Chapter

III. Guidelines for Administering a VAT

Author(s):
Alan Tait
Published Date:
June 1991
Share
  • ShareShare
Show Summary Details

Milka Casanegra de Jantscher and Carlos Silvani

This chapter provides guidelines on some of the main issues of VAT administration, such as taxpayer identification, filing and processing of returns, control of stopfilers (i.e., taxpayers who have previously filed but have omitted filing for a particular period), control of delinquent accounts, and penalties for noncompliance.

Before discussing in detail the proposed guide-lines, some comments on our overall approach to VAT administration might be appropriate.

Background

Goals of VAT Administration

The goal of tax administration is to promote voluntary compliance. This is usually achieved by creating a reasonable possibility that noncompliance will be detected and when detected, appropriate penalties will actually be applied.

Effectiveness in reducing noncompliance should not be confused with efficiency. An administration can be quite efficient, in terms of showing a low cost of collection, while at the same time being ineffective in deterring noncompliance.

All aspects of VAT administration should be designed with the aim of increasing voluntary compliance. Swift detection of stopfilers, broad audit coverage, and levying appropriate penalties are particularly helpful in this regard. Of course, these activities must be supplemented by appropriate programs to assist taxpayers to comply with VAT.

Previous Experience with Sales Taxes

When considering a VAT, it is common practice to analyze the administration of the sales tax (if any) that the VAT will replace, to see whether it is possible to build on some of the existing administrative procedures. It is often argued in developing countries that previous experience with sales taxation would provide an appropriate base for the forthcoming VAT. This is not so in practice, however, because of certain flaws in these countries’ systems and procedures. The main flaws that are usually found include the following:

(1) Taxpayers face unnecessary inconveniences in filing and paying sales taxes.

(2) Manual procedures used for detecting stopfilers are unreliable. Such defaulters are detected, if at all, many months after the due filing period.

(3) Follow-up on stopfilers is slow and haphazard. No effective procedures exist for quickly communicating with stopfilers and obtaining the corresponding return and payment of the tax.

(4) Procedures for detecting delinquent accounts and collecting the tax are weak.

(5) Appropriate procedures for selecting returns for audit are practically nonexistent.

(6) Supervision of auditors is lax. There is usually a complex and lengthy system for reviewing additional assessments, but effective supervision of what the auditor is doing is generally missing.

(7) Auditors assigned to audit sales taxes find it difficult to disengage themselves from the methods used to make in-depth audits of income taxes. The notion of addressing a sales tax audit only to specific items, such as purchases made in a particular month or invoices issued in another, has usually not been developed. This means that the number of sales taxpayers audited is generally very low and that many additional assessments of sales tax are finalized years after the relevant tax period (see Chapter VII for further discussion on audit).

In tax administrations where some or all of these circumstances prevail, it is obvious that the only way to implement a VAT successfully is to make a clean break with the systems and procedures used to administer previous sales taxes. How can this break be accomplished? Some countries, such as Algeria and Venezuela, have considered the overhaul of their entire internal tax administration (including not only sales taxes but all other internal taxes) in preparation for introducing a VAT. Others, such as Argentina, have thought of a separate organization to administer VAT. Yet other countries, such as Korea and Portugal, have established special VAT units within the existing tax department and have implemented the tax using new systems and procedures.

In practice, developing countries usually adopt a VAT because of the pressing need to generate revenue. This means that the VAT implementation date cannot be set far enough in the future to allow a complete overhaul of the systems and procedures used throughout the tax department. So it has been found that the best solution is to establish a new system for administering VAT that is separate from whatever flawed systems are used to administer other taxes. Once the VAT has been operating successfully for some time, the systems used for administering it may be applied to other taxes. Thus, in several countries, including Portugal and Uruguay, the introduction of the VAT has become a pilot project for improvement of the tax administration as a whole.

Basic Requirements for Administering a VAT

Some of the basic requirements for successful administration of a VAT are the following: an appropriate taxpayer identification system; a simple VAT return form which does not request information that cannot be processed in a timely fashion; an effective taxpayer assistance program; a reliable electronic data processing (EDP) system, which provides accurate and timely information; systems for cross-checking information in VAT returns with information from other sources to detect underreporting; an enforcement system that applies different strategies to different kinds of non-compliance; and, finally, a sound and effectively applied penalty system. These requirements are dealt with in some detail in the following sections.

Registration and Taxpayer Identification

The efficient and timely registration of all taxable persons is essential for the successful implementation of a VAT. Obviously (though some countries have managed not to recognize the need), the legal provisions of the VAT act and the major operational systems must be decided before registration can start. Equally important is the need for early training of staff in the tax administration offices to deal with inquiries on registration requirements. Below are brief comments on the main issues related to registration and taxpayer identification.

Persons to Be Registered

Legal provisions on this topic should include the following:

  • All persons whose present sales of taxable goods and services have exceeded or are expected to exceed an X amount a year or a Y amount a quarter are required to apply for registration before a specific date on a prescribed application form. Taxpayers should be registered and have the required records and invoices by the date the VAT is supposed to start (see Annex I for a sample VAT registration form).
  • Persons whose annual sales do not exceed the relevant limits should be allowed to apply for registration if they need to do so for trade reasons, for example, so that they can issue tax invoices when selling goods to registered persons or to sell goods for exportation and obtain a VAT refund on such sales.
  • Irrespective of the level of his sales at any time, a registered person should be required to comply with all the provisions of the law including submitting returns, paying tax, and keeping records, until his name is removed from the register.
  • Taxable persons who fail to register are nonetheless liable to pay the VAT on all taxable sales made after they became liable to be registered.
  • Only registered persons should be allowed to issue tax invoices and to deduct input taxes incurred on their purchases.
  • All registered persons must exhibit their registration certificate at their principal place of business and copies of the certificate at all other places of business.
  • A registered person should be required to notify the tax administration, within a limited period of time, of any changes affecting the details shown on the registration certificate or on the application form for registration.

Measures to Promote Registration

Adequate publicity by notices, free booklets, and television and newspaper advertisements is necessary to ensure that all persons who must register know that they should do so and know how and where to obtain application forms and other information. Blank application forms and leaflets outlining the VAT should be given freely to applicants. There should be trained staff in tax administration offices to explain the VAT structure and the legal obligations of persons in business. Outstanding publicity campaigns along these lines have been implemented, for example, in Korea, Mexico, New Zealand, and Taiwan Province of China.

Once taxpayers are registered, staff should make brief educational visits to newly registered taxpayers. Priority should be given to those who have not previously paid any other type of sales tax or where there appears to be substantial revenue risk (e.g., large taxpayers). Visits should also be made to those identified as potential VAT taxpayers who have not yet been registered.

The educational visits serve a number of purposes, such as (1) confirming that the registered person is a taxable person by reason of turnover or, if below limit, that he has valid trade reasons for needing to be registered; (2) confirming the accuracy of the registered person’s name, address, and telephone number; (3) confirming that the self-assigned economic activity code is correct; (4) checking that the taxpayer’s accounting system is satisfactory and that he knows how to issue invoices fulfilling all VAT requirements when selling to VAT taxpayers or final consumers (non-VAT taxpayers); and (5) checking that the taxpayer knows how to account for his output and input tax so that he can make timely and accurate tax returns.

During the educational visits, the tax administration staff should try to help the trader and understand his problems. This is extremely important for the successful launching and administration of VAT. If staff find evidence of late registration, they should act to levy and collect the VAT on all taxable sales made between the beginning of the VAT and the date of application for registration. The applicant should not be allowed to issue tax invoices retroactively for these sales nor should he be allowed to claim any input tax in respect of such sales.

VAT Number

A decision must be made on the number to use for identifying VAT taxpayers. It is best to have one unique and reliable number to cover all taxes, including the VAT. However, sometimes this is not a realistic short-term solution, so a separate VAT number must be allocated to VAT taxpayers. In this case, the VAT number should be cross-referenced with other numbers and should be designed bearing in mind that in the medium term the VAT number should become the taxpayer identification number (TIN) covering all types of taxes and taxpayers, including those not liable to the VAT. To design a TIN, it is important to consider the purpose of the TIN and the problems related to its use.

What Is a Taxpayer Identification Number?

A TIN is a code to identify a taxpayer. Each taxpayer must have a single unique TIN. The TIN has two main objectives: (1) to facilitate computer applications, such as detecting stopfilers and delinquent accounts; and (2) to help cross-check information on taxpayer compliance, for example, the selective cross-checking of sales and purchases among VAT taxpayers.

Generally speaking, there are three types of TINs:

(1) Sequential—the number is assigned in a sequential order when the taxpayer registers; (2) biographical—the number is assigned according to some unchangeable characteristics of the taxpayers, for example, date and place of birth; and (3) combination—the number has some digits that represent biographical characteristics of the taxpayer and some digits that represents equential numbers.

To produce a reliable input, TINs should be self-checking, that is, they should have a check digit. The purpose of a check digit is to detect errors, for example, the transposition of numbers when a TIN is written in a document or transmitted into magnetic media.1

Frequent Problems

Some of the problems related to the use of TINs follow:

(1) Changing taxpayer characteristics. The TIN should not include taxpayer characteristics that may change over time, such as economic activity, type of taxpayer (natural person or a legal entity), or location (address) of the taxpayer. This creates problems because these characteristics may change and therefore the TIN would have to change. The TIN does not require any particular meaning; if an element has a meaning, as in a biographical TIN, it must be an element that does not change over time. The TIN, once assigned to a taxpayer, should not change.

(2) Duplication of TINs. To avoid the problem of duplication, there should be strict controls to ensure that no TIN is assigned to more than one taxpayer and that each taxpayer is assigned only one TIN. Use of existing numbering systems, such as the social security and national identity systems, may cause problems if they do not have these strict controls.

(3) TIN for companies. Only one TIN should be assigned to each company. Sometimes a TIN is assigned to each branch of a company but this is not recommended. For conglomerates, a separate TIN should be assigned to each separate legal entity.

(4) TIN by type of tax. Some countries set up a different numbering system for each type of tax, and this should be seen as a problem to be solved. In a definitive numbering system, only one TIN should be assigned to each taxpayer no matter how many types of taxes he pays.

(5) TIN with too many digits. The TIN need be only as long as is necessary for identifying taxpayers. Eleven digits are sufficient to identify the entire world population.

(6) Alphanumeric TINs. This characteristic often creates problems because the letters “l” and “o” of the English alphabet are easily confused with the numbers “1” and “0”; some computer devices cannot process alphanumeric inputs. Also, alphanumeric keyboards slow input and increase the chance of input error.

Economic Activity Code

To produce statistical information for analyzing the performance of the tax system and for better auditing, each taxpayer should have an economic activity code, which should get recorded in the taxpayer identification master file. At the time of registration, the taxpayer should assign the code to himself (using the tax administration’s economic activity code table); the code of each large taxpayer should be reviewed, however, preferably at the initial educational visit, since an incorrect use of a code by a large taxpayer could cause serious statistical distortions. VAT registration forms should require a written description of the business, as well as the numeric code. This information should be recorded to facilitate the examination of the self-assignment. The computer must produce a list of taxpayers containing name, economic activity code, and the written description of the business activity provided by the taxpayer. Thus, any major discrepancy will be quickly noticed by the tax officials reviewing the economic activity code.

It is advisable to follow the structure of the International Standard Industrial Classification (ISIC) code for the economic activity code. This helps to compare tax statistics with the national accounts and with international statistics. The ISIC uses only Arabic numbers. The numbers used to identify divisions and groups are arranged according to a decimal system described below.2

Therefore, the ISIC may be expanded or reduced without changes in the basic system. An economic activity code with approximately three hundred different groups is sufficient to cover all relevant economic activities.

Invoicing and Bookkeeping Requirements

In general, the VAT law should prescribe a minimum number of records to be kept. These records, books, and accounts should be kept up to date and be available for auditing at any reasonable time.

Invoice Requirements

There are two types of invoices: (1) tax invoices, to register sales and purchases among VAT taxpayers; and (2) final consumer invoices, to register sales to unregistered persons (final consumers).

Tax Invoices

Tax invoices are crucial for VAT control. They establish both the tax liability of the supplier and the amount of the deduction allowed to the registered purchaser. A tax invoice should be issued only by VAT taxpayers and contain the following information: the name and address of the VAT-registered person issuing the invoice; the VAT registration number; the date of issue of the invoice; the serial number of the invoice; the quantity and description of the goods or services sold; the unit price and the amount charged, excluding VAT; the VAT charged; and the name, address, and VAT registration number of the buyer.

The original and one copy of the tax invoice must be kept by the purchaser. The original is for his records to support his credit claim on a deductible input. The copy should be available upon request from the tax administration to cross-check sales reported by suppliers and purchases deducted by buyers. (Chapter IV provides more detail and an example of a tax invoice.)

Final Consumer Invoices

This is a simplified type of invoice for registering sales to unregistered persons, who should be considered final consumers under the VAT. On this invoice, the price may be shown as including VAT and the name and address of the buyer may be omitted. Only one copy of the invoice is necessary. For documents issued by cash registers, special requirements should be established to ensure that these sales are properly registered in the VAT account at the correct time, as discussed below.

Bookkeeping Requirements

Every VAT-registered person should keep records of all tax invoices they issue and receive, including the serial number and the date of the invoice, the amount charged, and the VAT charged. The records should be kept in such a way that the VAT authorities are able to check the accuracy of the VAT returns. (See Chapter IV for examples of purchase and sales books that help in preparing tax returns.) All records must be kept up to date and maintained for a period (usually mentioned in the VAT act) of about five years.

The tax administration may approve the use of a cash register system as an alternative to issuing invoices, provided that it identifies the goods or services taxable and the amount of VAT. The till roll should be totaled at least daily to show the values of taxable goods and services and those exempt from VAT, if any. These totals should be recorded daily in a permanent record and used to determine the VAT payable at the end of each period. (Of course, the till roll must be kept as part of the records.)

Credit Notes

Where credit notes are issued, they should contain the same information as tax invoices and, in addition, the date and serial number of the tax invoice on which the VAT was originally charged and brought to account and the reason a credit was given. No credit for the VAT in the VAT accounts should be allowed for credit notes issued to clear the books of bad debts.

The Collection Function

Purpose of Collection

Collection is concerned with identifying registered persons who fail to make a return and those who file but do not pay. The tax administration’s actions against stopfilers or delinquent taxpayers should be strong and costly enough for taxpayers to persuade them to file and make timely payments. Usually, taxpayers will fulfill their obligations if noncompliance results in additional net expenses to their businesses. Therefore, taxpayers’ compliance depends on the likelihood of being detected promptly by the tax administration and having the penalties enforced.

The simplest way to identify and punish stopfilers and delinquent taxpayers is through quick and intensive action based on a computerized system. Collection has to rely largely on computers because there is no known manual system that can process vast numbers of tax returns and detect nonfilers or delinquent accounts promptly and reliably. Most European countries, as well as many Latin American countries, rely heavily on computers for collecting VAT.

Computerized lists of stopfilers and delinquent accounts should be produced every month. Appropriate reminder letters should be printed by the computer, as a first step to enforcing taxpayer compliance. If the postal system does not work satisfactorily, the letters could be delivered through collection agents. After a reasonably short period of time, a second letter should be sent, warning those taxpayers who still fail to file or pay the due tax that legal prosecution will be initiated if noncompliance persists. Summaries of computer outputs should be given to management, and management must follow up on actions taken by operational offices and give proper instructions when delays occur.

The same procedures should be followed for late VAT returns as for the VAT returns submitted on time. Payment of tax should not be a prerequisite for filing returns, although payment of interest and penalties for late payment as well as the tax due should be collected by all legal means without delay. The VAT return should show in a separate box the penalties paid by the taxpayer (see Chart 5 in Chapter IV), so that a computer system can check them and report any discrepancies.

Tax Return Forms

Tax administrations use the tax return forms to request data from taxpayers. However, if the authorities cannot make use of the data promptly, the requests merely slow down the tax collection process. Simply being asked to supply information is not intimidating to taxpayers. Effective enforcement is the only way to improve voluntary compliance. In the case of the VAT, the administration’s ability to convert data promptly into usable information is basic; after a certain period of time, the information collected becomes useless. Therefore, it is pointless to ask taxpayers to give full details about sales and purchases because it would be impossible to process such information accurately within a reasonable time frame.

Chart 5 in Chapter IV reproduces a draft VAT return form for a typical VAT, with two rates for domestic sales and a zero rate for exports-information that is adequate and also can be processed rapidly. This VAT return has been designed as a combined tax return and payment form. Therefore, no special receipt should be issued when the return is submitted; the stamp on the copy of the return, which the taxpayer keeps, should be the only receipt needed.

There is no need to ask for attachments to the return, although taxpayers must keep, in an orderly manner, supporting documentation; also, taxpayers’ records must be made available to the tax administration officials upon request. Forms printed on carbonless copy paper would be easier to complete, and certain types of falsification would be prevented through the use of such forms.

Only one return, consolidating sales and purchases of the head office and branches, should be permitted for each registered taxpayer. The head office and the branches should be treated as one taxable entity.

Filing of Returns and Payment of Tax

Based on experience, using banks to collect VAT has generally been successful, since they are used to receiving payments and handling money. Collection through banks is a sort of “privatization” of tax collection. Banks are not used universally, although a number of countries including Argentina, Brazil, Italy, Japan, Mexico, Portugal, and Spain use banks and several others are moving toward this system.

As regards fees paid to banks for collecting taxes, four alternative methods are currently being used in different countries: (1) A fixed amount of money is paid for each tax return or payment received, regardless of the amount of tax collected. (2) A percentage of the tax collected is paid, regardless of how many tax returns or payment receipts were received. (3) Banks keep collections for a certain period before transferring them to the treasury (the problem with this method, however, is that the remuneration to banks varies with the interest rate; for a given holding period, the higher the real interest the greater the remuneration). (4) The final alternative is a combination of the different methods mentioned above.

The role of banks can vary greatly: from receiving only payments to receiving tax returns, even if they do not report any tax due. In the Philippines, for example, banks receive VAT returns and payments, but if no tax is due, the taxpayer must file the return in the tax office. In some countries, banks are also in charge of data entry so the tax administration receives from banks not only tax forms but also magnetic tapes containing data reported by taxpayers on their tax returns. The best option, however, will depend on the circumstances of the particular country and therefore should be defined case by case. The general features of a collection system where all VAT returns and payments are received through the banking system is described below.

VAT Returns and Payments Received Through Banks

Taxpayers should submit VAT returns to an authorized bank in the area where they are registered. Authorized banks should be required not only to accept VAT payments but also tax returns without payment (i.e., excess credit returns, returns reporting no operations, or returns not accompanied by the full amount of tax due). The VAT return should consist of an original and one copy. The tax administration should keep the original, the taxpayer the copy. Banks should stamp and date both the original and the copy.

To prevent data processing errors, the banks should only accept returns preprinted by the tax administration’s computer or those with a preprinted taxpayer identification label. Other returns would need to be verified by the local tax administration office before they could be accepted by banks.

Returns should be processed by the bank in groups of, say, 50 (except those in the last batch of the day which may be less than 50). Each batch should correspond to a teller to help prevent fraud; this would establish a link between the return, payment, and the person receiving it. Each day the bank’s branches should send the returns to their head office. Within three to four days of receiving the tax returns, the bank’s head office should send them to the tax administration for processing.3

Each batch of returns should be accompanied by a batch control sheet (BCS); each BCS should be numbered consecutively by the branch. The BCS should contain the name of the branch, number of the BCS, date, amount of tax received, amount of excess credit declared corresponding to the tax returns in the batch, and number of tax returns included in the batch.

Accounting

The basic accounting unit should be the batch; the declared amount actually paid must tally on each return and in the batch with the cash, check, or certificate used to settle the liability. A subsystem should be set up to deal with tax payment checks that bounce.

The total amount of taxes collected by banks, as shown in the batches received by the tax administration, should be compared by computer with the collection remittance report submitted by the banks to the treasury or to the central bank. Deposits in the treasury or the central bank should be made within a set period.

Refunds

The administration of VAT refunds poses special problems in developing countries. In most of these countries, the legal and administrative framework is such that officials become reluctant to give tax refunds. Taxpayers often have to comply with tortuous procedures to obtain any kind of tax refund.

Practically all developing countries give VAT refunds to exporters. A growing number of such countries, however, require other VAT taxpayers to carry forward their excess credits indefinitely or until the end of the calendar year. Thus, for example, in the Philippines and in the Taiwan Province of China, refunds of excess credits are granted only to taxpayers making zero-rated sales or if the excess credit originates from the purchase of capital assets; other excess credits must be carried forward. While this solution may be objected to on grounds that it erodes the capital-goods exemption, in practice it reduces the workload of the administration and allows it to concentrate on more productive tasks.

As regards refunds to exporters, developing countries have some of the same problems as industrial countries. Evidence of abuse and fraud is widespread. Authorities must choose between unattractive alternatives. On the one hand, too intensive a check before issuing a refund will impair the competitive position of the exporter. On the other hand, if export refunds are unchecked, serious abuses may escape detection. Probably the best solution is a discretionary policy to refund automatically to traders with consistent and regular exports, well documented and reliable, but to delay refund to traders with exceptional or irregular exports until the refund claims have been validated. However, in all cases careful checks (with delay if need be) should be made on all new businesses or traders just starting to export.

Collection by Customs

The customs administration should be ready to collect the VAT on all goods cleared either at import or the exbonded warehouse from the date the VAT is supposed to begin. In most developing countries collections of VAT by customs represent 40-60 percent of VAT revenue.

The relevant customs forms will need to be amended to provide boxes for the calculation of the VAT (where chargeable) and for the insertion of the importer’s VAT registration number, if he is registered. Of course, the TIN for VAT should become the single identification number for all tax liabilities, including customs. The customs declaration form should relate to the VAT as well as to customs duties. The value for the VAT should be the customs value plus customs duties actually charged, if any (and any other amounts for fees, stamps, etc.).

Customs brokers and importers should be given timely notification of these requirements to allow them to calculate the VAT and fill out the new customs forms.

Role of Electronic Data Processing

Background

There is no doubt that electronic data processing (EDP) must play a key role in administering a VAT. An effective EDP is indispensable not only for collection but also for selecting taxpayers for audit and for providing audit support systems (see Chapters VI and VII).

EDP processing should begin with all data included in the VAT returns being entered and all batches containing tax returns being validated, whether by the tax administration or by banks (see above). After this process has been completed, the master file should be generated, which should be used for most of the information systems mentioned below.

To generate the master file, a strict validation system is crucial so that the information would be reliable and accurate. Returns filed must agree with the accompanying BCS as to the number of returns in the batch, the amount of money received (as shown in the returns), excess credit, etc. The initial validation system must be designed to ensure that the information recorded in the computer is the same as that on the returns, even if the information on the return is absurd. For example, if the taxpayer reported that 2 + 2 = 3, it should be so recorded; the error correction process at the time of validation should correct only errors of transcription (inputting). Once entered into the computer, the return should not be amended in any way. Later on, there will be other processes for correcting errors made in the returns and sending taxpayers an official assessment, when necessary. The only purpose of the initial validation process is to guarantee that the computer and the returns contain the same data. This should be kept totally separate from the official assessment process, which should take place at a different time.

A deadline should be set for completing the processing and validation of returns. In no case should the time limit exceed one to two weeks from the date the return is filed. For VAT administration, timely information is crucial. Investing in more efficient equipment is useless if data are not entered correctly and on time.

Information Systems to Be Developed

Priority should be given to the following systems:

VAT Register. This is the identification master file. The system should provide the tax offices with a list of VAT registration numbers to be assigned, issue tax certificates, keep the VAT register up to date, produce a list of taxpayers withdrawn from the register, and provide the tax offices with a list of taxpayers sorted by economic activity and level of turnover.

Preprinting Tax Return Forms or Taxpayer Identification Labels. This system should print name, address, VAT number, and economic activity code on blank tax return forms or on adhesive labels for mailing to taxpayers.

Accounting. This system should validate the BCS and the tax returns received from the banks and record the amount of taxes collected by banks in cash or checks.

Tax Return Files. This system should maintain cross references between tax returns received and the location of the batches where the returns were filed.

System to Control Remittances from Banks to the Treasury or Central Bank. This system should check that the VAT collected by the banks is deposited with the treasury (or central bank) within the time limit.

Control of Stopfilers. This system identifies stopfilers, prints reminder and warning letters, and follows up on actions taken by the tax offices.

Current Ledger Accounts of VAT Taxpayers. This system registers all the VAT tax returns submitted by taxpayers and all the VAT debits and credits.

Control of Excess Tax Credit Applied to the VAT. This system detects incorrect tax credit carried forward by the taxpayers, prints reminder letters, and follows up on the action taken by the tax offices.

Control of Penalties. This system detects penalties incorrectly paid, prints reminder letters, and follows up on the action taken by the tax offices.

Control of Refunds. This system records and controls refunds and should be linked with the systems for controlling excess credits and for selecting cases for verification.

Selection of Taxpayers for Audit. This system selects taxpayers for audit, using, as far as possible, the criteria set out in Chapter VII. These criteria should be applied to homogeneous groups of taxpayers, for example, those with similar turnover level, economic activity, and geographic location.

Audit Support. This system reproduces data included in the VAT tax returns submitted by taxpayers, pointing out arithmetical and other errors, such as tax credits incorrectly carried over. External information systems should process and file information on taxpayers’ economic transactions such as imports, exports, sales made to government agencies, and sales made to large firms. Upon request by the tax offices, these systems should provide details on information filed in support of selection and verification for audit purposes (Chapter VII describes the main features of these systems).

Follow-Up of Appeals. This system follows up on appeals procedures and establishes relative performance of tax offices and auditors regarding the ratio of appeals to assessments.

Centralization or Decentralization of EDP?

Data processing tasks can be performed with different degrees of centralization or decentralization. Although there are no general rules for defining an adequate degree of centralization and/or decentralization, it is better to avoid extremes. In general, in many developing countries external considerations will determine the degree of centralization. For instance, poor communications (post, telecommunications, etc.) may require district offices to do more of the processing, whereas existing surplus capacity on mainframes will make central processing more economical, and so on.

When new procedures are introduced, a high degree of centralization is advisable, so that it is possible to monitor and control unforeseen situations. Once procedures have been sufficiently tested, it is better to move toward decentralization. This makes it possible both to bring data processing closer to where the taxable events occur, and therefore speed up data gathering and error correction, and to actively involve the operational units with the information systems. The latter point is of fundamental importance if the information systems are to yield results that have a practical value for tax administration. Enforcement is the duty of the officials of the operational units, and the systems’ objective is to support them in their work. This will not be achieved, however, if these officials do not participate in the design and operation of the information systems.

Penalties

As with any other tax, compliance with VAT will depend largely on how well taxpayers are informed of their obligations and on how rigorously penalties for noncompliance are enforced. It is not enough to enact penalties in the VAT law—the penalties must actually be applied.

Penalties should be sufficiently high so as to deter evaders.4 A tax system can be expected to function smoothly and produce its full revenue potential only if penalties exist and are regularly enforced. In many countries, the strictest penalties set out in the tax code, such as prison sentences, are rarely, if ever, applied. In other cases, even less strict penalties have been rendered ineffective by the granting of tax amnesties.

Taking into account the experience of countries in which VAT has been established, it is strongly recommended that reasonably high fines be imposed for violations that strike at the heart of the VAT, such as failure to register, to issue invoices, to file returns, and to pay the tax. Penalties should be prescribed for failing to issue an invoice and for issuing an invoice that understates the value of the transaction or the amount of the VAT charged, or is false in any other way. As the VAT invoice is the key to control and is evidence that the seller has charged the VAT that he must pay to the government, the failure to issue an invoice or to keep copies should be treated as a very serious offense.

The penalty for failure to pay the tax by the due date (which should be X percent for the first month or part thereof plus Y percent for each following month or part thereof) should be applied automatically to all late payments and should not be waived by any authority.

Apart from fines, there are other penalties that can impose a severe financial burden on noncom-pliant taxpayers. In Bolivia, Chile, the Philippines, and Taiwan Province of China, for example, VAT taxpayers who commit certain offenses may be punished with a temporary shutdown of their premises (or with the suspension of their trading license, which has the same effect and is a penalty successfully applied in several states of the United States to enforce sales taxes). This type of nonfinancial penalty has been successful in improving compliance and could be applied for the repeated nonissuance of invoices. It could also be considered for taxpayers who persistently fail to file a return after being officially reminded to do so.

A penalty that imposes a considerable financial burden is suggested for those who fail to register. Once identified, taxpayers who have made taxable sales without registering for the VAT will be assessed the full tax on these sales but will not be allowed to deduct the tax paid on their purchases.

Penalties that impose a financial burden on taxpayers and can be applied without resorting to criminal courts are more likely to be applied than imprisonment, but imprisonment should be included in the statute as the ultimate deterrent. The commissioner of taxes should be granted authority to impose fines and other financial penalties (including shutdown of business premises) mentioned above.

Annex I. Example of Application Form for VAT Registration
1

The check digit is calculated according to a mathematical formula. The TIN number and the check digit should be consistent with the formula. If numbers get transposed when a TIN is written, the check digit and the numbers of the TIN will not be consistent and, therefore, the error will be detected.

2

The categories used in the ISIC consist of major divisions (one-digit codes), divisions (two-digit codes), major groups (three-digit codes), and groups (four-digit codes). The codes for the divisions range from 1 through 9, and each division may be divided into nine major groups, at the third digit of the code. (Details can be found in “International Standard Industrial Classification of All Economic Activities,” Statistical Papers, Department of Economic and Fiscal Affairs, United Nations, 1986.)

3

As mentioned above, part of the processing (data entry) can be done by the banks.

4

A detailed discussion on penalties can be found in Alan A. Tait, Value-Added Tax: International Practice and Problems (Washington: International Monetary Fund, 1988).

    Other Resources Citing This Publication