Introduction
Taxation is one of the most important activities under fiscal operations in every economy. It is the main source of government revenue. Therefore, effective taxation processes play a pivotal role in determining the ability of an economy to meet the needs of its citizens. Thus, taxation can be viewed as an important practice in helping the government to provide public goods efficiently and effectively. One kind of tax that plays a pivotal role in funding government activities is the Value Added Tax. In the United Kingdom, value added tax is the main source of the government revenue. The value added tax finances the largest fraction of the government spending.
Value added tax can be viewed as the kind of tax that is imposed on all goods and services (Directgov 2011). This is fixed at a certain rate that applies for every product. For instance, the VAT rate was 17.5 percent in 2009 but was increased to 20 percent the following year. It is usually included on the prices before one buys a product. Every business in the United Kingdom is entitled to the value added tax. However, some of the businesses manage to evade tax illegally through fraud.
Despite the importance of the VAT in the UK economy, this kind of tax faces a number of issues in its implementation. Due to the issues arising from its implementation, the UK economy has not managed to optimize the collection of the value added tax. These issues have undermined the efforts to promote effective collection of the value added tax. There are issues that are emerging on the implementation of the value added tax implementation, which calls for appropriate policy changes. As already noted, VAT is one of the most important form of direct tax that forms an important part in the United Kingdom. Since its introduction in 1954, VAT has proved to be one of the most successful forms of taxation in many countries where it has been adapted. In fact, it has been rated as one of the most important fiscal innovation of the century (Adam et al. 2011). Its introduction led to a significant improvement in many economies’ ability to meet public needs. It has also been one of the most efficient methods of collecting revenue for the U.K.
There are several issues that face the implementation of VAT in the United Kingdom. These include exemptions, non-compliance & differentiation, and exemptions. These problems have undermined the government’s effort to raise its revenue effectively to meet the needs of its citizens.
Implementation of VAT in UK
As already noted, every business in the United Kingdom is entitled to VAT. It is imposed in all products and services in the country. While purchasing the goods or services from the final agent in the chain, the price of the products is inclusive of the value added tax. The customer does not need to pay it directly. Value added tax is charged at every stage of production because the producers are forced to pay tax for the inputs used in the production process. VAT can, therefore, be viewed as the tax that is charged for every value added on a product.
Non-Compliance
One of the major issues facing the VAT in UK is non-compliance. In every economy, fraud and tax evasion are some of the major issues that undermine effectiveness in tax administration. Tax evaders and fraudsters have led to as significant loss in the tax revenues collected by the government every year. For instance, it was found that the government lost approximately £ 11.5 billion through non-compliance (Read and Gregoriou 2007). This reveals a significant difference between what the government is collecting and what it could have collected if all the companies and individuals complied with the standards set. The fact that the government loses a significant fraction of its revenue poses a major concern that needs to be addressed in order to solve the problem before it deteriorates.
Although there is a significant gap between the collected and the potential revenue, it is important to note that this difference cannot be fully attributed to the fraud activities. Some of this difference can be attributed to innocent error or legal avoidance. However, this represents just a small fraction. A significant part of this difference can be attributed to tax evasion.
There are two general methods through which tax evasion in the UK takes place. The first one is where the traders tend to understate the taxable sales or overstating its creditable inputs. The other category is where the traders disappear completely without having paid their VAT arrears.
To begin with, the first category is one of the most common categories of tax evasion. There are a number of practices that are involved in understating taxable sales and overstating creditable inputs. For instance, organizations may decide to work cash in hand. By so doing, organizations or individuals fail to record sales that are subject to taxation. Through this process, an organization evades taxation.
Organizations can also fake invoices for input purchases. In this case, organizations or individuals alter the invoice in order to avoid being taxed. Similarly, tax evaders may claim that certain sales are zero rated when they are not supposed to be. Another way that evaders use is exploiting different rates of VAT for various transactions. They take the advantage of the difficulty in policing borderlines to evade tax. For instance, the difference between consumption and business expenditure is one of these factors that foster tax evasion based on the difficulties in policing borderlines. Many businesses have used this method in evading taxes. Most of these problems emanates from the lack of uniformity in the system. This has to a greater extent contributed to tax evasion by many businesses and individuals.
Some aspects of the policy can also foster tax evasion. For instance, the choice of threshold, the speed at which the payments are demanded and the rates at which the refunds are given and the sheer level of resources devoted to HMRC’s enforcement activities also plays a significant role in determining tax evasion (Adam et al. 2011).
Another major form of tax evasion that significantly contributes in tax evasion is when large companies have large VAT liabilities. However, this risk is mitigated by dividing the VAT on final scale evenly across the supply chain. Therefore, the trader does not gain significantly by disappearing. This has significantly helped the policy makers in reducing the gap between the potential and the actual VAT.
In most cases, the traders with more liabilities than turnover are more likely to evade VAT than those with fewer liabilities.
Solution
In order to solve the problem of tax evasion, it is advisable to broaden the VAT base. By so doing, an organization will be in a position to maximize its VAT. Reduction of the number of boundaries will significantly help in reducing the chances of misclassification (Schenk and Oldman). This will minimize errors and evasion.
In order to reduce disappearance of the traders in tax evasion, it is necessary to facilitate even distribution of the tax along the supply chain. By so doing, the gains for an individual trader for escaping will be reduced. Therefore, the traders will not have any incentive to trade off their long term goals just for negligible gains.
Export Zero-Rating and Compliance
Zero rating is where the government refrains from taxing certain products. This can be made in order to provide certain incentives or to promote availability of certain product that may be basic or important to the entire population. However, zero rating has contributed to VAT non-compliance. By zero rating the exports, the traders gain a lot from the authority through large scale refunds. However, the government is able to recover through the tax charged on the inputs. Therefore, when the companies evade taxation through fraud activities, the government will lose significantly and will collect taxes whose total differs considerably from what they ought to have collected. In fact, the authority may end up losing more through refunds on exports than what they collect through the tax imposed on the inputs (Read and Gregoriou 2007).
For instance, the missing trader intra-community in the 2000’s is one of the frauds where this took place across the EU. As a result, the authority loses significantly from such activities. This implies that there is a need for a more effective approach of dealing with zero-rated products. As a result of these frauds in UK, the treasury projections on expected receipts were billions of pounds above what was actually realized. In 2006, the economy recorded a staggering £20.7 billion of trade flows associated with MTIC fraud in the first half of 2006 alone (Read and Gregoriou 2007).
Zero-rating has also led to carousel frauds. In this case, importers purchase products that are not taxed or that are zero rated and then adding VAT while selling to another trader as if the commodity was taxed and then disappearing with the VAT due. By so doing, the main efforts of zero rating commodities are undermined. Consequently, the buyers end up buying certain commodities at unnecessarily higher prices. These frauds reveal that there is a need for the authorities to change the zero-rating system in order to mitigate such frauds. The country lost significantly through these kinds of frauds.
From the past studies, it has been identified that these frauds were triggered by the break in the VAT chain at export (Adam et al. 2011). This problem has resulted from the authorities paying more out of the system than what is really entering into the system. This has significantly reduced the total revenue to the government. This has been one of the major challenges in the AU since its development in 1993 (Schenk and Oldman 2007). The UK has lost a significant amount of its revenue from such activities. In the AU, border controls have been banned as a way to promote free trade among the members. As a result, the ability of a nation to raise revenue at the borders has been nullified. Consequently, this has opened new avenues for fraud activities. After the border controls were lifted, the authority has to use paper trail to raise tax revenue. This involves account auditing to raise revenues. This process increases the chances of tax evasion. Traders can easily dodge and escape without paying any tax.
In an attempt to solve this problem, the government has tried to practice reverse charging. In business to business transactions, reverse charging will place the liability on the buyer and not vice versa. This has helped the authority to mitigate fraud. Through reverse charging, it is possible to prevent frauds by preventing an entity that have purchased a product from claiming back input VAT, which has not actually been paid. This can significantly help in solving the problem arising from these frauds. When reverse charging is effectively employed through the line, there is no possibility of collecting anything until the final transaction is made. This process has been effectively implemented in computers and mobile phones.
VAT Implementation at the International Level
At the international context, the implementation of the VAT becomes very crucial. In this case, the AU plays a significant role in the operation of the EU. AU is one of the key players in making VAT policies. In connection to this, the UK has been forced to adopt certain policies as a precondition to be a member of the community. This has to a great extent affected the implementation of VAT in the economy. For instance, the AU forces the members to adhere to reduced rates, forbids extension of zero rating to new items among others (Schenk and Oldman 2007). It also sets the minimum standard rates. All the members are expected to follow these agreements. The AU has also implemented policies that discourage the members from imposing tax to the member countries. In this case, the UK is forced to remove VAT tax imposed on imports from the members’ states. This causes lack of uniformity in the taxation process consequently encouraging frauds (James 2009). When tax is imposed only to some traders, non-member countries may take the advantage to import their goods under the umbrella of another member country. The authority may end up losing a significant amount of tax.
Conclusion
In conclusion, this discussion has clearly revealed that VAT is one of the kinds of taxation that plays a pivotal role in the UK’s economy. It contributes to a significant fraction of the government revenue. However, the difference between the potential and the actual VAT collected by the government in UK remains very high. This gap can be attributed to the methods applied in imposing this kind of tax. This raises a need to have changes in the taxation systems in order to maximize the annual VAT collected in the economy. The UK government has however managed to mitigate these frauds by practicing reverse charging.
Reference List
Adam, S. et al. 2011. Tax by Design. New York, Oxford University Directgov. 2011. VAT Basics for Consumers.
James, M., 2009. The UK Tax System: An Introduction. UK, Spiramus Press Ltd.
Read, C., and Gregoriou, G.N., 2007. International Taxation Handbook: Policy, Practice, Standards and Regulations. Burlington, Elsevier.
Schenk, A. and Oldman, O., 2007. Value Added Tax: A Comparative Approach. Cambridge, Cambridge University Press.