VAT reform: Let’s not make it complicated

Indirect taxes that cover Value Added Tax (VAT), Special Consumption Tax (SCT), Banking and Insurance Transaction Tax (BITT) make a significant contribution to Turkey’s total tax revenues: Approximately 60 percent, which is double the OECD average of 30 percent.Indirect taxes that cover Value Added Tax (VAT), Special Consumption Tax (SCT), Banking and Insurance Transaction Tax (BITT) make a significant contribution to Turkey’s total tax revenues: Approximately 60 percent, which is double the OECD average of 30 percent.

VAT alone accounts for almost 35 percent of Turkey’s tax revenue, and therefore plays an essential role in the Turkish tax system. But in practice VAT has many problems. These problems include a prevalent use of fraudulent invoices and a long and tedious VAT refund process that urgently needs solving for the health of the whole economy. That is why redesigning the system has become a priority for policymakers, with a comprehensive reform expected in 2018.

If we compare SCT with VAT, our two main consumption taxes, we notice that the former has few faults, functions fairly well and provides a reliable tax income to the government. The latter, on the other hand, generates large-scale problems that undermine the entire tax system, the VAT collected at customs notwithstanding. Since the VAT on imports is highly manageable and relatively easy to control, the focus should be on domestic VAT, which needs to look more like SCT. This would curb the ever-growing problem of fraudulent invoices and the refund issue. 

Here is a to-do list for streamlining the VAT system:

1) Exclude some sectors. The transactions of banking and insurance companies are subject to BITT. When these institutions purchase something subject to VAT, they are treated as ordinary consumers. This practice causes no problems, which shows that it is possible to exempt certain sectors from VAT. So instead of insisting on one percent VAT and pushing for reams of unnecessary VAT-related documentation, it would be much more effective to tax those businesses/industries with high tax revenue potential and minimum tax administration costs. For instance, why don’t we exempt raw or non-processed foods, instead of demanding them to pay the one percent tax? Such a move would also incentivize the development of domestic agricultural production.

2) Take it to the last or first stage depending on the sector. In some sectors, covering all stages of the value chain is much more costly than taxing one of the stages.  As successfully applied in SCT, taxing only the final/initial stage could be more effective, given that some of the stages are difficult to tax. 

3) Omit all “services” and list only the ones subject to tax. “Service” businesses, such as independent professional services, represent the most challenging area of VAT taxation. That is why there are so many reverse-charging regulations i.e. making buyers rather than sellers responsible for the payable tax. The list is very long. Some of them, with their deduction rates, are cited here to give an idea: Construction (2/10), market research (9/10), machinery/equipment repair (5/10), catering (5/10).  Rather than having such a complicated system, we could focus on easier services with high tax potential, such as aviation or shipping (cargo).

4) Deterrent punishment. We do have imprisonment penalties in Tax Procedural Law (TPL) for fraudulent invoice issuers and users. But they are barely enforced. Very few perpetrators have been jailed to date.  These penalties ought to be enforced to intimidate those abusing the VAT’s credit mechanism.  The law should also include a specific crime to cover the traders of fraudulent invoices who receive commission for the fake bills they supply. The prison time for this crime should be at least double the current prison time for tax crimes defined in TPL.

5) More steps should be taken to reel in the informal economy. VAT-related problems are especially apparent in the informal (shadow) economy. We need more incentives to encourage more formal business practices and more severe penalties to discourage informal practices. For instance, not notifying a tax administration about establishing a new business on time is determined a First Class Irregularity in TPL but the fine for this offense is only 130 TL, as of 2017.

6) In conclusion, we should redesign the VAT system in a way that suits the context of our country. To achieve this, we need to work on some longstanding formulas that reflect Turkey’s own experience with indirect taxes.

Alper C. DEMİR is a tax auditor