As part of standby arrangement with the World Bank and the IMF, the government has moved a bill in the Parliament for the approval and enforcement of VAT. The provisional governments have also moved the bill in their assemblies. The main reason behind the swiftness of Federal government is that the IMF has made the release of next tranche conditional to at least moving the VAT bill during the current year.
Sub-national VAT issues in the federal countries and what are the issues specific to Pakistan's are of critical importance, which needs to be discussed before this bill become the law. It is also relevant to point out that the government of Sindh has raised certain legal issues challenging the legitimacy of federal government to collect the tax on services that fall within the domain of provinces.
This issue apart, there are many different issues relating to defining the point of destination where the VAT is collected. Is it the point of entry in the country or at the point where it is consumed for production where the VAT has to be collected needs to be addressed instead of raising more conflict in a country ridden with conflicts. We will try to examine all these issues.
To begin with, let us examine what are the features that determine whether the VAT at sub-national level where dual VAT can be enforced. On this issue, Professor Richard Bird and Pierre-Pascal Gendron in their classic book, "the VAT in developing and transitional countries," have identified different features of alternative federal VAT model.
The following are the features of alternative 'Federal' VAT models: In a country where the finance minister and the FBR admit tax evasion of around Rs 500 billion, the factor of potential interstate evasion is of immense importance and which we will discuss in rather graphic detail. It is not clear that the person dealing with the supply of goods and services simultaneously shall fall in whose jurisdiction.
In the context of the share of provinces, the crucial point is the definition of the point of destination. What is the point of destination for goods arriving at Karachi seaport and being imported by a person from NWFP? Would the concerned provinces shall agree to allow credit adjustment and just collect tax on value addition.
To further elaborate this point, tax on raw material is collected at 21% rate, whereas the final products such as home appliances are sold at 16%. It means that the provinces where actual production takes place will end up in giving refund of the differential amount, which could vary from 1% to 6%.
The point that needs due attention and demands answer is that if one province collects the taxes on the raw material that is used in the manufacturing of goods in other provinces, what would be the rate of trust and acceptance among the provinces. The answer we get off this phenomenon when zero-rating was introduced among the EU countries.
In order to address fraudulent refund, the UK introduced reverse charging and Germany works with uniform rate. Have this issue been seriously considered by the GoP or they play with the policy (we will cross the bridge when it comes)? What is the assurance that we will reach the bridge?
As we know that the VAT works on heavily on allowing credits and purchases. This issue should have been discussed and clear consensus should exist before its imposition as law. These concerns were raised by a local expert, in the VAT conference held by the FBR in Islamabad, but they did not find a place in the written recommendation of Dr Hafiz Pasha's repot.
Currently, there is lot of trust deficit amongst the federating units and between units and the state. It is in knowledge of every one that main port is situated in Sindh. Tax will be collected by Sindh on goods as they arrive and consequently its share will be much bigger than the other provinces.
Here Balochistan will be worst hit because of its peculiar terrain did not help industry to establish and flourish. The ports in Sindh generate lots of services that are ancillary and incidental to clearance of goods that shall take place in Sindh. These services include handling and transportation of goods even though these goods may be meant for interior of Pakistan, Sindh shall be collecting the tax once such services are commissioned.
The other provinces will be having no option but to allow deduction to the taxpayer of all the collection already made by Sind. If we examine the data of the federal countries where the VAT is operative, it is evident that no one has managed to work at expectable system at two levels of government (centeral and state). During the meeting of the National Finance Commission (NFC) at Lahore, it was decided that respective provinces would collect the tax on services.
However, there is big change in the proposed bill and the Federal Board of Revenue has been assigned to collect the taxes at both levels as the provinces are said to be not in a position to enforce the VAT. The proposed VAT bill failed to address the core issues to justify this change and does not provide clear directions.
There are different forms of the VAT system adopted by different countries as per their requirements. It has been argued that centralised VAT (existing in Germany), where the revenue is shared with the state is the best system (Tat 1988). If we look into the dual Vat system, only Germany has a single rate throughout the country.
However, this might not work in our situation. In our scenario, other provinces of Pakistan will not be bound to follow the single rate. There is a lot of literature on different countries. Unfortunately, no literature can shed more light on the dual VAT in Pakistan.
In federal countries where regional governments are strong, it is not easy to say that the federal or the regional government will agree to the single point question. In a study by Bird and Abel (2007), the main conclusion was that even in weaker regional units, there is preference for transferring the right to the federating units.
It is assessed that asymmetrical regional tax system that now exists in Canada may become of far more acceptable system in such countries. We may know that in Bosnia, two tiers of taxes were created under the Dayton Accord in 2001. It proved disastrous and they had to revert to the central government.
The first important point that we need to know is that we can have dual Vat only in such countries where real autonomy exists. The second point is that dual VAT needs high administrative requirements at both levels. They have also pointed out that there is no need of single administration where two VATs have to work.
Here the proposed bill totally ignores this important point and has invested the FBR sole role to collect the VAT. Such system succeeds only where compliance to cardinal principles is made at inception stage. While deviating from this principle, the government has not made any evidence available with the bill that made essential to fortify the fort of the FBR.
It appears that the government intends to keep the purse in its pocket and pleases the provinces in the manner it finds convenient. It is not clear as to why the provisional government that have much more stronger delivery systems even at Union council level, has not accepted the challenge of enforcing the VAT on the services.
The provinces or the federal government has not identified risky areas such as inter state evasion or trade deficit and instead has retained the VAT at central level due to lack of capacity at the regional levels. We may add that the VAT would not deliver unless the FBR ensures that there is no inter-state evasion in the form of credit adjustment and refunds.
We know that persons indulging in fraudulent adjustments claims where purchases against the invoices are issued by the person registered in the other provinces. Again the law provides a lot of discretion to select the city where they want to register instead of netting them in the province where actual business is conducted or the place from where supplies are made. This flaw has not been rectified in the proposed bill.
The FBR in the past went for single registration for the person carrying out different businesses. This provided the chances to fraudsters to claim the input tax against the claim of other sector. The VAT operates on sectoral basis and such single registration negates this principle.
Coming back to Professor Bird's table, the dual VAT needs central state's co-operation. In our context, federal government has usurped such co-operation. Professor Bird also recommended to have restricted VAT in case of inter-state evasion. There are four options: Independent VAT, dual VAT, joint VAT or central VAT.
In this context, our options are restricted as the federal government could tax only goods. However, it has succeeded in taxing the services, either through provisional ordinances or excise in the VAT mode. These all approaches did not yield the desirable results as our tax-to-GDP ratio in these years remains below even pathetic benchmark of 10%.
Whatever the system we adopt within our constitutional restraints, the primary concerns relate to its enforcement. The enforcement strategies are not available with the FBR; otherwise it would have at least recovered 500 billion rupees that it claims to have evidences of evasion.
The VAT could only be enforced if there are linkages between the supply chains from entry to exit. Currently, such linkages are only available for the formal economy. We may also know that the formal economy transfers the cost of whole incident to end consumer. In our case, 40% of the end consumer lives below abject poverty line.
It is surprising to know that a country with population of 170 million has only around 35,000 GST payment filers. The responsibility of the government was to engage the donor agencies on core issues for the implementation of the VAT with a view to bringing any positive change in the taxation system to generate revenue. It is unclear that as to how a seasoned expert like Michael Keen would not have listened and understood such important issues.
Instead of making hasty decisions, the Parliament and the provisional assemblies need to discuss the issue threadbare and only with sound modifications should allow the passage of the bill. Unless, issues raised in this article are not addressed, it is feared that the nation will be facing a monster in the form of VAT and aggravating trade deficit among the federating units.
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Feature Independent Dual VATs Joint VATs CVAT
VATs
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Rate autonomy Yes Yes No Some
Administrative High High Lower Moderate
Requirements
Need for Single
administration No No Yes No
Need for central state
co-operation No Yes Complete Yes
Potential of interstate
evasion High Restricted No Restricted
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