Thukten Zangpo

Bhutan faces challenges in raising enough domestic revenue due to its narrow tax base and complex tax structure, according to a recent World Bank report “Public Expenditure Review”.

The report states that the external grants and non-tax revenue currently make up more than 50 percent of the total revenue, exceeding the average for similar countries where it’s less than 25 percent.

Non-tax revenue includes revenue from government agencies, dividends, and transfer of profits from state-owned enterprises.

The Bank said that this dependence created significant fluctuations in revenue and hinder long-term financial sustainability.

One key issue identified is the narrow tax base and stagnant revenue.

The Bank said that the personal income tax, sales tax, excise duties, and customs duties all fell below what’s expected based on Bhutan’s GDP per capita.

A study found that Bhutan’s tax effort is 70 percent lower than other similar countries. A study on tax gap analysis found that Bhutan could have potentially increased its total tax collections by 5.4 percent of GDP in fiscal year 2020-21.

The report also highlighted that the country’s revenue from personal income tax has remained stagnant over the period 2015-2022.

To address these issues, the Bank recommends lowering the PIT threshold. It said that the current PIT basic exemption threshold of Nu 300,000 narrows the tax base to only about 65,000 individual taxpayers.

The threshold lowered to Nu 100,000 would reduce the maximum marginal rate to 25 percent. This will cover an additional 85,832 people and distribute the burden of taxes over a larger base.

Currently, the individual taxpayers are not taxed on capital gains from the sale of immovable property such as land or buildings, or movable property such as shares or securities. Moreover, small and medium enterprises largely remain outside the tax net due to various tax incentives.

The Bank also said that Bhutan could implement a comprehensive goods and services tax (GST).

The GST could replace the current sales tax and excise duty, which is expected to eliminate cascading of taxes on businesses, promote ease of doing businesses, and expand the tax base.

The sales tax and customs duty paid on goods at point of entry are subject to many exemptions, only few of them covered by sales tax at the point of sale. These taxes paid on goods at point of entry can have a cascading effect on businesses if such goods are not covered by sales tax at point of sale.

An assessment by the Bank found that implementation of GST would boost the revenue by about 2 percent of GDP. However, the GST roll out has been deferred until the necessary software and information system are ready.

The Bank said that the government could streamline tax exemptions. The report stated a review of tax incentives offered under the Fiscal Incentives Act. It added that while some incentives may be justified, a significant portion of the revenue is currently being foregone due to exemptions, particularly large businesses.

In 2020, tax expenditure was 2.9 percent of GDP, owing mainly to customs duty (58 percent), sales tax (42 percent), and green tax (0.2 percent) foregone on imports.

A significant proportion of sales tax revenue is foregone due to exemptions as most domestically produced goods and services are not subject to sales tax.

In 2019, sales tax forgone amounted to 27 percent of total sales tax collection. The distribution of revenue foregone in fiscal year 2020-21 due to direct business tax incentives reveals that most benefits were claimed by large and medium businesses in the manufacturing, financial, and tourism sectors.

The report also called for simplifying tax administration for small businesses, where the complex tax assessment for small businesses discourages compliance and diverts resources from larger tax contributors.

Only one percent of the total registered businesses account for about 60 percent of business income tax revenues. Most companies and businesses are small and do not contribute significantly to revenues, but tax administration still focuses on assessing them.

BIT collection from small and micro businesses in urban areas is made based on a complex estimated assessment.

Currently, tax officials make the estimated assessment by physically visiting shops. Sole proprietors with income from different sources are taxed at different rates, which creates arbitrage opportunities and incentives for tax evasion.

The report also identifies weaknesses in Bhutan’s tax compliance monitoring system. Establishing a dedicated Large Taxpayer Unit, improving risk assessment, and automating non-filer detection are all recommended measures.

Consolidating various tax identification numbers into a single taxpayer identification number would improve tax administration by facilitating taxpayer identification for administrative actions like detection of non-filers, third party information reporting and data matching like data matching in respect of interest earned on bank deposits, dividends paid by public companies, contract income, and asset sales, and information sharing with other government agencies, it added.