World Bank Document

DISCUSSION PAPER Public Disclosure Authorized Report No. DRD228 DEVELOPMENT OF A VALUE ADDED TAX IN COLOMBIA By Guillermo Perry and Alba Lucia Orozco de !ciana Mejia? Millan y Perry Ltda Bogota? Colombia Public Disclosure Authorized February 1987 Development Research Department Eco~omics and Research Staff World Bank Public Disclosure Authorized The World Bank does not accept responsibility for the views expressed herein which are those of the author(s) and should not be attributed to the World Bank or to its affiliated organizations. The findings, interpretations, and conclusions are the results of research supported by the Bank; they do not necessarily represent official policy of the Bank. The designations employed, the presentation of material, and any maps used in this document are solely for the convenience of the reader and do not imply the expression of any opinion whatsoever on the part of the World Bank o·r its affiliates concerning the legal status of any country? territory 9 city 9 area 9 or of its authorities~ Public Disclosure Authorized or concerning the delimitations of its boundaries 9 or national affiliationo DEVELOPMENT OF A VALUE ADDED TAX IN COLOMBIA By Guillermo Perry and Alba Lucia Orozco de Triana Mejia, Millan y Perry Ltda Bogota, Colombia February 1987 Development Research Department Economics and Research Staff World Bank The World Bank does not accept responsibility for the views ~xpressed herein which ate those of the author(s) and should not be attributed to the World Bank or to its affiliated organizations. The findings, interpretations, and conclusions are the results of research supported by the Bank; they do not necessarily represent official policy of the Bahk. The designations employed, the presentation of material, and any maps used in this document are solely for the convenience of the reader and do not imply the expression of any opinion whatsoever on the part of the World Bank or its affiliates concerning the legal status of any country, territory, city, area, or of its authorities, or concerning the delimitations of its boundaries, or national affiliation. ABSTRACT The paper describes the development of a VAT to suit Colombia's need, the major problems with administration and structure (before and after the 1974 reform) and changes in the VAT during the 1983-84 Tax Reform. The paper presents guidelines for the effective coordination of the VAT with other taxes, and for planning and administering the VAT in economies with a significant foreign trade sector, and for deciding on the number of rates and the coverage of the VAT. This paper was prepared for the Conference on Value Added Taxation in Developing Countries, sponsored by the Public Economics Division, Development Research Department, The World Bank. Table of Contents Page No. I. Development of the Value Added Tax in Colombia •••••••••••••••••••••• ! II. Major Problems With Administration and Structure •••••••••••••••••••• 6 A. Prior to the 1974 Tax Reform •••••••••••••••••••••••••••••••••••• 6 B. Between 1974 and 1983 ••••••••••••••••••••••••••••••••••••••••••• 7 1. Differential Rates, Zero Rated Goods and Refunds •••••••••••• ? 2. The Difference between Processed and Unprocessed Goods •••••• 8 3. Problems with Vertical Integration •••••••••••••••••••••••••• 8 4. Problems with VAT Concerning Imports and the Resale of Imports ••••••••••••••••••••••••••••••••••••••••• 9 c. After the 1983 Reform ••••••••••••••••••••••••••••••••••••••••••• 9 III. Comparative Analysis of the VAT Structure Before and After the 1983-1984 Tax Reforms •••••••••••••••••••••••••• 10 A. Neutrality and Control ••••••••••••••••••••••••••••••••••••••••• 11 1. Neutrality, Theoretical Aspects •••••••••••••••••••••••••••• 11 2. Problems with Control.. "Neutrality" in Practice ............ 13 3. Conclusions •••••••••••••••••••••••••••••••••••••••••••••••• 18 B. Rates and Incidence •••••••••••••••••••••••••••••••••••••••••••• 18 C. Taxing Capital Goods ••••••••••••••••••••••••••••••••••••••••••• 20 D. Revenue Considerations ••••••••••••••••••••••••••••••••••••••••• 22 E. Services.a•o•••••••••••••••••••••••••••••••••••••••••••••••••••24 IV. Additional Administrative Considerations ••••••••••••••••••••••••••• 25 A. Administration of Income and Added Value Taxes A Joint Approach •••••••••••••••• ~···•••••••••••••••••••••25 B. Preparation of the Tax Administration for the 1974 and 1983 Reforms •••••••••••••••••••••••••••••••••••• 28 1 • 19 7 4 Reform •••••••••••••• o ••••••••••••••••••••••••••••••••• 2 8 2. 1983 Reform ................................................. 29 a. Information Systems •••••••••••••••••••••••••••••••••••• 29 b. Auditing ................................................. 30 Appendix ................................................................... 3 2 Footnotes •••••••••••••••• ~ ................................................ 36 Tables 1. Relative Revenue Importance of the Various Sales Tax Rates 1965-1968 2. Services Included and Rates 3. Distribution of Sales from Manufacturing Firms 4. Marketing Margins for Manufactured Products 5. Concentration in the Retail Trade (1970 - Census) 6. Concentration in the Wholesale Trade (1970 Census) 7. Increase in Taxpayers Due to Extension of VAT to the Retail Level B. Incidence of Increase in Collections By Rate Groups 9. Sales Tax Collections 10. Sales Tax Returns by Sector - 1984 Sample - 1 - I. DEVELOPMENT OF THE VALUE ADDED TAX IN COLOMBIA A sales tax was established in Colombia in 1963 through special authority granted by Congress in order to respond to a serious fiscal crisis. Until that time, there had been only excise taxes on tobacco, alcoholic beverages and cotton. 1/ However, a lack of administrative preparation necessitated postponing its application until January 1965. 2/ Initially, this was to be a single stage tax applied at the manufacturing level. It was to cover only "finished" goods, and sales between industrial firms would be exempt upon presentation of a certificate from the purchaser to the effect that the product in question would undergo subsequent transformation. Yet, so as to avoid any form of double taxation, firms were allowed to reduce the sale price of goods in accordance with the cost of those raw materials on which a tax had been paid for any reason whatsoever. These provisions were extremely difficult to administer. Subsequently, in 1966, all sales between manufacturing firms were taxed (Decree 1595 of June) except those to buyers producing tax exempt goods or products for export; and manufacturers were allowed to credit taxes paid on the purchase on inputs "incorporated" into the product. In 1968, credit was extended to include all taxes paid on inputs "totally consumed" in the production process (Decree 2049 of July) and later, in 1974, to include taxes paid on any purchase made by the firm, except the acquisition of capital goods (Decree 1988 of October). Consequently, this gradually became a kind of "gross product" value added tax at the manufacturing level; more precisely, a "consumption plus gross investment" type of VAT, limited to manufactured goods (plus some services). - 2 - The tax on capital goods and subsequent ruling against crediting taxes paid on their purchases, was defended by reasons of simplicity in terms of administration and collection. 3/ However, there were also economic arguments in its favor based on the fact that capital goods were subsidized by the exchange rate policy and by low interest rates. 4/ Similarly, the tax first applied to imported finished manufactured goods at only one stage that of sale -- with provisions intended to avoid double taxation like those previously mentioned. Since this tax did not apply to direct imports, which were becoming common, in 1971 all manufactured goods began to be taxed at the moment of import (Decree 435 of March ). 5/ Exports, foodstuffs, drugs and textbooks were exempt from the beginning. The sale of inputs utilized to produce such goods was also exempt by virtue of certification from the purchaser. The difficulties encountered in controlling this procedure occasioned its elimination in 1974 and a system of zero-rating and refunds was created in its place. However, this reform considerably extended the list of zero rated goods, particularly with respect to transportation equipment, agricultural machinery, equipment and inputs, thereby making the refund process a headache for tax authorities. So as to compensate for regressivity inherent in the tax, differential rates were established from the beginning, in addition to an exemption on foodstuffs. These ranged between 3 percent (basic), 5 percent, 8 percent and 10 percent. Later in 1968, the 5 percent rate was eliminated and the 10 percent increased to 15 percent. In 1971, rates were raised to 4 percent (Basic), 10 percent, 15 percent and 25 percent. 6/ The most complete - 3 - studies on incidence of taxation in Colombia 7/ concluded at the time that, although exemptions granted a slight degree of progressivity in the first 4 deciles of income distribution, the tax was extremely regressive from then on, even despite differential rates. In 1974, the basic rate was increased to 15 percent and a 6 percent preferential rate was set for "wage goods" (clothing, footwear and major inputs used for building popular housing) and capital goods, plus a 35 percent rate on luxury consumer goods. 8/ Moreover, this reform eliminated certain protectionist elements in the tax which imposed higher levies on selected imports than those applying to domestically produced

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