13 Self-Assessment by Taxpayers
- Liam Ebrill, Michael Keen, and Victoria Perry
- Published Date:
- November 2001
The VAT can play a pivotal role in developing modern methods of tax administration, based on effectively monitored voluntary compliance. This chapter deals with its role in respect of a key aspect of this approch to tax administration: self-assessment.
Under a system of voluntary compliance (meaning that taxpayers comply with their basic tax obligations without the intervention of a tax official) taxpaymers self-assess: that is, they calculate and pay their own tax liabilities. They must complete their returns and submit them with their payments to the tax administration. If they do not, the tax administration detects this failure and takes appropriate enforcement actions, including applying the penalties specified in the law. Returns are then subject to the possibility of audit.
In many countries, the development of self-assessment is closely linked to the rise of the VAT. Thus, in countries such as France and the United Kingdom, while VAT systems and procedures have been built around self-assessment from the outset, the move toward self-assessment for other tax liabilities such as the personal and corporate income tax has been more recent. Until the early 1990s, all countries willing to introduce a VAT broadly followed the same approach—administrative preparations for implementation of the new tax were always based on the assumption that the VAT would be a self-assessed tax.129 It was mainly at that time that several countries in transition—first CIS countries, then China and Vietnam—decided to introduce VATs using procedures not based on self-assessment.
In terms of their acceptance of the basic principles of self-assessment, the countries surveyed in Chapter 6 fall into three categories.
Countries in which sound procedures have been implemented
Only 42 percent of the surveyed countries (13 out of 31) have implemented modern collection procedures (using simple filing and payment forms and a self-assessment system). In these countries, reflecting best tax administration practices to simplify the taxpayers’ compliance burden, VAT filing and payments are made in a single step at the bank, using a simple, combined return and payment form. These forms were often designed with FAD assistance. In developing countries, implementation of such practices often requires significant efforts.
Countries using self-assessment procedures with complex requirements
Almost half of the surveyed countries (15 out of 31), while using self-assessment procedures, place excessive data requirements on taxpayers. In these countries, the forms may include several pages, with taxpayers sometimes requested to attach additional documents (such as copies of invoices and import declarations), significantly increasing compliance costs. In several countries, filing and payment can also be in separate locations, compounding administration difficulties by impeding the reconciliation of payment and return data. This has been the case, until recently, mainly in transition economies, where taxpayers file the return at the tax office and pay their liabilities at a bank. This practice can be a serious impediment to the timely detection of delinquent taxpayers (in particular, those who file a return, but do not pay their tax liabilities).
Countries that introduced the VAT without self-assessment
As noted above, the issue of self-assessment reemerged in the early 1990s, as transition economies moved toward VAT implementation with little experience of tax administration and little appreciation of what would be required to administer an accounts-based tax. Among the surveyed countries, only 3 out of 31 do not use nominal self-assessment procedures. However, looking beyond the survey, the VAT is administered without self-assessment procedures in 16 (mostly transition economies) of the 120 or so countries in which a VAT has been introduced. In these countries, taxpayers must go—in principle, each month—through a complicated process to file and pay their VAT liabilities. In this process: (i) the taxpayer files a return at the tax office; (ii) the tax office reviews the return and prepares the payment notice; (iii) the tax office sends the payment notice to the taxpayer; (iv) the taxpayer sends his payment to the bank; and (v) the tax office reconciles assessment notices and payments. In some of these countries (Russia, for example) the payment notice is provided on the spot to the taxpayer who must wait in the office until the VAT return is checked. The taxpayer must then to go to the bank to pay the tax due.130
Why Self-Assessment? Factors and Problems
What Are the Conditions for Implementing Self-Assessment?
Research at the IMF on the VAT in the early 1990s viewed the concept of self-assessment as core to the recommended strategy for implementing a VAT. Thus, Casanegra de Jantscher and Silvani (cited in Tait, 1991, p. 30), consider that “all aspects of VAT administration should be designed with the aim of increasing voluntary compliance. Swift detection of stopfilers, broad audit coverage, and appropriate penalties are particularly helpful in this regard. Of course these activities must be supplemented by appropriate programs to help taxpayers comply with VAT.” Based on that research, the conditions for the successful implementation of self-assessment are summarized in Box 13.1.
As background, the VAT literature initially emphasized the self-checking mechanism of the VAT (through the chain of invoices that are required at each stage though the retailer). This could be seen as consistent with implementing self-assessment procedures—if the VAT is a “self-enforced” tax, it should also be “self-assessed.” However, experience indicates that the positive impact of self-checking on VAT compliance can be overestimated. The main connection between invoicing and record-keeping obligations on the one hand, and self-assessment procedures on the other hand, is simply that traders able to comply with the requirements of an accounts-based tax are also those able to fulfill their obligations under a self-assessment system. If returns are kept simple, they can be easily completed using information readily available from taxpayers’ records. Provided the threshold is sufficiently high to eliminate small businesses from the VAT net, all registered taxpayers should therefore be able to keep both proper records and self-assess their tax liabilities.
Why Is Self-Assessment So Important for VAT Administration?
One way to appreciate why self-assessment is important to an effective VAT administration is to consider the impact of not having self-assessment.
Box 13.1.Conditions for an Effective Self-Assessment System
The conditions that support a self-assessed tax system include:
Simple tax laws. Complex laws can significantly increase compliance costs, reducing tax compliance. A “simple VAT law” would provide for limited exemptions, a single positive rate, a zero rate limited to exports, and a high threshold.
Services to taxpayers. The tax administration should assist taxpayers in meeting their obligations. Taxpayers should receive clear information describing their obligations, the taxes applicable, the dates when taxes are payable, etc. They also need to be informed of changes to the laws and should have easy access to information and tax forms.
Simple registration, filing, payment, and refund procedures. Tax forms should be readily available to taxpayers and procedures easy to comply with.
Collection enforcement. Prompt detection of taxpayers who fail to submit tax returns, and/or pay tax due, is critical to improving tax compliance, especially regarding large taxpayers.
Audit. Taxpayers need to know that if they fail to comply with the tax laws, they face a reasonable risk of being detected. The tax administration should have sufficient resources to audit a reasonable percentage of taxpayers to increase the risk of detection of noncompliance.
Penalties. Noncompliers need to know that if they are detected, penalties will be strictly applied. Moreover, tax fraud should be prosecuted through the criminal justice system.
Access to independent review of decisions. Taxpayers should have access to an appeal process to protect their rights. When they disagree with the results of an assessment, they should have access to judicial processes for the resolution of disputes with the tax administration.
Filing and payment procedures without self-assessment typically require taxpayers to carry out several steps in the tax office and at the bank. While such time-consuming procedures may sometimes be accepted by enterprises for annual tax liabilities, it is a serious drawback when tax returns and payments are due monthly, as is usually the case for the VAT. Moreover, these alternative filing procedures often call for more complicated tax return forms and supporting documents (such as customs bills of entry, copies of purchases and sales invoices, or lists of invoices).
Tax administration’s effectiveness
Burdensome procedures would also have a negative impact on the tax administration’s effectiveness. Absent self-assessment, tax officers need to deal each month with substantial paper work—processing returns, issuing payment notices, and reconciling liabilities and payments for all registered taxpayers. Failure to complete these tasks in time may jeopardize monthly revenue collections.131 In an attempt to cope with this paperwork, countries have typically embarked on ambitious computerization programs to speed up the processing of returns and issuance of tax notices—this is not an effective use of computer resources.132
With self-assessment, tax officials can concentrate on dealing with the minority of taxpayers who do not comply with their tax obligations, while, absent self-assessment, most tax administration resources need to be allocated to paper work. Moreover, when liabilities are assessed each month by the tax administration, tax officials are often reluctant to apply penalties (levying of which would imply that the assessment process had not been conducted smoothly and effectively). In some cases, it would not seem appropriate to discuss an assessment during a field audit when liabilities have already been agreed to by both the tax administration and the taxpayer during the monthly assessment.
Experience in countries without self assessment shows that there is usually no difference between the liabilities reported by large taxpayers on their returns and the liabilities calculated and mentioned in the payment notices prepared by the tax administration. These amounts may differ somewhat in the case of small taxpayers, but this appears mainly to reflect the incentive to negotiate the amount of tax due in the absence of self-assessment procedures. One explanation of both the reluctance to apply penalties and the support of procedures involving regular discussions between taxpayers and tax officials is the opportunities that result for collusion, particularly in countries where the salaries of civil servants are low. In some surveyed countries, concern over corruption was a major reason for the implementation of a self-assessment system, with modern filing and payment procedures through banks.
What Are the Main Reasons for Resistance to Self-Assessment?
Three main explanations are given to account for the resistance to self-assessment in the surveyed countries:
“Small traders may be illiterate.”
Self-assessment has been opposed in a number of developing countries on the grounds that many traders would not be able to keep proper records and file their returns accurately. However, the issue is likely to be more one of the level of threshold; provided this is set sufficiently high, all enterprises then required to register for the VAT should be able to keep proper records and self-assess their tax liabilities. Moreover, in several surveyed countries, while resistance to the VAT regime may be blamed on presumed weaknesses in maintaining records, the true source may be reluctance of the business community to have tax officials accessing records and being able to cross-check VAT and income tax liabilities.
“Most businesses underreport their tax liabilities.”
This has also been mentioned in countries in transition. In these countries, a number of officials seem to be firmly convinced that taxpayers cannot be trusted, especially those in the emerging private sector. However, such reactions should gradually decrease as senior tax officials improve their experience with the basic tax administration principles of market-based economies and taxpayers become more familiar with the new tax laws.
“The conditions for implementing self-assessment are not met.”
This is the most compelling argument, and is most relevant in transition economies where the VAT was introduced without adequate preparations in the early 1990s. Since that time, significant work has been undertaken (with technical assistance) to improve the VAT operations and explain the requirements of a modern tax administration to these countries’ tax authorities. However, to this point, progress in implementing FAD’s recommendations and meeting the conditions for an effective self-assessment system has been slower than expected.
Over the past ten years, it has been difficult to convince some countries to implement self-assessment procedures for their VAT.
Against that background, the following summarizes the approach that has been adopted within FAD for its technical assistance program in this area. In essence, that approach involves less than satisfactory balancing of the need to support self-assessment against the often observed resistance of national authorities to the concept.
Attention paid to VAT preparations in countries with no experience of self-assessment
When a country has made the decision to implement a VAT, significant attention should be paid to the administrative preparations. Based on the consensus that the VAT is a self-assessed, accounts-based tax, the implementation timetable typically recommended varies from 18–24 months; this includes approximately 15–20 months for the preparation of the VAT organization; the design of forms and computer systems supporting self-assessment procedures; and taxpayer education and staff training programs. In the surveyed countries with little or no previous experience with self-assessment, a longer timetable is likely appropriate to take the necessary steps toward the VAT, such as the establishment of pilot LTUs, the development of a function-based administration, taxpayer education programs, and modern collection forms and procedures. For example, two to three years prior to VAT introduction, FAD had assigned long-term experts to help implement LTUs and new tax administration systems in Albania, Benin, Togo, Vietnam, and Sri Lanka. While this approach was reasonably successful in most cases, including for countries with little experience of self-assessment, it was less successful in some countries.
Approach proposed in countries not willing to introduce self-assessment procedures
Such cases pose real difficulties, illustrated by the following two cases in which the IMF was involved.
First case: In 1997, two years before the introduction of the VAT, the government stated that it wanted to introduce a VAT using the non-self-assessment procedures described above. As an alternative, FAD advisors suggested the following compromise as a simplification: (i) all VAT taxpayers would have to submit a return that would be checked by the tax administration (as provided for in the VAT law); (ii) a tax payment notice would be sent to taxpayers only when anomalies are detected in the return (instead of to all taxpayers); and (iii) other taxpayers would simply have to pay the amount mentioned in their return.
Second case: This is one in which, with the benefit of hindsight, more attention could have been devoted at the outset to the difficulty of implementing a VAT without self-assessment. Later in the preparation process, IMF advice did target the lack of modern procedures and effective enforcement programs as key weaknesses of the tax administration and recommended a comprehensive strategy to improve tax compliance. This strategy was based on the gradual introduction of self-assessment procedures in pilot units established for large taxpayers. Such units have recently been established. In these units, as a first step toward self-assessment of VAT liabilities, the payment notice is provided on the spot to the taxpayer after the VAT return is checked. The taxpayer must then pay his VAT liabilities to a bank office located in the pilot unit.
In both cases, the advice was, appropriately, for intermediate steps to facilitate a gradual implementation of self-assessment procedures, rather than for alternative solutions.133 However, again with the benefit of hindsight, the difficulties in implementing even these strategies may have been underestimated.
Recommended strategy in countries where the VAT was introduced without self-assessment procedures
In recent years, countries that have introduced VATs without appropriate preparations have experienced difficulties. For example, in Russia and the other BRO countries, lack of familiarity with traditional taxpaying mechanisms, weak tax administration procedures (including the lack of self-assessment) combined with the lack of proper accounting standards and major shortcomings in policy design (such as the margin methods for certain categories of taxpayers and the use of the origin principle) have impeded the performance of the VAT since its introduction at the end of 1991. Faced with this reality the basic strategy recommended by FAD included measures such as the improvement of the VAT law, establishment of LTUs, gradual introduction of self-assessment procedures, appropriate penalties, and enforcement programs.134 Little progress has been achieved until recently. Decisive steps, beyond the scope of technical assistance, are needed to provide a more stable political environment and a stronger political commitment to implement the necessary reforms.
In summary, self-assessment is clearly central for the effective operation of a VAT. Indeed, for most tax administration experts the question is not how to administer a VAT in a country without the capacity to administer a self-assessment system, but how to implement the basic principles of self-assessment in a country willing to introduce a VAT. The transitional arrangements recommended, in some cases, may not be an adequate response to this problem. In short, current thinking based on evidence of the past decade is that, if true self-assessment cannot be implemented, the country is not ready for the VAT and should defer its plans.