Indirect tax administration: Best international practices
November, 17th 2008
When one door of happiness closes, another opens; but often we look so long at the closed door that we do not see the one which has been opened for us.
Indirect taxes constitute one of the most significant sources of revenue for the Government of India. For efficient revenue collections, a sound administrative system is a prerequisite. While tax policies and tax laws create the potential for raising tax revenues, the actual amount of taxes flowing into the government treasury, to a large extent, depends on the efficiency and effectiveness of the revenue administration. Quality of indirect tax administration is both a key economic indicator and a driver.
The quality of revenue administration influences the investment climate in the country. Foreign firms contemplating investment are not only concerned about the formal tax system, but also with how the system works. A revenue administration that is perceived to be arbitrary or predatory discourages investment. Further, weakness in enforcement capacity of the revenue administration puts lawabiding firms at a competitive disadvantage, as others are allowed to get away with tax evasion.
Weakness in revenue administration leads to inadequate tax collections. Financing of the resulting budget deficit through borrowing or monetary expansion can cause an unsustainable increase in public debt or inflation, respectively. In the alternative, revenue shortfalls shrink the budgetary resource envelope, thus affecting the governments ability to implement its policies and programs and provide public services. Unexpected dips in revenue collections also cause budget cuts that result in major inefficiencies in public expenditure management.
Finally, reform of the revenue administration may be needed to enable it to keep up with the increasing sophistication of business activity and tax evasion schemes. With globalization, goods and services are produced by taxable entities in multiple countries. This presents vast opportunities for manipulating transactions to reduce the tax burden. The existence of tax havens, electronic financial transactions and the increasing use of the Internet in commerce pose major challenges in enforcing tax laws. Even run-of-the-mill domestic taxpayers are increasingly using information technology for running their businesses and for accounting. Without a matching increase in the professional and technological capacity of the revenue administration, its chances of monitoring taxable activity and countering tax evasion are seriously reduced.
It is pertinent to mention that indirect tax administration should be such that it creates a respect for rule of law. This is most important inasmuch as it would not only lead to efficient tax compliance but also transparency in the system.
Tax Design and Tax Administration
Tax design and tax administration are critical means to establishing an efficient revenue gathering mechanism in a country. Most of the countries of the world are striving to put in place an optimal tax administration system. However, there are no standard sets of designs befitting the requirements of all the countries. Jurisdictions differ in respect of their policy and legislative environment and their administrative practices and culture. Each revenue authority faces a varied environment within which it administers its taxation system. As such, a standard approach to tax administration may neither be practical nor desirable in the particular instance. Care should always be taken when considering a countrys practices to fully appreciate the complex factors that have shaped its particular approach.
While different tax and customs administration reform projects in recent years have had country specific variations, most have sought to (i) improve the organization and management of revenue administration; (ii) strengthen the legal and regulatory framework; (iii) broaden the tax base by registering potential taxpayers; (iv) facilitate voluntary compliance; (v) improve capacity to process the massive information flows resulting from declarations filed by taxpayers, payment transactions and administrative actions; (vi) enhance availability of information about taxable transactions and administrative actions; (vii) develop risk-analysis capacity to zero in on cases involving potential violations of tax laws; (viii) strengthen investigation, audit and enforcement capacity; (ix) improve appellate procedures; (x) enhance analytical ability to carry out fiscal studies to assess tax burdens, collection trends, compliance gaps and impact of tax policy changes; and (xi) reduce corruption.
Features of an ideal Indirect Tax Administration
It is in the interest of tax authorities to communicate their vision clearly and honestly to businesses and to have a simple and efficient communication system for tax payers. The majority of countries have an internet site which offers guidance to tax payers on typical issues but again, the quality of the content and the regularity of updates on these sites varies from country to country. The mission statement and taxpayers charter should be clear and focused. There should be transparency and fairness in the tax administration. Further, clear guidance and open communication between authorities and businesses is a key requirement for an ideal tax administration. Automation of processes and procedures are not only essential in view of the rapid advancement of technology but it also ensures quick and smooth compliance. Further, it also leads to reduced discretionary element in decision making of the tax officials. Strategic risk management approach to audit is another key feature of an ideal tax administration. Advanced administrations have found that a well designed audit program is critical to reducing the extent of fraud and evasion. Improvements in audit planning, collection of relevant information, methodology of conducting the audit and training of auditors are the key areas of focus. A few advanced countries have laid down specific guidelines for auditors. Enhancing audit capacity is extremely crucial, as with the increasing sophistication of business transactions, including cross border transactions, it is essential that revenue administration be able to match wits with potential tax evaders.
Organizational Design Models for Indirect Tax Administration
Reforming outdated organizational structures can lead to significant benefits, including more effective and efficient tax administration and improved tax payer compliance. Following are the different kinds of tax models perceived and implemented by various countries:
The type of tax model - The earliest organizational model employed by tax administrators was based principally on type of tax criterion. This entailed the operation of separate multifunctional departments for each tax that was largely self-sufficient and independent of each other.
While this model serves its purpose, it entails numerous shortcomings:
(1) Duplication of functions causes inefficiency;
(2) It is inconvenient for the taxpayers having multiple tax dealings (e.g. businesses), requiring them to deal with different departments on similar issues;
(3) It severely complicates the management of taxpayers compliance, with its
separate audit and debt collection functions;
(4) It increases the likelihood of uneven and inconsistent treatment of taxpayers across taxes;
(5) It impedes the flexible use of staff whose skills were largely confined to one tax; and
(6) It unnecessarily fragments the overall management of tax administration, thus complicating organizational planning and co-ordination.
The functional model - Under the functional model, staff is organized principally by functional groupings (e.g. registration, accounting, information processing, audit, collection, appeals, etc.,) and generally works across taxes.
This approach to organizing tax work was introduced to enable greater standardization of work processes across taxes, to simplify computerization and arrangements for taxpayers, and to generally improve efficiency.
However, this model also is not without its weaknesses-fragmentation by function can lead to poor/inconsistent service while standardization (e.g. a one size fits all approach) may not be appropriate given the myriad of behaviors and varying attitudes to tax compliance to be addressed.
Compared to the tax type model, this model is perceived to offer many advantages and aimed at improving tax administration performance (e.g. providing single points of access for tax inquiries, unified system of taxpayer registration, common tax payment and accounting approaches, and more effective management of tax audit and debt collection functions.)
The taxpayer segment model - A more recent trend among a number of developed countries has been to organize principally around segments of taxpayers (e.g. large businesses, small/medium businesses, wage earners, etc.).
The rationale for organizing around taxpayer segments is that each group of taxpayers has different characteristics and tax compliance behaviors and, as a result, presents different risks to the revenue. In order to manage these risks effectively, the revenue body needs to develop and implement strategies (e.g. law clarification, taxpayer education, improved service, more targeted audits) that are appropriate to the unique characteristics and compliance issues presented by each group of taxpayers.
Grouping key functional activities within a unified and dedicated management structure increases the prospects of improving overall compliance levels. While application of the taxpayer segment model is still in its early stages of use, many countries have partially applied this approach by creating large taxpayer units.
Organizational Model Followed by India for Indirect Tax Administration
India currently follows the Type of tax model of tax administration. This model is followed for each Central indirect tax customs, excise and service tax, and also followed for the State indirect tax, i.e., VAT.
Within the type of tax model, the geographical model is followed. The jurisdiction over the tax matters is geographically distributed to the Commissionerates, Divisions, Ranges and Circles.
Most revenue administrations are moving over to a functional organization structure, as against a structure based on tax types. This involves creating specialized units for taxpayer assistance, processing of tax returns and payments, tax audits, investigation and intelligence, appeals, recovery of tax arrears, financial management, human resource management, fiscal studies etc.
Key Issues in Organizational Design
To sum up, the key issues in organizational design relate to various areas such as technology, costs and benefits analysis, people issues, communication and training. Organization design must keep pace with the ever evolving technological pace. One must of course weigh the pros and cons of organizational design changes.
Communication should be in manner that it makes the potential taxpayers awareness of the general concepts of taxation and why they should pay their taxes. Revenue administration can organize awareness raising campaigns involving TV skits, radio programmes, advertising pamphlets, organising seminars and workshops etc. Last but not the least, the tax officials must be trained in a manner that they can positively contribute to an efficient and ideal tax administration in the country.
Tax is an economic device and with proper usage, it would benefit the country and the people at large. But when it is misused, it would affect all people and make all of them dishonest eventually. This would be the consequence of any ill conceived tax laws; no matter how effective is the tax education in the country. Reforming revenue administration is neither quick nor simple. For revenue administration reform to be successful, critical requirements have to be met, including: a strong political commitment to reform, with clear decisions and the provision of necessary resources; professional and stable leadership; a willingness to abandon old, ineffective practices; and the establishment of a formal reform project with a clear achievable mandate, agreed objectives, and realistic timeframes.
Sustained and well thought out efforts in implementing best practices will modernize Indian indirect tax administration and will facilitate introduction of an All India Goods & Service Tax.
(Author is student of Symbiosis Law School, Pune)
1. The Nuts and Bolts of Revenue Administration Reform By Jit. B. S. Gill, Lead Public sector Management, Specialist Europe and Central Asia Region
2. Background paper prepared for International Tax Dialogue on the VAT, Rome March 15-16, 2005.