods or services with annual turnover

below Tk. 20 lacs, and for those within the scope of cottage industry,

registration is not a lawful requirement. Even then some of them want to

register, they can and this is called self- registration. The only advantage of

registration, whether self or legally imposed, is that the registered producer,

supplier or trader can adjust input tax against output tax which can have a

significant role in pricing and selling the goods or services.

Requirement for Registration



Application in form ‘Mushak-6’ shall have to be filed with concerned divisional

VAT officer for registration, Name and address of the organization, taxpayers

class, name of goods produced or procured, trade license No., TIN, if available

IRC / ERC No. (where applicable) shall have t be mentioned in the application.

Following documents shall be enclosed with the application:-

Trade License

TIN Certificate (if available)

IRC / ERC Certificate (where applicable)

List of all sale center when applied for central registration.

A declaration in form ‘Mushak-7’ regarding place of production or purchase

sale or stock of goods and its inputs

Central Registration

When supply of vatable goods or services or export-import business is

conducted from more than one place but the accounts are centrally maintained,

NBR can, by a special or general order direct to register only the head office of

business. It is known as central registration. Thus, NBR through SRO No. 167-



local/95/119-Mushak directed for registration of head offices of insurance

companies when accounts and records are centrally maintained.

Necessity of Registration

When the annual turnover or sale of producer or trader of vatable goods or

supplier of vatable services exceeds Tk. 20 lacs registration is a legal necessity.

Turnover of any person, registered under turnover tax, when exceeds in any

continuous 12 months Tk. 20 lac, he shall have to apply to the divisional VAT

officer for registration within 30 days after the end of the tax period. In the case

of a person carrying on his business where VAT has been newly imposed, he

shall be required to be registered from the day of such imposition.

Following service providers and suppliers of goods are required to be registered

for VAT even when annual turnover is less than Tk. 20 lacs. (SRO No. 172-

Law/2003/380-Mushak)

Suppliers of Goods

Cigarette containing tobacco manufactured mechanically or manually.

Suppliers of Services

Motor garage and Workshop

Film Studio

Dockyard

Survey Firm

Construction Firm

Sales Centers of Furniture

Advertising firm

Gold Smith and Silver Smith, shop owner and gold refiner

Printing Press

Medical Center



Architecture Firm

Pathological Laboratory

Indenting Firm

Consultancy and Supervisory Firm

Freight Forwarder

Lease holder

Clearing & Forwarding Firm

Banking Service Provider

Audit and Accounting Firm

Electricity distributor

AC launch service

Glass Cutting Firm

Procurement Provider

Buyer of Auction Goods

Satellite Cable operator

Organizing issuing credit card

Security Service

Money changer

Transport Contractor

Tailoring shop and Tailor

Lessor of transport vehicle

Architect, Interior designer or decorator

Person joining the board meeting

10.0. Advantages of VATConceptThe rise of the value added tax (VAT) is a spectacular fiscal phenomenon. Within a

rather short span, this tax has exploded from its rudimentary form to become the state-of-



the-art tax on goods and services all around the globe. Today the VAT has come to be

acclaimed more and more as the most efficient, broad based and revenue-productive

system of indirect taxation. In recent times VAT has been increasingly adopted by many

developing countries around the world that share with Bangladesh the same policy

objectives of development and socio-economic stability and are subject to the same

constraints that may affect the efficiency of the tax administration. VAT is a tax on the

value added by a firm to the goods and services it buys from other firms. Operationally,

the taxpayer adds VAT at a given rate to its sales and then deducts the amount already

paid as VAT on its purchases before paying the net amount to the tax department. VAT

thus avoids the taxation of inputs and its base is the final goods.

1. NeutralityThe greatest advantage of the system is that it does not interfere in the choice of decision

for purchases. This is because the system has anti-cascading effect. How much value is

added and at what stage it is added in the system of production or distribution is of no

consequence. The system is neutral with regard to choice of production techniques, as

well as business organization. All other things remaining the same, the issue of tax

liability does not vary the decision about the source of purchase. VAT facilitates precise

identification and rebate of the tax on purchases and thus ensures that there is no

cascading effect of tax. In short, the allocation of resources is left to be decided by the

free play of market forces and competition. A significant factor in the importance

attached to VAT in the EU countries is its ability to treat intra-commmunity trade as also

trade with other countries with complete neutrality, that too without any distortion by

taxation. This is possible when the VAT is applied where the goods are consumed and

not at a place where goods are produced.

2. Certainty and TransparencyThe VAT is a system based simply on transactions. Thus there is no need to go through

complicated definitions like sales, sales price, turnover of purchases and turnover of

sales. The tax is also broad-based and applicable to all sales in business, thus there is little



room for different interpretations. Similarly, due to the basic feature that it gives credit of

tax paid on earlier stage, the buyer will always ask for invoice. Thus the scope of tax

avoidance or evasion will be much less. The disputes will also be fewer. This system

brings certainty to a great extent. So also, the buyer knows, out of the total consideration

paid for material, what is tax component. Thus, the system ensures transparency also.

3. In Widespread UseVAT is in use in well over sixty countries throughout the world. In its usual form, it is a

transaction-based consumer tax applicable to both goods and services, with the invoice

(on which the VAT liability may be shown separately) acting as the basic evidential

document. It is neutral in effect, the tax liability on sales (outputs) being offset by the tax

paid on purchases (inputs). It thus avoids "cascading"; tax being paid again on goods

which have already borne tax, which frequently occurs in the case of general sales taxes.

4. Harmonized System of TaxationVat became popular because of its built-in advantage of harmonizing the tax structure. It

leaves very small room for interpretation. Even the entries prone to varied interpretations,

under VAT, do not make any difference either to dealers or the Government. Ideally

under VAT, there should be only one basic rate. In any case, typically, VAT involves

lowering the number of tax slabs/rates resulting in reduction of litigation/

5. Better Revenue Collection and StabilityThe Government will receive its due tax on the final consumer/retail sale price. There

will be a minimum possibility of revenue leakage, since the tax credit will be given only

if the proof of tax paid at an earlier stage is produced. This means that if the tax is evaded

at one stage, full tax will be recovered from the person at the subsequent stage or from a

person unable to produce to proof of such tax payment. Thus, in particular, an invoice of

VAT will be self enforcing and will induce business to demand invoices from the

suppliers. Another attribute of VAT is that it is an exceptionally stable and flexible

source of government revenue. The stability of VAT as a revenue source stems from the

fact that if consumption is less volatile the income system provides a flexible instrument



of taxation, since it is collected on a current basis. The decision about revenue can also be

taken correctly as variance in rate of tax has directed relation with revenue collection.

6. ExportsVAT frees exports from the burden of tax in that the tax paid on inputs can be identified

and recovered by the exporter. Consequently, goods enter into international trade on an

equal footing in this respect with those from other countries.

7. VAT as an Aid to Tax ReformA full VAT paid on importations and extending throughout manufacturing,

wholesale/distribution and retail businesses - and including services - provides a wide tax

base and, depending on the state of the economy, a buoyant source of revenue. Because

of this revenue-generating capability, the introduction of a VAT can be used to reform or

modify other taxation structures. For example, high customs tariffs may be lowered, a

complex series of excise-type rates of tax simplified, or an unsatisfactory sales tax

removed.

8. Planning SkillsIn order to produce good results, the introduction of a VAT, whether a full or partial

("credit") system, needs to be carefully planned. This requires the setting up of a team

dedicated to the work and allows new skills to be developed, possibly with the assistance

of consultants who have been involved in such projects in other countries.

9. Increased Administrative CapabilitiesThe introduction of a VAT will require the drafting of new law and new regulations. For

the administration, this will involve the setting up of new organizational structures, the

designing of new procedures and forms, writing of new instructions, arranging for the

provision of better management information and statistics, etc. This gives the

administration the opportunity to develop new skills and abilities which can subsequently



be deployed right across the tax systems. A necessary feature of a VAT is the

introduction of computer systems or the enhancement of those currently in operation. In

country experience may be limited in this area of work and the gradual approach to the

taxation system can be of real benefit here.

10. New Relationship with TaxpayersIn some developing countries, contacts between the administration and the taxpayers are

limited to routine control duties and to enforcement and audit activities. Introducing a

new tax allows a fresh approach to be made. Publicity campaigns can be designed with a

view to improving the taxpayer's view of officialdom. Simple explanations as to why a

new tax is required and how it will work may improve the image of the taxation

authorities. Different approaches to the education of taxpayers can be adopted, and the

use of explanatory leaflets in easily understood language and in eye-catching layout can

help. Many steps can be taken to improve the administrator/taxpayer relationship which

may lead in the longer term to improved trader compliance.

11.Better Record Keeping by the Business CommunityThe control of VAT rests on the use of invoices and the keeping of records by the

taxpayers. Larger companies in most countries generally keep adequate records, usually

held on computers. Often it is the small companies, frequently sole proprietorships that

are not keeping proper records. It is these people that are the most difficult to control

effectively for the purposes of taxation. In this connection, much will depend on the level

of turnover at which businesses are required to register for tax. If the level is set too low,

the cost of adequate control may become excessive. Good publicity aimed at the

education of taxpayers in the requirements of the tax will facilitate its administration and

can lead, in time, to a general improvement in business procedures.

12. Use of Unique Numeric IdentifiersFor a VAT it is essential that each business registered for the tax is identified by means of

an identification number unique to that business. Where a suitable system of numbering

already exists, it should be used for the VAT. Where it does not, a system of unique



numbers (incorporating check digits) will have to be developed. Once established the

VAT system of unique numbers can be extended to other tax and associated areas. This

can lead to each business using one number for most of its transactions with government.

13. Training: An Essential Element of ProgressA neglected area in many administrations is training. Good training is expensive to

design and carry into effect, but the rewards are great. Work is done better and

complaints are fewer; there is greater flexibility in the use of staff whose morale and

motivation are improved. As a result, costs are reduced. To introduce a new tax with any

degree of success, staff at all levels must be well trained - from junior clerks to top

management. This provides a further opportunity to improve on past performance. In the

case of VAT, experience is gained in such matters as reviewing and re-designing training

organizations, obtaining accommodation where this is currently inadequate, obtaining

modern training equipment, preparing new course material, examining and improving

training methods. Careful selection of a central core of trainers is essential since they will

be responsible for training the staff, and some expert assistance may be necessary. Here

again, much of the training experience and the strategies adopted for VAT can be used,

after any necessary adaptation, to improve the situation in regard to other taxes.

14. Other Benefits of VATThe VAT avoids most of the negative features of the sales tax and excise taxes. It

removes cascading, allowing the tax content of any product to be known with greater

degree of certainty and thus leading to better resource allocation decisions as the

investment decisions can be taken independent of the tax policies. The self policing and

cross checking properties of VAT as well as its collection in stages, leave less incentive

for evasion. There is no frequent change in tax policies allowing investors to operate in a

certain and stable tax environment. VAT simplifies tax administration and increases

efficiency in resource allocation.



11.0. Disadvantages of VATDespite having the above advantages, the VAT is not free from its limitations. It has the

following limitations:

I. Price Effect of VAT on Retail PriceA persistent criticism of the VAT form has been that since the tax is payable on

the final sale price, the VAT usually increases the price of the goods. However,

there appears to be an intrinsic reason as to why should have any inflationary

impact if it merely replaces the existing equal yield tax. It is possible that the final

price under the VAT system may not be more than the price under the sales tax

system. A survey of the price effect of introducing in more than 130 countries

resulted in a conclusion that in more than 80% countries it did not alter the rate of

inflation. It may also be pointed out that with the introduction of VAT; the tax

impact of raw material is to be totally eliminated.

II. Cost of Administration to StateAnother point which needs consideration is the question of the cost of

administration to the state. Because of introduction of VAT, the administration

cost to the state can increase significantly as the number of dealers to be

administered will g up significantly. However, this increase is required to be

evaluated against the likely gains under the VAT.

III. Compliance cost to the DealersIt is argued that for compliance with the VAT provision, the accounting cost will

increase. The burden of this increase may not be commensurate with the benefit to

traders and small firms. Though under sales-tax laws, it may be stated that a

transaction of sale is liable to tax, but for the purpose of the liability, the purchase



nucleus is required to be found out. If the purchases are from a registered dealer,

it will be a resale., if purchases are from outside the state, the sale will be a first

sale. Therefore, even without the introduction of VAT, for taxation of a sale

transaction, the source of purchase has to be considered. Under the VAT also, a

closed account of the purchase will have to be maintained. Therefore, there may

not be significant increase in the cost as compared with the

IV. Increase in Working Capital RequirementAnother possible weak point in the introduction of VAT, which will have an

adverse impact on it is that, since the tax is to be imposed or paid at various stage

and not on last stage, it would increase the working capital requirements and the

interest burden on the same.

V. RegressiveOpponents of the VAT argue that the VAT, like ant other consumption based-

revenue source, is inherently regressive. Those least able to pay face the highest

overall burdens. Because it is believed that the VAT is a broad based tax levied on

essential goods and as such must be regressive.

Other demerits of VAT system are-

The VAT needs a formal economy where all economic units from importers to

retailers document their transactions, and maintain accurate records. However in

developing countries, the informal economy covers substantial trading which is

not documented and registered. Moreover, the low literacy rate may result in poor

compliance of the VAT Act and Rules. Therefore, the VAT in such countries may

fail to achieve its objectives.

From the perspective of equity and justice, necessities and small units are

exempted from the VAT. Although this reduces administration costs of the



government, and the burden of compliance on the small units, such exemption

narrows the tax base, distorts the system and limits its success.

12.0. Economic Effects of the VAT

The performance of the old tax system was not at all satisfactory from the revenue point

of view. While increased revenue is ever demanding for infrustructural, social and

institutional development for this poor country, the tax-GDP ratio is only half of our

neghbouring countries (In India, Pakistan, and Srilanka the tax-GDP ratio is 17, 14 and

15 percent respectively). So, though the purpose of introducing the VAT is overall reform

of indirect taxation, the main objective of the government is to raise the revenue

maintaining possible equity and efficiency of the taxation. The various effects of the

VAT are discussed below.

Price Effects of VATThe most sensitive aspect of VAT introduction is its effect on prices. It is because of this,

the policy makers of different countries are often reluctant to introduce VAT in their

countries. This fear is essentially groundless. VAT can lead to a once-for-all increase in

prices if more revenues are desired. But there is nothing inherently inflationary about

VAT. A study on international experience involving thirty nine countries shows that there

was no price increase in twenty two countries. In the rest of the countries, there were one

time price increases. Since VAT is a very big structural change, it often creates

uncertainties in the minds of the businessmen and the consumers the consumers

anticipate inevitable price increase, while the businessmen use the across the board tax

increase to widen profits. Prices could rise for reasons other than VAT as well, depending

on the timing of VAT introduction. Although price increases were also apprehended in

Bangladesh, the experience suggest that there has not been any significant rise in prices

that could be attributed to VAT.



The Vat can lead to a once and for all increases in prices and if more revenues are desired

but there is nothing inherently inflationary about the VAT. A study on international

experience conducted by Alan Tait of the IMF shows that out of 31 countries there is no

price increase at all in 21 countries. In the rest of the countries, there were one time price

increases.

It is very difficult to find out how much price has incresed in Bangladesh due to the VAT.

An in-depth study required for this purpose. However, 5 percent and 4.5 percent inflation

rates in 1991-92 and 1992-93 respectively in Dhaka city compared to 9.3 percent and 6.3

percent in 1989-90 and 1990-91 respective indicate no adverse effect of the VAT on

domestic price level.

Another way of finding the effects VAT on price level is to compare the consumer price

indices (CPI) before and after the introduction of VAT. For this purpose, CPI of middle

income group of Dhaka city and CPI for rural families at Dhaka are taken into

consideration.

Table 9Annual Average consumer price indices for

Middle Income Group in Dhaka City

Year Food Rate of Increase

Clothing and

Footwear

Rate of Increase

General Index

Rate of Increase

98-99 566 --- 348 --- 579 ---99-00 606 7.07 374 7.47 633 9.3300-01 648 6.93 399 6.68 689 8.8501-02 684 5.56 410 2.76 724 5.0802-03 676 -1.17 422 2.93 734 1.3803-04 679 0.44 431 2.13 747 1.77



Table 10Consumer Price Index for Rural Familities at Dhaka

Year Food Rate of Increase

Clothing and

Footwear

Rate of Increase

General Index

Rate of Increase

98-99 449 --- 830 --- 480 ---99-00 463 3.12 936 12.77 510 6.2500-01 493 6.48 1025 9.51 556 9.0201-02 526 6.69 1082 5.56 591 6.2902-03 516 -1.90 1120 3.51 593 0.3403-04 526 1.94 1151 2.77 606 2.19

Both the Tables show the rates of increase of CPI are much lower in post VAT periods

compared to pre-VAT periods. To examine the price effects VAT from the point of view

of groups of commodities, indices of wholesale of agricultural and industrial products

have been considered. Table 11 gives the picture.

Table 11Indices of wholesale of agricultural

and industrial products in Bangladesh

Year Agrl. Products

Rate of Increase

Indust. Products

Rate of Increase

All Groups

Rate of Increase

98-99 1175 --- 1034 --- 1129 ---99-00 1276 8.60 1118 8.12 1225 8.500-01 1297 1.65 1233 10.29 1276 4.1601-02 1333 2.77 1303 5.68 1323 3.6802-03 1353 1.50 1331 2.15 1346 1.7403-04 1437 6.21 1361 2.25 1413 4.98

Table 11 also shows that the rate of increase of indices of wholesale price of industrial

products is lower in podt-VAT periods though it shows slightly different picture in 1993-

94. The rate of increase of indices of wholesale price of agricultural products of post-

VAT periods show inconclusive trend. This may be due to the fact that agricultural



commodities have been kept outside the purview of VAT. However, it is noticed that

price could rise for reasons other than the VAT as well. For example, exppansionary

wage and credit policies are often associated with a prise rise.

Distribution EffectsIt is usually argued that VAT is a regressive tax, as it is applied at uniform rate and there

are few exemptions. But it can be made progressive if the items consumed by the rich are

taxed more. In fact, the taxes replaced by the VAT were no less regressive. VAT is not

designed to correct inequities. It is a part of the overall tax system in the country and as

such the impact of VAT should be considered in the context of the overall tax system. In

fact, tax system is not an efficient instrument for ensuring equity. If more revenues are

available to the government, equity aspect could be better taken care of by increasing the

supply of government services targeted to the poorbetter housing, improved medical

care and better education.

Revenue EffectsIn the developing countries, VAT has been acclaimed as a money machine. In India,

revenue growth was twenty eight percent, in the first year of the introduction of MOD

VAT compared with twelve percent in the year before. In Indonesia, revenue collection

just doubled during the first year of introduction of the VAT. In Argentina, Chile, Costa

Rica and Korea, the ratio of revenue to GDP grew by fifty percent during the first three

years compared with revenue from indirect taxes replaced by the VAT.

In Bangladesh, VAT has been found to be moderately revenue augmenting during the

first years of introduction. In terms of complexity of development, demand for human

resources and the impact it will have the society, the implementation of VAT in

Bangladesh will rank as one of the most significant development projects ever undertaken

in this country. The introduction of VAT in any country poses a gigantic management

problem. The transitional issues need special attention which often span over 3-4 years.



Once the transitional phase is over, and the base is consolidated, then the benefits of the

system come into full play. It is, therefore, imperative to strive hard to lay the system

firmly in place, initiate related changes and integrate the same into socio-economic

mosaic of the country as surely and as smoothly as possible so that the tax induced and

related distortions are removed, paving the way for industrial expansion along

economically justified lines and at the same time enough revenues are generated to

reduce external dependence and contribute to the building of a self-reliant Bangladesh.

The Vat has been acclaimed as the money machine. Most of the countries introducing the

VAT have achieved remarkable success in internal resource mobilization. In India,

revenue growth was 28.5 percent in the first year of the introduction of MODVAT

compared with 12 percent in the year before. In Indonesia, revenue collection was just

doubled during the first year of the introduction of the VAT. In Argentina, Chile,

Costarica and Korea, the revenue of ratio to GDP grew by at least 50 percent during the

first three years of the Vat adoption, compared with revenue from the indirect taxes

replaced by the VAT. The VAT was in UK rasing by 19 percent of central government

revenue from taxation. An al pervasive tax base and efficient system of administration

and direction helped to increase revenue substantially.

In Bangladesh, VAT is also proved to be augmenting. The following table gives a clear

picture:

Table 12

Revenue from sales tax / VAT (in million taka)

Head 1997-98 98- 99 99-00 00-01 01-02 02-03 03-04 04-05Sales tax/VAT 5359 5059 5318 10141 11165 28661 40650 43900i) On imports /exports

5359 5059 5318 10141 --- --- --- ---

ii) Locally manufacturing

--- --- --- --- 2002 8987 10350 11400

iii) Import VAT

--- --- --- --- 7892 15328 17400 18250

iv) supple mentary duty

--- --- --- --- 1271 4364 12900 14250



The table 12 shows that tax revenue has increased about 3 times in 1992-93 and 4 times

in 1993-94 compared to 1990-91. The VAT on imports as well as local manufacturing is

increasing every year at respectable rate.

a) Effects on Equity, Efficiency, and Neutrality:

As mentioned earlier, VAT is a proportional tax to lifetime income. Even if it considered

as regressive, this regressive effects can be reduced by applying a zero rate to products

with a higher weight in the consumption basket of the low income groups. Equity can be

maintained by exempting necessities and small units from the VAT. In Bangladesh, for

example, wholesalers, retailers, and the firms whose annual sale is less than Taka 1.5

million are exempt from the VAT. For egalitarian reason, supplementary duties at

different rates are imposed on luxuries in addition to the VAT.

Equity of VAT can also examined by comparing the tren of CPI of rural-urban population

after the introduction of VAT. Table 4 and table 5 show that the rate of increase of CPI of

middle income group at Dhaka city and that of rural families at Dhaka have the similar

trends in post-Vat periods in Bangladesh. So the VAT in Bangladesh does not adversely

affect the consumption pattern of any particular group and hence, it is equitable.

However, equity of Vat from the point of view of vertical income groups could not be

examined due to data limitation.

The VAT in Bangladsh is levied at a uniform rate of 15 percent. Although, a few goods

and services are exempted from the VAT for equity reasons, it could be argued that VAT

in Bangladsh generallybears high marks of neutrality.

b) Effects on the Balance of Trade:

A destination based VAT requires a border tax adjustment, which levies the VAT on

imports and rebats the VAT on exports. This border tax adjustment is commonly



perceived as providing a trade advantage, but this adjustment does not improve the

balance of trade.

Apparently, it seems that taxing imports and exempting exports would create a cost

advantage for domestic industries that would in turn improve the balance of trade.

However, this apparent cost advantage resulting from border tax adjustments would be

quickly offset by an adjustment in exchange rate if the changes in other macroeconomic

policies do not occur.

The balance of trade in Bangladesh has been shown in table 13. The table shows that the

balance of trade does not differ significantly before and after the introduction of VAT,

though it is slightly better in 2000-01, 01-02, and 02-03 compared to 1999-2000. This

suggest that appropriate changes in macroeconomic policies are required to have the

benefit on the balance of trade from VAT and for this purpose, further research is

essential.

Table 13Balance of Trade of Bangladesh (Crore Taka)

Year Export Import Balance98-99 4268.6 9507.5 -5238.999-00 5141.5 11330.5 -6189.000-01 6027.2 11187.7 -5160.501-02 7419.8 13275.6 -5855.802-03 8821.5 13819.8 -4998.3

c) Effects on Investment and Economic Growth:

The VAT has increased revenue in Bangladesh and this increased revenue could be used

to reduce the fiscal deficit, reduce the public sector borrowing requirement, allow interest

rate to fall and thus stimulate investment. Investment will be further increased as capital

goods are exempted from the VAT in Bangladesh. This resulting increase in investment

wil in turn accelerate economic growth. Table 14 shows investment stimulation in

Bangladesh.



Table 14Investment in Bangladesh (million Taka)

99-00 00-01 01-02 02-03 03-04 04-05 05-06Investment 94427 95955 109851 135214 158937 194651 221200a) Private 47275 48562 60063 74406 80676 110172 139343

b) Public 47152 47393 49788 60808 78261 84479 81857

It is observed from the table 14 that investment in Bangladesh is increasing over the

years, and the rate of increase is higher in the post-VAT periods than pre-VAT periods.

For example, the rate of increase of investment was only 1.6 percent in 2000-01 against

23.0 percent in 2002-03 and 22.5percent in 2004-05. However, the VAT is not the only

contributor to this increased investment. There are many factors like interest rate, govt.

policies etc., which work behind this success. A detail study is certainly needed to see the

net effect of VAT on investment. Nevertheless this study finds a positive correlation

between VAT and investment.

13.0. Tax Reform

Introduction of value added tax (VAT) in July 1991 replacing sales tax on imports and

many domestic excises, at a rate of 15 percent of the manufacturing-cum-import stage is

a major tax reform in the country. It is argued that among others it will raise revenue

yield by increasing the tax base and improving the elasticity of the tax structure of the

country. Sales tax on import covered under VAT accounted for about 12.2 percent of the

total tax estimates for 1991/92 and the commodities previously under excise coming

under VAT, accounted for about 8.1 percent of the total tax yield.

The major contributor to the excise taxes (about 70 percent), namely, tobacco, natural

gas and petroleum were initially left out of the VAT net. Thus 60 percent of the VAT tax

yield came from sales tax on import which was already the most efficient tax head since,



once the import duty is paid, one cannot avoid paying sales tax. Given the tax rate, tax

yield under this head will be similar by whatever name it is collected. VAT replacing

excises show that it still accounts for only around 8 percent of the total tax yield and as

such the tax base remains very narrow. Unless VAT net is comprehensive it cannot

achieve among other, the objectives of being a general tax covering, as far as practicable,

all goods and services and be levied on all stages of production and distribution including

the retail stage.

A piece meal introduction of VAT negates its theoretical superiority over other tax

handles because effect of an exemption prior to final stage is accumulation of tax caused

by including previously paid VAT in the base upon which a later VAT is applied. Thus

the cascading effect, which VAT was supposed to have avoided, is reintroduced. In fact,

almost all the attributes to VAT such as being neutral, non-discriminatory between

products etc. on which it is theoretically justified to be superior to other tax systems are

completely destroyed unless it is a comprehensive one.

Theoretically there is no reason as to why the tax structure of Bangladesh should not be

elastic. Direct tax rates are very progressive while ad valorem tax rates imply

proportional tax rates for indirect taxes. Therefore, as national income increases, yield

from direct taxes should increase at a faster rate since higher proportion of increased

income would be paid in taxes. Elasticity of tax bases should determine the overall

income elasticity of indirect taxes. We have noted that all the major tax bases of indirect

taxes are elastic. Hence there is no reason as to why even overall indirect tax yield should

be inelastic. The problem was identified to lie primarily on administrative capability. The

success of VAT, on the other hand, crucially depends on efficient administration and

developed accounting system. One need not argue about the state of accounts keeping in

ordinary transactions in Bangladesh while poor administration is the major weakness of

our tax system. Thus poor tax administration and narrow tax base remain to be the crucial

stumbling blocks in improving our tax revenue and elasticity of the tax structure.

Composition of indirect tax yield, on the other hand, still remains similar to what it was

before the tax reform. Excise taxes still accounted for about a quarter of total tax revenue



in 1991/92 and about 70 percent of it was contributed by tobacco, natural gas and

petroleum which were left out of VAT net. VAT replacing excise show that it still

accounts for only around 8 percent of total tax yield implying that the tax base under this

head is still very narrow.

To get full advantage of VAT it should be comprehensive covering both the production

and distribution and unto the retail stage. The elasticity of the tax system can be ensured

only if it covers all sales. If the tax is truly general, no matter what part of the economy is

expanding, the VAT will respond at once to that activity. During a transitional period,

such as the one Bangladesh is passing through now, a zero rate of tax at the retail stage or

to goods and services that are to be exempted from paying taxes may be imposed. This is

a technical device to operate a complete VAT structure while still exempting some

commodities entirely from tax. The zero rates is an actual tax rate of the VAT, the same

as 15 percent, 10 percent etc. Thus, the credit offset on purchases can be claimed against

the liability i.e., zero. On the other hand, a good which is exempt cannot claim any credit

and has no tax liability against which to offset it and thereby pays tax on input which

must be wholly passed on or absorbed.

In this way, the zero rates allows consumers complete exemption because, for instance,

the retailer can claim full amount of tax he has paid on his input and, therefore, pays no

tax, while all the previous stages have passed their tax liability fully forward. Initially it

will involve the required cost of administration without yielding any revenue. But this

will bring all economic activities under the VAT system which will help achieving the

ultimate objective of having an elastic tax system for the country.

Inevitability of the imports as a tax base was reinforced when value added tax (VAT) was

introduced in the country. In relation to the domestic production, excises, and in relation

to the imports, sales tax and development surcharge were replaced by a very simple form

of Value Added Taxes in 1991. Introduction of VAT was the result of global popularity

of the system as a modern tax and the increasingly felt need for harmonization of the tax

systems across the world. It is interesting to note that the replacement of the sales taxes



and the DSC at the import stage by the VAT resulted in a higher effective rate of duty,

but went rather unnoticed for obvious reasons. However, the single flat rate of VAT is

ideally simple in nature, but inconsistent with the broader policy of differential treatment

of different commodities for obtaining non-revenue socio-economic goals of the nation.

VAT at the import stage confirms the inescapability from the foreign trade bias of the

prevailing tax-structure. Starting with Caves who analyzed Canada’s Tariff structure

from a political decision making perspective, various alternative tax reform models have

been developed for explaining the existing tax structures. On the face of it, the reform

activities in Bangladesh illustrates an environmental dependency model where the

changes occur in response to the political and economic environment in the context of

which the tax policy makers operate. But a deeper analysis reveals a Niskanian rational

model where the individual bureaucrat is assumed to be rational actor seeking to

maximize personal gain and self-interest in course of day to day activities.

In this light, tax reform in Bangladesh, appears of to be mainly the product of

bureaucratic polity who seeks to protect their position by minimizing the political cost of

tax program while preventing a budget short-fall. They are constrained by the nexus of

the political-government and the income-earners cum consumers as the interest groups.

Any substantial reform would that the political government affords to break this nexus

and comes forward with reform package purported to make a breakthrough in revenue

mobilization. In a variant of this model, it has been suggested that minimization of

political cost may be considered an objective function of the governments. Political cost

in essence is the untoward possibility of displacement from authority. Any political

regime coming to power through an illegitimate way is destined to face significant level

of threat. Given that the power regime is aware of it, it has been asserted that some

political behavior organized around the goal of risk reduction is quite likely to take place.

In the prevailing circumstances, the foremost target of any revenue augmenting reform

would be to set up a long run pattern of revenue growth which is not lower than the

growth of national income and in addition, commensurate with the annual growth of the

expenditure budget. The long run trend should be at such a level that any minor

fluctuation would not threaten with a budget deficit and would not call for ad hoc fiscal



measures. This would require a linkage of the tax to its base and choosing a base which is

well linked to the growth of national income.

After a successful linking of the taxation mechanism with the growth of income, comes

the second target of harmonizing the tax program with the broader socio-economic

objectives of the country. Operationally this would require comprehensive rationalization

of the tax structure in conformity with the national plans for growth and development.

This would demand an integration of the tax planning with the tax policy making. This

integration would be required at the official level and would call for re-organization of

the entire tax policy sector. Unless such steps are taken, it is feared that the formulation

of reform oriented tax policy would continue in the traditional incremental pattern and

the source of the problem would continue to exist. Finally, any major revenue

augmenting tax reform is expected to raise the tax liability of the people in direct or

indirect way. This would, therefore, require political will and capability of a stature that

transcends the capacity of the bureaucratic polity. Consequently, unless there is a political

leadership of the reform movement, it is unlikely that any worthwhile reform program

will materialize.

14.0. Why VATA striking feature of recent tax reforms world-wide has been the steadily growing number

of countries adopting the Value Added Tax (VAT). Since the 1960s, more than 60

industrial and developing countries have embraced the VAT and it has become the main

consumption tax across the globe. Although the specific reasons for adopting the VAT

differ from one country to another, the main argument is that properly designed VAT

raises more revenue with less administrative and economic cost than other broadly based

taxes. VAT does not influence the methods of doing business, it ensures neutrality in

international trade by freeing exports of tax, treats import and domestic goods the same,

and is much harder to evade in comparison to other consumption taxes. There can be no

doubt about the significant advantages to be gained from the introduction of VAT. This is

borne out by many of the studies carried out in countries which have introduced it,



showing a growth in revenue yield and stimulation of the economy. If a developing

country needs to review its taxation strategy, the use of a VAT as a first step should be

given serious consideration. The widespread use of this tax in highly industrialized and

developing nations alike indicates that it has a basic effectiveness that cannot be ignored.

However, it is not a simple tax, and needs care in its introduction and administration.

There is much to be said for making a virtue of necessity, and if it is decided to adopt a

VAT then the opportunity should be taken to upgrade the government department which

is being made responsible for its administration. The benefits of all the introductory work

(improved procedures, forms design, computer systems, training, publicity campaigns,

etc.) can then not only produce a better performance of the tax itself, but can also serve as

a valuable guide and example to be used to carry out improvements in the working

arrangements of other taxation regimes in force in the country. Furthermore, an effective

VAT can, in time, lead to improvements in record keeping and reporting by businesses

which benefits the whole of the trading community. In introducing a VAT many

countries have encountered serious difficulties due to two main causes. The first is that

the basic tax structure has been made too complex, e.g. too many rates of tax, too many

exemptions from tax, etc. The second is that the administration has found itself unequal

to the task of making the tax operate with a reasonable degree of success.

VAT AS AN INSTRUMENT OF TAXATION POLICYTaxation forms only one part of the economy of a country, and the proportion of gross

domestic product (GDP) it absorbs will vary according to the requirements and dictates

of the state. What is certain, however, is that an adequate and assured flow of revenue is

essential to any government. This is perhaps particularly true in those cases where

industrialization remains limited, domestic savings are too small to provide sufficient

investment for economic growth, and terms of trade are adverse with balance-of-

payments difficulties arising. Such problems are often of concern to developing

countries, and therein we examine the position of Value Added Tax (VAT) as a factor in

their taxation strategies.



A GRADUAL APPROACH TO CHANGES IN TAXATION

STRUCTURE

It would be inappropriate to review one tax in isolation,. An initial review of the total

taxation structure (direct and indirect taxes, including customs tariffs and any relevant

local or state taxes) is advisable. This does not mean, however, that action should be

taken to change all the taxation regimes at the same time. A step by step approach is both

safer and more certain of achieving the desired end result of improved revenue yield from

an increasingly compliant taxpaying fraternity.

THE ADVANTAGES FOR DEVELOPING COUNTRIES

In the case of developing countries, the approach recommended has many advantages.

The likely outcome of the exercise can be more accurately assessed and, because the

number of potential VAT taxpayers is likely to be fewer, the workload imposed on the

administration is much reduced. As an introductory measure, the adoption of a VAT can

be extremely valuable in carrying through subsequent changes in other areas of taxation.

15.0. VAT and the Tax Yield

VAT AS A PROPORTION OF TOTAL TAXATION

The revenues arising from the imposition of VAT can be considerable and, in those

countries in which it has been introduced, it has provided a large proportion of the total

tax yield. In the case of the European Community (EC), the percentage of total revenue

provided by VAT in 1988 varied between member states from over 14% to over 24%.

The tax also formed a considerable proportion of GDP, between over 5% and over 9%

(ignoring Portugal and the Netherlands). In Bangladesh VAT (local and import stage

including supplementary duty) constituted about 44% of total tax revenue in 1995-96.

THE IMPORTANCE OF INDIRECT TAXATION



The position of VAT in the taxation systems of developing countries is not so clear, as

separate figures for that tax are not readily available. Nevertheless, figures available,

related to domestic taxes on goods and services, and taxes on general sales or on

turnover, or VAT show wide variations, but clearly emphasize the importance of indirect

taxation in the economies of developing nations. The indications are that the adopting of

VAT could, in some instances, facilitate revision of certain excise-type taxes and also

those imposed on particular types of services.

16.0. Obstacles and the Objectives

OBSTACLES FACING THE REVENUE ADMINISTRATIONS:

inefficient management and organizational systems;

weaknesses in revenue collection procedures;

un-consolidated or inconsistent legislation;

evasion and corruption;

information systems handling risk profiling;

inadequacy of staff incentives, and

shortage of skills and training.

OBJECTIVES:

strengthening the organization and administration management;

improving duties and tax collection;

introducing information technology solutions;

drafting laws and regulations;

improving staff terms and condition, and

facilitating the movement of goods.

17.0. Revenue Administration Modernization and Reform

Program.



Effectiveness of a revenue collection system is achieved by a clear understanding of, as

well as, a consistent interpretation of the appropriate legislation. Proper legislation and

legal drafting is necessary to ensure that revenue collection and enforcement officers

have the necessary powers to perform their functions effectively. It is essential to have an

implementation plan to improve the effectiveness and efficiency of a tax collection

procedure. It is important to review and prepare administration, management and human

resource strategies. Taxes and duty evasion, corruption and noncompliance severely

reduce potential revenue yield and weaken the ability of governments to carry out their

functions efficiently. To deal with such problems, and to strengthen enforcement and

investigation measures following steps can be useful:

introducing new administrative, supervisory and auditing procedures;

introducing risk analysis and profiling techniques;

improving the co-ordination and exchange of information, both in-country and

internationally;

improving the quality of recruitment, remuneration packages, promotion and

personnel practices;

introducing improved collection systems;

enhancing detection and investigative system and procedures, and

designing and delivering appropriate training programs.

TrainingTraining is a fundamental component of capacity building, being a mechanism by which

knowledge, experience, skills and technology is transferred; creating indigenous ability to

take control and continue to develop functions independent of external help. For this

reason a strong training component embracing a variety of techniques from seminars,

classroom learning, and distance learning packages, through to on-the-job training by the

utilization of counterpart staff during all stages of development is necessary.



LegislationTo ensure that the revenue collection and administration legislation is adequate to enable

the Income Tax, Sales Tax/Value Added Tax, and Customs and Excise Departments to

undertake their delegated responsibilities effectively, and prepare amendments where

shortcomings exist.

Development PlanningTo define an administrative and operational framework for the organization around which

the program of reform and modernization will develop.

Prganization & StructureAn analysis and where necessary, modification of the structure and prganization to ensure

that it can meet the requirements placed upon it.

Business Process Re-engineering/Personnel/Instructional ManualsA thorough review of all operational and administrative issues designed to reflect the

objectives of the Revenue Department to enable change to take place efficiently,

effectively and with the support of staff at all levels within the organization.

AutomationDesign, development and implementation of a program of automation that will optimise

the efficiency of the organization and ensure that all relevant information is captured and

utilized effectively.

Anti Corruption Activities



Implementation of specialist teams with the objective of targeting areas of abuse and

ensuring that corrective action is implemented, and that revenue collection is enhanced in

the short term.

InvestigationDevelopment of an effective Investigation Division to operate within the organizational

framework of the Revenue Department.

EnforcementImplementation of effective enforcement procedures throughout the organization.

PublicityDevelopment and implementation of publicity program designed to inform, educate and

demonstrate the transparency of the organization.

Internal AuditCreation and training of an Internal Audit Department designed to ensure that all

procedures and controls are properly and correctly applied by all staff in the organization.

18.0. The VAT Modules

The basic modules comprise:

Registration and De-registration

Return Processing

Automatic Processing of Penalties, Assessment and interest

Trade Accounting

Visits to Traders

Control and Verification



19.0 General Equilibrium Formulation of the VAT System

The theory of value added tax (VAT) suggests three broad types of value added taxes

which differ in their treatment of capital goods and depreciation of the capital stock in

calculating respective tax bases (Ferh et al, 1994 and Shoup, 1990). These are

consumption, income, and gross product type VAT. For instance, under the consumption

type, each firm computes its tax base by subtracting all its purchases of intermediate and

capital goods and depreciation of the capital stock from its total sales. The tax base for

an income type VAT is calculated by deducting purchases of intermediate inputs and

depreciation of the capital stock from total sales. The gross product type VAT base is

computed by subtracting only the purchases of intermediate inputs from total sales. The

purchases of capital goods and depreciation are not subtracted. Thus the difference

between the three types of value-added tax bases is in their treatment of capital goods and

depreciation of the capital stock. Under the consumption type VAT, both purchases of

capital goods and depreciation are deductible. In the case of income VAT, only the

depreciation of the stock is subtracted. The deduction of purchases of capital goods or

depreciation is not allowed under the gross product type VAT.

Sullivan (1965) argues that three concepts of national income accounts are related to the

three bases suggested for the value-added tax. These are: personal consumption

expenditures; national income proper; and gross national product. The corresponding tax

bases are the consumption-type, income-type and gross product-type respectively. To

show the linkages between national income accounts and the tax bases, Ferh et al (1994)

consider a closed economy at an aggregate or macro level. At an aggregate level, total

sales minus total outlays on intermediate inputs yields the gross national product.

Purchases of capital goods are equal to gross investment expenditures (net investment

and depreciation). When gross investment is deducted from gross national product, one

obtains aggregate consumption as the aggregate tax base. Under the income VAT, only

the depreciation is subtracted from gross national product. In this case, the aggregate tax



base equals aggregate net value added or national product. In the case of gross product

type VAT, gross investment is not deductible from gross national product. The aggregate

tax base, therefore, equals the gross national product.

With respect to international trade taxation, two distinct principles are in operation (Ferh

et al, 1994 and Shoup, 1990). Under the 'destination principle', exports leave a country

free of any VAT, while imported commodities are subject to (import) VAT at the rate

applied to comparable domestic goods. The 'destination principle' ensures that

commodities are taxed in a country where they are consumed (the country of destination),

regardless of the country where they are produced. Exports are zero rated under this

principle. This means that no VAT is charged on export sales, and that VAT on all inputs

used in the production of exports is rebated. In contrast, under the 'origin principle' there

is no rebate for VAT on exports, and imports are not taxed in the importing countries. If

this principle is applied, commodities are taxed in the country where there are produced,

regardless of the country where they are consumed. There are three methods by which a

taxpaying firm can assess its tax liability. These are subtraction, tax credit and addition.

However, tax credit method is widely used as it is compatible with consumption VAT

system. Almost all countries that have introduced the value-added tax system, adopt the

consumption-type VAT because it is easier to compute and all purchases including

purchase of capital goods from other firms are deductible from a firm's sale (Shoup,

1990). However, certain countries such as Argentina, Peru and Turkey have adopted the

income type VAT. On the other hand Finland, Morocco and Senegal have employed a

gross product type VAT. The gross product VAT, as it does not allow deduction of both

purchases of capital goods and depreciation, discriminates against the use of capital

goods which perhaps explain its restricted use (Shoup, 1990). The developed and semi-

industrialised economies mostly use the VAT system in its comprehensive form. A

comprehensive VAT refers to a system that includes producers, wholesaler and retailers.

The Government of Bangladesh introduced the value added tax (VAT) in 1991. Like

many developing economies, the VAT is restricted to domestic manufacturing activities

and imports. The VAT system introduced in Bangladesh is of the consumption type and



is based on the destination-principle. Thus, all imports and domestic production,

excluding primary agriculture type products and most services, intended for final

consumption, are subject to VAT. In accordance to the destination-principle, exports are

zero-rated. This means that no VAT is charged on export sales, and that VAT and other

indirect tax on all inputs used in the production of export goods is rebated. The VAT is

consumption-type since all VAT paid on intermediate inputs and capital machinery is

creditable against VAT payable on the sale of domestic output.

To incorporate the VAT system in the model, we start with revenue specification of the

VAT system. Under the VAT formulation, the excise duty on domestic manufacturing

activities and sales taxes on import are replaced by VAT, and the VAT paid on

intermediate and capital goods are credited to the domestic manufacturers as offset

against the VAT on domestic output. Thus, only the domestic sales are subject to the

VAT and there is no VAT on intermediate and capital inputs. In a generalised

framework, assuming that domestic sales ( ) equal the sale of the i-th manufactured

product and that the VAT paid on composite intermediate inputs are rebated against the

VAT on domestic sales, revenue under the VAT system (VATREV) equals:

(I)

where, is the uniform value-added tax rate. The first component of the above equation

denotes revenue from domestic VAT base; second part shows the VAT from the imports

and the third component captures the rebated amount of VAT paid on composite

intermediate inputs. The government income equation of the model incorporates revenue

from the VAT system (i.e. VATREV).

(II)

The rebate or credit mechanism is specified through the composite intermediate input

price equation . The adjusted composite intermediate input price is defined as:



(III)

The second part of the right hand side of [ ] depicts

the amount of VAT paid on composite intermediate inputs which are deducted from the

gross price of composite intermediate inputs.

The domestic price of import is also modified by the value added tax payable on c.i.f.

imports:

(IV)

The other price that is directly influenced by the VAT system is the domestic sale or

activity price. Thus, the domestic sale or activity price is adjusted to include the VAT

specification:

(V)

Subject to the condition that when , , and when , , so that, the

VAT and excise duty can not be applied on the same product simultaneously.

The export supply equation is also modified to include the value added tax;

(VI)

Similarly, in order to incorporate the supplementary duty, all the above 6 equations are

modified to represent supplementary duty into the system.



20.0. Conclusion

Effective management of VAT will do away with multiple levies like Entry Tax,

Turnover Tax, Additional Sales Tax, Surcharge, CESS, Octroi etc. There is no place for

any other kind of taxation. One window tax reduces the collection cost to the States with

easy compliance by taxpayers. In view of the anticipated advantages over a period of

time all states and Union Territories including special category states have in principle

agreed to shift to VAT from April 1, 2003. However, some of the states are still

attempting to push forward the deadline as this will allow all states to effect the transition

to VAT at the same time. This will also provide some more time to the central

government to amend central sales tax act, bring legislative changes for implementation,

taxation of services at state level and settlement of procedure for compensation to states

on account of losses in revenue collection due to implementation of VAT. The delay

would also give the states more time to put administrative arrangement into place and

training employees for the new system.

Clearly, there is a need to popularize the scheme of VAT through persuasion, allaying the

genuine fears of all the parties. New regime will be theoretically superior to the existing

regime known to all. If effectively implemented, it will ensure greater transparency. It

will also have the great merit of being simpler to monitor. Even from the revenue angle, it

should increase the revenue in the hands of the State Governments. However, it is feared

that in the first few years of VAT, the State Governments might face shortfall in revenue.


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