Understanding VAT Refunds

In practice, value added tax (VAT) refunds are often a source of anxiety and dispute between the tax authority and taxpayers. It is therefore worthwhile to examine the issue of VAT refunds at its root. That is, to recall that a refund is a logical consequence of the VAT system we have adopted as a tax on consumption, introduced to replace the Sales Tax (pajak penjualan/PPn in Indonesian).

VAT as a Domain of Consumption Tax

The word consumption, in the context of VAT as a consumption tax, as stated by Ad von Doesum and Gert-Jan van Norden (2011), refers to private consumption conducted by the final consumer. This implies that it is the final consumer who bears the burden of VAT. The mechanism of imposition operates through collection by other parties designated by law.

A taxable person (pengusaha kena pajak/PKP in Indonesian) is the party given responsibility for collecting VAT on the supply of taxable goods (barang kena pajak/BKP in Indonesian) and/or taxable services (jasa kena pajak/JKP in Indonesian). Provided that the taxable person does not consume the taxable goods and/or taxable services, the taxable person is not the party intended to bear the burden of VAT. To ensure that VAT is not borne by the taxable person, the method of crediting input VAT against output VAT is applied as one of the methods of imposing VAT (the output VAT–input VAT method).

Through this method, a taxable person obliged to collect output VAT on supplies of taxable goods and/or taxable services has the right to credit the input VAT paid on the acquisition of taxable goods and/or taxable services used in the course of carrying on their business activities. It is this right to credit that guarantees the taxable person is not the party bearing the burden of VAT. This is what is meant by neutrality in the VAT concept, whereby the taxable person remits only the excess output VAT over input VAT (Herbain, 2013).

There is a possibility that in a given taxable period, input VAT may exceed output VAT. This is especially the case for taxable persons engaged in export activities. This excess input VAT is a right of the taxable person, which the state is obliged to return. Therefore, when this excess arises, the taxable person's right to claim back the excess input VAT arises immediately.

Within the general VAT system, there are three methods that may be used for the repayment of excess input VAT payments. One of these is through a refund. So, what principles and practices should govern the refund of input VAT overpayments by way of refund?

Principles and Practice of Refunds

In principle, a refund must be granted promptly once the tax payment has been received by the tax authority (Juan de la Cruz Higuera Ornelas, 2017). VAT experts are in agreement on this point. Tait states explicitly that, in order to maintain VAT neutrality, all excess input VAT over output VAT must be refunded promptly (Tait, 1988).

Similarly, Schenk and Oldman (2007) note that a well-structured VAT system is one that grants taxable persons the right to recover their excess input VAT immediately after such excess arises. Meanwhile, Liam Ebril et al (2001) state that a refund must be paid promptly after excess input VAT arises, without regard to the nature of the business activities of the taxable person or any other conditions giving rise to the excess input VAT payment.

This has prompted many countries, particularly developed nations, to pay refund claims within four weeks of submission. In Luxembourg, for instance, although there is no prescribed time limit for the repayment of excess input VAT, the tax court in that country has held that the resolution of the refund claim process must be completed within no more than two months (Herbain, 2013).

However, in some countries, refunds often take several months, or even more than a year. Refunds have become a source of dispute between tax authorities, particularly in cases of delayed refund payments resulting from an audit (Walpole, 2014). Yet according to the European Court of Justice (ECJ), the fact that a taxable person has fulfilled its obligation to collect VAT on transactions it has carried out is sufficient to conclude that a VAT burden has been borne by the taxable person, entitling it to claim repayment of the excess that has arisen (Tzenova, 2014).

Tax refunds should be an automatic process, such that an audit or other administrative processes should not impede the refund process. Turkey is one country that has implemented a straightforward procedure for the refund of input VAT overpayments. In that country, refunds of up to TRY4 billion are granted without any audit or specific guarantee being required (Soydan, 2002).

The administration of refunds is a commonly encountered problem. In most countries, there is a legal and administrative conceptual framework governing the administrative process for refunds. Nevertheless, the regulations that have been established generally provide the government with a relatively lengthy period within which to pay refund claims submitted by taxpayers (de Jantscher, 1986). One reason for this, as cited by Grandcolas (2005), is that governments generally consider that they have the authority to defer refund payments on the grounds that the funds can be used temporarily to finance the government budget.

Delays in payment during the refund process typically occur when the state budget is under pressure and when tax targets are not fulfilled. This occurs when the tax authority does not have a credible system for projecting and monitoring refunds. As a result, the government frequently fails to set aside sufficient funds to fulfil those refund claims (Harrison and Krelove, 2005). Moreover, there is no interest that the tax authority is required to pay on late refund payments (Switata, 2008).

Without an effective policy regarding excess input VAT, the collection of VAT can significantly distort business activity (Grandcolas, 2005). To avoid this, the Netherlands and New Zealand, for example, pay refund claims within a prescribed period, generally 30 days (Harrison and Krelove, 2005).

VAT law also requires that compensation be provided in respect of any VAT amount not refunded within a reasonable period, as a means of enforcing discipline upon the tax administration. Several countries, such as South Africa, Singapore, the UK and the Netherlands, have also established interest compensation for late payment of refund claims by the government. Harrison and Krelove (2015) point out that excess input VAT that is not promptly refunded is equivalent to the government being indebted to the taxpayer.

Conclusion

Repayment of excess input VAT over output VAT must be made as promptly as possible. Delaying the offset process or the granting of a refund is tantamount to undermining the principle of VAT as a tax on consumption.

Neither an audit nor any other administrative procedure should serve as grounds for delaying a VAT refund. For, once again, a refund is a logical consequence of the application of VAT as a tax on consumption. Further, any rejection of a valid refund claim effectively transforms the nature of VAT from a tax on consumption into a tax on sales.