vegetables, fruit, cereals), VAT legislation states specific product types that are exempt, e.g. red chilies in Pakistan (green chilies are treated differently for some reason), palm oil in Sri Lanka (but not other types of vegetable oil), most vegetables in the Indian state of Nagaland but not onion, garlic and ginger. Similarly, a number of related non‐food goods are subject to different VAT rules. India, Pakistan and Sri Lanka also grant VAT exemptions for inputs and machinery to support specific industries.

VAT exemptions distort consumption and production decisions and increase compliance and enforcement costs due to classification issues. Exemptions can distort consumption decisions when exempt products compete with non‐exempt during sales to final consumers. Exemption of intermediary inputs from VAT may increase the cost of final goods as buyers are not allowed input tax credit on purchases of exempt items, so that part of the value added in a final product is taxed more than once.<sup>21</sup> This creates incentives for producers of VAT exempt items to self‐supply and undertake more activities down the supply chain than they otherwise would, so that value added at the intermediate stages is not taxed. For example, firms whose outputs are VAT exempt have an incentive to supply their own security, cleaning, technical support and other services rather than contract them out and face irrecoverable VAT bills.<sup>22</sup> Furthermore, VAT exemptions increase tax compliance and administration costs (as well as opportunities for tax evasion), particularly for firms producing both VAT exempt and non‐exempt products.<sup>23</sup> The narrative below discusses differential treatment of goods and services for VAT purposes in each of the four countries.

In Bangladesh, the current VAT legislation is characterized by a narrow base and widespread use of presumptive taxation. Most unprocessed food items and a number of raw materials such as skins and hides, wood, wool, cotton and jute are exempt; VAT exemptions are also granted to six categories of services (Table 6). Under the VAT Law, the government can fix tariff value for certain items, so that VAT is levied on a presumptive basis on some notional value rather than on the actual transaction value. For example, tariff value for mild‐steel products produced from re‐rollable scraps is TK 4000 (USD 51) per metric ton.<sup>24</sup> Furthermore, over 20 services are taxed according to fixed value addition bases of 10, 25, 30 and 60 percent.<sup>25</sup> The resulting VAT rates are 1.5, 2.25, 4.5 and 9 percent. For example, VAT on the construction service is calculated on 30% of the base (30 x 15%), for a total rate of 4.5%.<sup>26</sup> Suppliers of

> 21 Consider the following example: _Firm B buys taxable inputs from firm A for $100 and pays VAT at the rate of 15% for a total of $115. Firm B produces an exempt product and adds value of $30. It cannot claim any input credit and sells its output to firm C at $145. Firm C produces a taxable good but since it has paid no VAT on B’s product it cannot claim any input tax credit on it. Had firm B been liable for VAT, it would sell its product to firm C for $149.5 ($130 +19.5 VAT) and claim $15 as input tax from the government. So, the tax the firm actually transmits to the government would be 19.5‐15 = $4.5, which is 15% of 30 (firm B’s value added). For whatever price firm C sells its product, it can claim 19.5 as input credit if firm B is liable for VAT. If firm B is exempt, the $15 input tax becomes additional revenue to the government, which is likely to translate into increased cost of the final product._

> 22 Mirrlees, James et al. 2011. Tax by design. Institute for Fiscal Studies. Oxford University Press

> 23 Ibid

> 24 ‐ Bangladesh National Board of Revenue. Value Added Tax  http://www.nbr <u>bd.org/valueaddedtax.html accessed on March 10,</u> 2015

> 25 Ahmed, Nasiruddin. 2013. Improving Tax Compliance in Bangladesh: A study of Value Added Tax, Institute of Governance Studies, BRAC University

> 26 Saleheen, Ahmed and Noore Siddiquee. 2013. “Tax Innovation or Excise Duty in Disguise? Deviations and Distortions in Value‐ added Tax in Bangladesh”. International Journal of Public Taxation, April 2013.

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