KOREA'S VAT REGIME-Success Factors and Policy

Implications-

April 2011

Ministry of Strategy and Finance

KOREA's VAT IntroductionKOREA's VAT Introduction

VAT's contribution to KOREA's Economic DevelopmentVAT's contribution to KOREA's Economic DevelopmentMajor Factors behind Successful VAT regimePolicy ImplicationsPolicy Implications

Contents

Contents

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Ⅰ. Korea's VAT Introduction

Ⅰ. Korea's VAT Introduction

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Complicated Indirect Tax System

•the Korean Government started 1st 5-year Economic

Development Plan in1962

•to mobilize fiscal revenue needed to finance the

Economic Development Plan, several new tax items

added and tax rates raised

Korea’s first half of the 20th century

1910 ~ 1945 : under the colonial rule 1950 ~ 1953 : the Korean War 1961 : military coup 1962 : 1st 5-year Economic Development

Plan

BackgroundBackground

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In 1971, the Korean government started to consider abolishing complicated indirect taxes in multiple tax rates and adopting the VAT regime to establish a simple and neutral tax system as well as secure financial resources stably

Major Tax Items as of 1971  Tax Rate

Direct Tax Personal Income Tax 8∼70%Corporate Income Tax 20∼40%

Indirect Tax

Business TaxCommodity TaxTextile TaxPetroleum Product TaxGas & Electricity TaxTravel TaxAdmission TaxEntertainment & Food TaxLiquor TaxTelephone TaxStamp TaxDefense SurtaxTax on Monopoly Profits

0.5%∼35%2∼200%10∼40%

20∼300%10∼15%

10%10∼250%2∼20%

10∼200%15%

KRW10∼KRW150,0000.1∼30%

100%

different tax rates among goods & services ⇒ distortion of relative pricestoo many indirect taxes and rates ⇒ high compliance & administration cost

Korean Tax Regime before introducing VAT

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It took 6 years to prepare to set up the VAT regime from considering VAT introduction in 1971 and its enactment in 1976•Consultation with Tax Experts of the IMF and the UN•Consultation with academia, business, research

institutions, media, financial institutions, lawyers•Persuading the opponent of the VAT introduction

Pros Cons

Simplification of tax system and tax administration   

 Immaturity of VAT infrastructure 

Promotion of export and investment

Possibility of inflation

Enhancement of the neutrality of indirect taxes

Regressivity of tax burden

6-year Preparation Period6-year Preparation Period

Pros and ConsPros and Cons

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To establish VAT infra •nation-wide campaign for issuing and receiving of receipts and use of cash register

•training tax officials•taxpayer education : 3 rehearsals participated by all 830,000 taxpayers

To ease the inflation worries•set guideline price for 851 items of goods & services•on-site inspection of the prices by 4,920 teams of gov’t officials

※ CPI increase rate (%) : ('74) 24.3, ('75) 25.3, ('76) 15.3, ('77) 10.1, ('78)14.5

To mitigate regressivity•tax exemptions for necessities

(food, public transportaion, books, medical & education service, etc)•Special Consumption Tax on luxury goods

(jewelry, passenger car, colour TV, audio devise, air conditioner, etc)

Efforts to mitigate Adverse EffectsEfforts to mitigate Adverse Effects

Ⅱ. VAT's contribution to Korea's Economic DevelopmentⅡ. VAT's contribution to Korea's Economic Development

• Major Source of Fiscal Revenue

• Streamline the Indirect Tax System

• Support Export and Investment

• Reduce Tax Evasion

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   Revenue (tril. in KRW) %

Value Added Tax  49.1 27.6

Personal Income Tax  37.5 21.1

Corporate Income Tax  37.3 20.9

Customs Duties  10.7 6.1

Inheritance & Gift Tax  3.1 1.8

Others 40.0 22.5

total 177.7 100.0

1978 1980 1990 2000 2010

3.4 3.8 3.7 4.0 4.5

Since its introduction in 1977, VAT has become a major source of government revenue •The Single Largest Tax

Item(2010)

•VAT revenue's ratio to GDP : 4.5%(2010)

Major Source of Fiscal RevenueMajor Source of Fiscal Revenue

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8 tax items & 55 tax rates → 2 tax items & 14 tax rates⇒ reduced tax compliance & administration cost

single tax rate for all taxable commodities and services⇒ increased neutrality

Pre-VAT regime (8) Post-VAT regime (2)

Business Tax (0.5∼35%)

Value Added Tax(10%)

Special Consumption Tax (10∼100%)

Commodity Tax (2∼200%)

Textile Tax (10∼40%)

Petroleum Product Tax (20∼300%)

Gas & Electricity Tax (10∼15%)

Travel Tax (10%)

Admission Tax (10∼250%)

Entertainment & Food Tax (2∼20%)

Streamline the Indirect Tax SystemStreamline the Indirect Tax System

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The VAT regime was in line with the economic development strategy in the 1960s and 70s : the export promotion and the gov't-led industrialization•zero rate to the export goods•input tax credit for the capital goods purchased

VAT regime has been quite favorable to export and capital formationVAT regime has been quite favorable to export and capital formation

Support Export and InvestmentSupport Export and Investment

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Issue & submit tax invoice with which the tax authority can cross check the transaction ⇒ Reduce Corporate tax & Income tax evasion, as well as VAT evasion

Reduce Tax EvasionReduce Tax Evasion

※ VRR(VAT Revenue Ratio) : 5th rank among 31 OECD countries(2005) * VRR = VAT revenue/[(consumption expenditures - VAT revenue)×standard VAT rate]

Ⅲ. Major Factors behind Successful VAT RegimeⅢ. Major Factors behind Successful VAT Regime

• Simple Rate Structure

• Simple VAT Payment Scheme for small businesses

• Cross-check system at every stage of transaction

• Cooperation between MOSF & NTS

• Training & Enlightenment

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① Relatively low rate of 10%• average VAT rate of OECD countries : 18%(Jan. 2010)

• low tax rate leads to low temptation of tax evasion

② Single rate

Single Rate System (7)   

multiple rate system (22)

Australia, Canada, Denmark, Japan,

Korea, Mexico, New Zealand 

Austria, Belgium, Czech Republic, Finland, France, Germany, Greece,

Hungary, Iceland, Ireland, Italy, Luxembourg, Netherlands,

Norway, Poland, Portugal, Slovak Republic, Spain,  Sweden, Switzerland, Turkey, UK

• easy to understand and calculate taxes payable• reduce tax payer's compliance costs and tax

authority's administrative costs

• easy to understand and calculate taxes payable• reduce tax payer's compliance costs and tax

authority's administrative costs

Simple Rate StructureSimple Rate Structure

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Exception to [output tax - input tax] payment scheme

Sole proprietor with annual taxable turnover of KRW 12mil. or less•exempt from book-keeping, issuing of tax invoice

•apply simple calculation method for VAT payable : VAT = turnover×2%

(reason) to alleviate the resistance for newly introduced VAT from small

businesses which lacks knowledge of tax law & bookkeeping ability

(why KRW 12milion) 80% of total tax payer

Problem : cut in the tax invoice flow

⇒ keep the rate of increase of the threshold lower than that of inflation rate

Simple VAT Payment Scheme for small businessesSimple VAT Payment Scheme for small businesses

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Threshold (KRW) CPI index

1977 12mil. 100

2010 48mil. 725

※ The ratio of simplified VAT taxpayers to total taxpayers

※ Change of threshold※ Change of threshold

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(B2B) mandatory issuance & receipt of tax invoices•heavy penalty on non-issuance or false tax invoice•to claim an input tax credit, a purchaser needs to

receive the tax invoice from a supplier ⇒ cross check between a supplier & a purchaser

(B2C) Incentives on credit cards & "cash receipt"•(consumer) allow a deduction for payments by credit

cards or in cash with "cash receipts" from gross income

• (supplier) allow a deduction for certain amount of sales by credit cards or in cash with “cash receipts” from output tax

Business

tax invoic

e Business

credit card

cash receip

t

Consumer

   

Cross-check system at every stage of transactionCross-check system at every stage of transaction

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The National Tax Service (NTS)

•identifies any irrational tax law articles during the

process of execution of laws

•proposes to MOSF for the amendment to such laws

The Ministry of Strategy and Finance (MOSF)

•reflects NTS’s proposals into the revision procedure

MOSF and NTS

•regular exchange of workforce

Cooperation between MOSF & NTSCooperation between MOSF & NTS

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Training•Train tax officials at the National Tax Officials Training Institute

•Establish National Tax College (1980)

Enlightenment•Inform the public of new VAT regime via mass media including TV

•Give a presentation on the new regime to business associations

•Tax officials visit taxpayers to enlighten them about the purpose

of the new VAT regime and how to comply with it

Training & EnlightenmentTraining & Enlightenment

Ⅳ. Policy Implications

Ⅳ. Policy Implications

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Introduction stage•Design a simple & convenient tax system ⇒ Mitigate tax resistance

•Prepare necessary infrastructures

•Cope with any potential problems

Maintenance stage•Improve the VAT regime in a steady manner to enhance taxpayer's convenience

Commitment and responsibility of politicians & administrative officials

Policy ImplicationsPolicy Implications

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Thank you!

Thank you!