Withholding, blocked credits & fiscal Balkanisation Dr Ikramul Haq A tax can retain the statutory label of value added tax long after its operating logic has been destroyed. This happens when the State collects tax on the gross invoice before the taxpayer's net liability is determined, blocks or delays input adjustment, and treats refunds as a concession. Pakistan has turned these exceptions into the system. Part I recalled the test laid down by our superior courts: output-input adjustment is 'of the essence of the tax'. A genuine VAT follows value addition. Withholding follows payment. These are not equivalent bases. Consider a service provider who bills Rs.100 plus Rs.18 tax and has borne Rs.12 tax on business inputs. The VAT attributable to that stage is Rs.6. If the customer withholds the whole or a substantial part of Rs.18, the treasury receives gross output tax before the Rs.12 credit is realised. The excess becomes carry-forward, refund claim or trapped capital. Legally it may later be adjusted; economically the business has financed the State. This inversion matters. Under VAT, an invoice gives the purchaser a fiscal asset and makes the supplier answerable for corresponding output tax. Under pervasive withholding, the purchaser becomes an unpaid tax collector, and the supplier's return becomes a reconciliation of deductions already made. Audit attention shifts from value addition to certificates, rates, exclusions and recovery. The self-policing chain is replaced by administrative capture of cash. At the federal level, the Sales Tax Act, 1990 contains the orthodox right of input deduction, but it also houses provisions that pull in the opposite direction. Section 7A prescribes minimum value addition; section 8 restricts credits; and the Third Schedule collects tax on the printed retail price of listed goods at the import or manufacturing stage. Special regimes, exemptions and reduced rates further interrupt the chain. The Sales Tax Special Procedure (Withholding) Rules, 2007 add another layer by requiring specified purchasers to deduct sales tax from payments. Each device may have been defended as anti-evasion. Together they convert VAT into a mixture of excise, minimum tax and advance collection. In Reform the reformers-VI: VAT without value addition?, it was demonstrated how retail-price taxation, presumptive arrangements, withholding and defective refunds hollow out the invoice-credit method. The consequence is cascading. Tax enters the cost of a compliant business when credit is barred or cannot be monetised; that cost is then marked up and taxed again. The consumer pays tax on tax, while the formal supplier becomes less competitive than an undocumented rival. The provinces have not corrected the federal mistake; they have multiplied it. Sindh, Punjab, Khyber Pakhtunkhwa and Balochistan administer separate sales taxes on services, while FBR deals with Islamabad Capital Territory and AJK operates its own regime. Each jurisdiction has its own schedules, classifications, withholding agents, returns, audits and interpretation of where a service is taxable. Sindh has separate withholding rules; Khyber Pakhtunkhwa issued its Special Procedure (Withholding) Regulations, 2024. The same province applies a four percent rate to specified government-funded construction contracts without input adjustment. This is convenient collection, not VAT: the base is gross consideration and tax embedded in cement, steel, fuel and professional inputs remains a cost. Balochistan's electronic return itself contains fields for both input credit and tax withheld by the buyer-an official acknowledgement that two different logics are being forced into one form. A bank or any other entity operating on all Pakistan basis files six monthly sales-tax returns-four provincial returns plus Islamabad Capital Territory (ICT) and AJK-amounting to 72 a year, before amended returns, reconciliations and audits are counted. The same transaction can attract competing place-of-supply claims. It was elaborated in Provincial sales tax chaos-II: Contradictions & fiscal Balkanization [Minute Mirror, May 12, 2026]. Fragmentation is not provincial autonomy. It is the taxation of one national market as several disconnected ones. The public data conceal the damage. The Ministry of Finance's fiscal operations for 2025-26 report provincial sales tax on services of about Rs.774.8 billion-Punjab Rs. 361.2 billion, Sindh Rs. 342.1 billion, Khyber Pakhtunkhwa Rs. 49.5 billion and Balochistan Rs. 22.0 billion. They do not disclose, sector by sector and month by month, how much came from genuine output-input settlement, withholding, no-credit rates, arrears or coercive recovery. Nor is there a readily accessible consolidated series for banks and telecommunications across all six jurisdictions. A rising collection number cannot tell us whether VAT is functioning. This is why, withholdingisation is described as a 'weapon of destruction' in Tax Proposals for Budget 2027-III [Minute Mirror, May 26, 2026]. It gives the appearance of efficient collection while weakening assessment, audit and refund capacity. The easier it becomes to collect from a few captive withholding agents, the less incentive the administration has to identify the true taxpayer, verify value addition or broaden the documented chain. Professor Ehtisham Ahmad deserves credit for diagnosing much of this failure. He has repeatedly argued that VAT is self-policing, that exemptions and presumptive taxes break the value chain, and that Pakistan reverted to an excise-mode production tax. His work also identified the instability of dividing GST by sectors and the political economy of collusion, weak administration and mistrust between the federation and provinces. Professor Ehtisham's Lahore Journal of Economics paper and later political-economy study should be read by those who still believe that another software platform or Finance Act can repair the system. His recent case for coordinated tax and digital transformation is also sound in one important respect: tax-by-tax tinkering cannot create a coherent national market. Three reservations must nevertheless be recorded. First, the 2009-10 reform was presented too heavily as the centrepiece of an IMF revenue programme, with expectations of a large and rapid increase in receipts. That sequencing encouraged governments to secure cash first and promise neutrality, refunds and administrative reform later. A VAT gains legitimacy only when credits and refunds work from the beginning. Revenue is the result of a credible chain, not a substitute for it. Second, the reported suggestion that FBR could administer VAT and pass provincial shares back offered administrative tidiness at the price of constitutional ownership. After the Constitution (Eighteenth Amendment) Act of 2010, harmonisation cannot mean enlarging FBR under another name. A National Tax Authority must be genuinely federalised, jointly owned and governed through the Council of Common Interests, with a common base, portal and audit protocol but constitutionally assigned revenues. This distinction is made in Reform the reformers-IX: Towards bona fide VAT for Pakistan [Minute Mirror, July 9, 2026]. Third, neither a high registration threshold nor digitalisation answers the design problem. A high threshold may protect small traders from compliance costs, but it leaves the final margin outside the credit chain; a very low threshold overwhelms weak administrations. Likewise, e-invoicing can match transactions, but it cannot turn a gross withholding levy, a no-credit rate or a delayed refund into VAT. Digital coercion applied to a defective law merely destroys VAT more efficiently. Professor Ehtisham's later political-economy diagnosis should be carried one step further. The problem is no longer only collusion, evasion or poor implementation. Anti-VAT principles are now embedded in statutes, schedules and rules. Removing them requires legislative reversal: withholding confined to narrowly defined, evidence-based fraud risks; full and prompt credit and refund; an end to minimum value-addition and no-credit reduced rates; gradual removal of Third Schedule taxation; a moderate, broad rate; and harmonised federal-provincial administration with independent dispute resolution. Pakistan does not suffer from too little collection machinery. It suffers from multiple machineries that collect without measuring value addition. Until tax follows the invoice-credit chain-and the published data disclose credits, refunds, withholding and sectoral incidence-the levy will remain VAT in name and an excise-cum-advance tax in substance. [To be continued] ________________________________________________________________ Dr. Ikramul Haq, Advocate Supreme Court, writer, literary critic, Adjunct Faculty at Lahore University of Management Sciences (LUMS), member Advisory Board and Visiting Senior Fellow of Pakistan Institute of Development Economics (PIDE), holds an LLD in tax laws. He was full-time journalist from 1979 to 1984 with Viewpoint and Dawn. He also served Civil Services of Pakistan from 1984 to 1996.
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