Familiarization with the Value Added Tax

Table of contents

Introduction
Chapter 1: The necessity of using the Value Added Tax
Chapter 2: The definition of the value added tax
Chapter 3: The history of the value added tax
Chapter 4: The method of implementing the value added tax
Chapter 5: Tax exemptions in the value added tax system
Chapter 6: The tax exemption threshold
Chapter 7: The relation of VAT and the law of aggregation duties
Chapter 8: The starting date of implementation of the value added tax system

Introduction

Tax is one of the important sources of government revenues. Stability and continuity of the flow of tax collection, play an important role in the government plannings for providing variety of the required public services in different areas.
Change and reformation of national economy and, as a result,  changes  in the style of production and distribution of wealth and income; requires rethinking of the existing taxes and their methods of tax collection.  Implementation of  the value added tax by more than 120 countries, all over the world, shows the efficiency and acceptability of this new kind of taxation in providing a reliable source of incomes for governments. Implementation of the VAT with a fixed rate, makes the forecast of government incomes possible resulting in possibility of better planning. On the other hand, the short term characteristic of collection of the tax, guarantees the continuity of the flow of income into the government's treasury.

Necessity of implementing value added tax

As mentioned above, tax is one of the main sources of government's incomes, which is collected under different names. The tax incomes make an important portion of the government's budget. In democratic countries where the tax system is supported by a lawful and participatory system; more than of 60% of the government's income in the budget come from tax incomes.

In Iran economy, according to the guidelines of the 3rd socio-economic and cultural development plan, and in order to decrease the government's budget dependence on the petroleum incomes, it was decided to increase the tax share in the composition of the government's revenues  by expanding the basis of taxation and by using the value added tax model.

Due to the above point and in accordance with the content of article 59 of the law of the 3rd development plan; the State Tax Organization ,  under the control of the Ministry of Economy and Finance, was established. Among the duties of this organization towards reforming and computerizing the taxation system of the country; implementing the value added system is one of the main duties of the State Tax Organization .

The reasons for choosing value added system by various countries are different, but the experience of those countries, which have been using the VAT, shows the following numerous benefits they get by using this new kind of taxation:

1.Value added tax is a methodology and way of thinking which shows a positive experience for many decades in different  countries, and is recommended by  majority of the economic and financial experts of the World Bank and International Monetary Fund.

2.In many countries which have used this kind of taxation model, the VAT used as a new source of income generator for governments and resulted in more social equity than the other tax models , without any negative effects on investment and production motivation.

3.Due to the fact that value added tax model is a self control system, which every tax payer plays the role of tax collector; the cost of tax collection is minimum.

4.Due to the fact that in VAT, the tax payers, for getting the tax credit, are required to present invoice; the situation for automatic recognition of the amount of tax payers transactions will be prepared, and as a result a comprehensive information system including all the transactions will be generated which, in addition to transparency of transactions between business units, will facilitate implementation of other taxes such as tax on incomes and businesses units.

5.Value added tax is a reliable, consistent, and at the same time,flexible source of income.

6.Due to the fact that VAT has a fixed rate, the time period for the tax to become definite is very short and it hasn't the difficulties of long time period of becoming definite in the cases of the tax on income and wealth.

7.Due to the fact the VAT is a new and modern model, its implementation results in improvement of technology, productivity of taxation system and taxation accounting  through office automation.

The definition of the Value Added Tax

Value added tax is not only a simple taxation system, but also is the most common model used in the world today. So, before any thing else, we should know the meaning of value added and value added tax. From economic point of view, the value added is the difference between the worth of outputs and inputs. But in compilation of the law, it is defined according to the accounting standards and by relaying on invoice method. By considering the above point, the value added is defined as the difference between the value of the goods and services supplied and  value of the goods and services bought by a person in a specific period of time.

By considering the above definition, the value added tax is a kind of multiphase tax, which is calculated and collected according a percentage of value added of the goods and services produced and supplied in the process of production and distribution cycle. This tax in fact, is a kind of tax on multiphase sales, which exempts the purchase of intermediate goods and services from tax payment.

History of the value added tax

The value added tax system was first introduced by Von Siemens in 1951. In fact, it was designed in order to solve the financial problems of German government. But in spite of the intense inclination and tendency of some countries such as Argentina and France to know about its structure; the VAT wasn't implemented by any country until 1954. After 1954, Brazil, Denmark and Germany; were among the first countries which introduced the VAT in their taxation systems. In Asia;  South Korea was the first Asian country, which in 1977 with the help of International Monetary fund (IMF), succeeded to implement the VAT in its taxation system. Subsequently, other countries such as Turkey, Pakistan, Bangladesh and Lebanon used the VAT as their taxation system. At present; more than 120 countries are using VAT as their taxation system.

In order to implement this kind of taxation model in Iran, the bill of VAT was first presented to the Islamic Consultative Assembly (Parliament) of Iran in January of 1987 by the government of that time. The VAT bill was reviewed by the Economic Committee of the Parliament and after making necessary revisions, it was presented to the Parliament for voting. After approving 6 Articles, due to   government request and for the reason of stabilizing the prices (economic adjustment policies) it was returned to the government.

In 1991, the financial department of the International Monetary Fund, for the purpose of reforming Iranian taxation system, proposed the use of VAT policy as one of the main factors for increasing the efficiency and reforming taxation system of Iran. Following  suggestions of the IMF experts; several studies on this subject have been made in the Ministry of Economic Affairs and Finance and  implementation of the VAT in Iran was discussed and agreed by majority of the internal and external experts, but  it wasn't implemented in practice. The Ministry of Economic Affairs and Finance, in accordance with its plan for economic mobilization of the country started the projects of reforming the taxation system and omission of different kinds of exemptions and duties  by substituting the larger tax basis. The feasibility studies of the above project have also been carried out. Due to importance of expanding of tax basis, as one of the main principles of the policy of economic stabilization, the taxation Deputy of the Tax Revenue Department of the Ministry of Economic Affairs and Finance, since 1997 has carried out a number of  scientific researches on socio-economic and cultural impacts of implementing the VAT in Iran. The bill of the value added tax (new version) after considering the economic effects of implementing VAT, and after several revisions, has been presented to the Parliament.

Implementation method of  the value added tax

According to the Value Added Tax system, every seller, at the time of selling of goods and services, will add the relevant tax on the invoice and collects it together with the price of goods and services from the buyer. the first seller pays the tax in whole to the government, but in the next stages, each seller pays to the State Tax Organization only an amount equal to difference (collected tax after deducting the tax which he has paid previously). This, will take place within two month period according to the proposed bill. To clarify the procedure of the VAT, one should pay attention to the following paragraph:

A car manufacturing company for producing its cars, buys its required parts from domestic market (part producers) and from external market (import). If we suppose that the value of internal supplied parts is 10 million Rials and the value of importing parts is 6 million Rials, and if we suppose that the value added tax rate is 10%; this company should pay (10,000,000*10%= 1,000,000) when he buys from internal market and should pay ( 5,000,000*10%= 500,000) when he imports parts  as value added tax to the State Tax Organization. Also, if this company sells its cars at 4o million Rials, when he prepares the invoice, must calculate the value added tax and is obliged to receive it from the buyer when he prepares the invoice ( 40,000,000 *10%= 4,000,000) . It is obvious that the price of the car for the buyer will be 44,000,000 Rials. The car manufacturing company must deduct its payment of tax in previous stages ( tax paid on buying from internal market and importation (which was 1,500,000 Rials)from the tax collected ( 4,000,000 Rials), and pay the remaining amount which is 2,5000,000 Rials with the tax declaration (return)  form to the State Tax Organization.

Tax received – (tax paid to internal part producer + tax paid on import) =VAT payable

4,000,000 - (1,000,000 + 500,000) = 2,500,000

As we can see,  total value added tax paid to the State Tax Organization is 4,000,000 Rials which is the sum of (1,500,000 + 2,500,000).

The above procedure has been shown in fig.1

Tax exemptions in value added tax system

In general, some goods and services are exempted from taxation due to the following reasons:

1. Decreasing the regressive virtue of the value added tax

2. Deceasing the effects of inflation and supporting low income groups

3. Decreasing the tax implementation and collection costs

The cases of tax exemption are highlighted in the article 13 of the value added tax bill.

The tax exemption threshold

Considering the fact that the value added tax, includes all the goods and services produced and/or distributed in economy, from implementation point of view, it has a special expanded tax basis. Regarding the above point, the value added of small businesses and retailers, in comparison with their large number, is two small; so the collection of their value added tax it is not justifiable. Exemption of small businesses with low value added has an important effect on increasing efficiency of the State Tax Organization.

The review and analysis of other countries experiences shows that, most of them, in order to decrease the collection costs of taxation and tax compliance, have made use of a tax threshold, and exempted many small businesses and retailers from tax payment. Defining and using the tax exemption threshold, helps the State Tax Organization to minimize its tax collection costs and maximize its efficiency in collecting the potential value added tax.

Due to the above points and studies and researches which have been carried out  by the economic experts, the tax exemption threshold in Iran has been considered at 1000 million Rials annual incomes.

Relation of the VAT and the law of aggregation duties

In line with the program of reforming the taxation system, the law of aggregation duties was introduced by the State Tax Organization from March of 2003.

The aim of the above law was not only the transparency and integration of the collection of duties, but also preparing the tax assessors for implementation of the value added system in the future.

Starting date of implementation of value added tax system

Due to the fact, that implementation of the VAT according to requires  infrastructures such as buildings, equipment,  training of the taxpayers and  the required tax personnel, designing  new forms and procedures, the State Tax Organization should prepare itself to implement the VAT, 24 month after the approval date of the bill.

It is hoped that the 6th Parliament, by approving the bill of value added tax, takes a major step towards reforming of the economic and financial structure of Iran.