VAT/GST Enforcement: A Critical Analysis
|Dr. Ikramul Haq, a leading international tax counsel, is a well-known author specialising in international tax, press, intellectual property, corporate and constitutional law. Dr. Ikram is Chief Partner of Lahore Law Associates (fax: +92 42 7226953, e-mail: firstname.lastname@example.org; website: http://www.paktax.com.pk). He is a member of the visiting faculty of the Institute of Direct Taxes in Lahore. He served for 12 years as Deputy Commissioner of Income Tax. He studied literature, journalism and law, for his Masters and Doctorate degrees. He has written many books on various aspects of Pakistani law and global narcotics trade, some of which are co-authored with his wife, Mrs. Huzaima Bukhari, Additional Commissioner of Income Tax. He has been awarded Doctorate of Law for his research: Tax Reform in Quasi-Constitutional Perspective.1
The levy of VAT-type[i] sales tax has assumed multidimensional importance in Pakistan’s politico-economic milieu. The IMF and other donor agencies think that levy of VAT is the most important measure for the documentation of the economy. The independent thinkers on the other hand stress that from pure economic point of view, leaving aside the political dimension of the conflict between the taxpayers and the Central Board of Revenue (CBR), a debate is needed to justify the levy of VAT-type sales tax at 15% in the peculiar Pakistani conditions. They strongly apprehend that the imposition at such a high rate will be a final deathblow for the country’s critically sick economy and will lead to more inflation, recession and poverty. Sales tax in its very nature, they argue, is a regressive tax, being an ad valorem imposed on the seller; a consumer ultimately bears its burden. It is well established that sales tax takes a larger proportion of small incomes than of larger incomes.
II. IMPEDIMENTS IN VAT ENFORCEMENT
The task of enforcing VAT in Pakistan is very difficult as more than 70 per cent of its economy is undocumented. Total untaxed part of the overall economy is 70 percent and, according to the current rate of tax collection, if it is taxed then current tax to GDP ratio could jump from 11 percent to 18.9 percent, with an addition of 7.7 percent. Dr. Aqdas Ali Kazmi, Joint Chief Economist, Planning Commission has stated this in his research paper Tax Policy and Resource Mobilisation in Pakistan. Dr. Kazmi has concluded that this 70 percent part of economy consists of 36 percent ‘pure’ black economy, 18 percent exempted economy, 9 percent illegal economy, 4.5 percent unrecorded economy and 2.5 percent informal economy (unreported economy). His study says that the problem in the low resource mobilisation is the rigid system of taxation, and the emphasis of the government to increase revenue, ignoring the details of the long-term policy measures.
The problem of Pakistan is that its tax system is not equitable. The burden of taxes is already less on the rich and more on the poor. In the face of this reality the government had abolished wealth tax, which was a tax on rich people. Wealth Tax has been pinching the higher echelons in civil-military bureaucracy having huge landed interests. On the one hand all the progressive taxes like gift tax, estate duty and capital gains on immovable property have been abolished in Pakistan during the last few years, and on the other in the name of documentation of economy the State has resorted to regressive taxation like presumptive taxes in income tax and turnover taxes in the shape of multi-point sales tax.
III. PROBLEM OF NARROW TAX BASE
Pakistan’s tax to GDP ratio is just 10.4 per cent against an average of around 20 per cent for other developing countries. In the Pakistani perspective, the independent tax experts argue that retail stage sales tax at a lower rate would be more beneficial from the point of view of generation of revenue, broadening of tax base and in the interest of the common people on whom the ultimate tax incidence lies. According to them taxation requires pragmatic thinking and is most effective when developed from the practical and possible agenda for building a sound tax administration. The widest possible taxpayer base has to be identified for any tax to be equitably spread across the whole taxpayer population. Even a small tax at a lower rate spread over a wide taxpayer base will invariably yield more revenue than a higher tax on a narrow base[ii]. The levy of VAT-type tax at 15% (16.5% where non-registered persons are involved) in Pakistan has failed to bring the desired results, as it is a higher tax on a narrow base[iii]. Had it been a 2 to 3% levy across the board, it could have been acceptable as well as successful in terms of yielding more revenue being a low rate tax spread on a wide taxpayer base.
It is an irrefutable fact that the incidence of sales tax finally falls on the consumers. If the people are forced to pay 15 per cent more for the things they buy, their purchasing power will be eroded substantially as there is no corresponding increase in their incomes. This will result in a sharp decline in demand. A fall in demand means a fall in production and a fall in production means a large fall in tax revenue. In Pakistan the industry is the largest tax-paying sector and any decrease in its income will have a negative impact on the tax collections in general and sales tax in particular. This phenomenon proved when large-scale industrial sector registered a negative growth of 0.7 per cent last year while the manufacturing sector overall grew by just 1.1 per cent.
The backbone of Pakistani economy after agriculture is small and medium size manufacturing sector in which millions are employed. Poor industrial growth means large unemployment and no employment for new comers. VAT is destroying country’s medium scale manufacturing sector, as most of the units in this sector are dependent on informal sector for buying raw material. This sector is yet not compelled by the Government to issue tax invoices for input purposes. The result is complete distortion in VAT system that cannot be successful unless complete chain of transactions is ensured.
This is the emerging (disastrous) role of sales tax in Pakistan economy. It is causing deathblow to already sick industry. Pakistan has about 190 dead and sick industrial units and the number is on increase since 1990, when on the advice of IMF, VAT at the exorbitant rate of 21 per cent was introduced. Since then, it is pushing more and more Pakistanis towards below poverty line. It has created and is bound to create more unemployment, as small and medium manufacturing units cannot survive in the VAT system. These units buy most of their inputs from informal sector, which is not at all ready to issue tax invoices.
The Government is forcing the manufacturing units to follow VAT but has adopted a policy of appeasement towards traders, wholesalers and retailers. They have been allowed to remain outside the record-keeping regime and just pay turnover tax on self-determined sales! The recent amendment(s) in Sales Tax Act of 1990 that certain class of taxpayers cannot sell raw material to unregistered persons is a direct admission on the part of the Government that it has failed to widen the tax base of VAT by brining into its net the mighty traders. However, the Government again decided to penalize the manufacturing sector through this amendment, whereas the real culprits, persons not willing to come into registration and record keeping regime, have been left untouched. This is a strange strategy that one who is complying law is being punished and those who openly defy it are left unpunished.
According to a recent Gallop Survey, there are 2 million small business houses/outlets in Pakistan, which include small-size service providers. Out of 2 million, there are only 4,00,000 manufacturing concerns, rest are 6,00,000 commercial service providers like workshops, vocations like barbers, drycleaners, tailors, doctors, small schools etc, whereas one million are retail/whosale outlets/stores. This small business sector is not dependent on bank loans and truly represents our vernacular business sector, where ustad (teacher) and shagird (pupil) relationship still exists. This sector is facing three big problems to survive. The top most issue is growing highhandedness of tax officials; the other two are ever-increasing cost of utilities and lack of modern skills and technology. These units are worst hit by the system of VAT.
IV. COMPARATIVE STUDY
The study of imposition of VAT and General Sales Tax (GST) on goods and services in other countries of Asia can be useful from policy implementation perspective vis-à-vis the Pakistani experience. The following is synopsis of VAT/GST in some countries of Asia:
India like Pakistan is a Federal State. The Central Government is empowered to levy taxes as per the entries listed in the First Schedule to the Constitution. These entries do not include sales tax. Sales Tax is the State subject in India, therefore, each State has enacted its own law to levy the sales tax in the concerned State. Since the sales tax is the State subject, the rates of the tax vary from State to State. There is no uniformity regarding the levy of sales tax, the procedure for collection and its administration. However, different States in India levy the sales tax generally in accordance with following principles:
(a) Sales Tax is levied at the time of first sales. In other words, when the goods are manufactured, the manufacturers will charge sales tax to the buyer. The buyer will fix up its sales price for resale of the said product after considering the sales tax that he has paid to the manufacturer. In case of buyer, it is second sale of the same product and therefore sales tax is not levied at the time of second sale unlike in the VAT system.
(b) When the retailer sells the goods to the consumer he will fix up his sales price depending upon the sales tax he has paid to the manufacturer.
(c) If the retailer or wholesaler is selling to another person be it a consumer or registered dealer in the same State the sales tax is not levied.
(d) If the buyer is a registered dealer and he has not purchased the goods from the registered dealer and used the same in his manufacturing activity, he has to pay purchase tax on the purchase he has made, which is popularly known as purchase tax. However, it is a part of sales tax and is levied to check tax evasion.
(e) The maximum rate is 14% and minimum is 2%. In case of liquor the rate of sales tax is 42%. If more revenue is needed the surcharge on sales tax is levied for temporary period. Similarly relief is also given from time to time depending upon the economy needs, promotion of industry and commerce and business etc. Many States have levied professional tax for augmenting the revenue of the State. Professional tax is levied on the professionals like Advocates, Chartered Accountants, Doctors, Consultants, and Businessmen etc. etc.
In India all the States and Central Government levied sales tax immediately after the independence in 1947. The main source of revenue in each State remains sales tax. India has completed 50 years of imposition of sales tax; therefore, the business community and consumers are well accustomed with it. The VAT is not yet introduced in India.
Pakistan is struggling hard to properly impose GST or VAT at the retail stage, whereas its former East wing, after independence in 1971 successfully introduced, first GST and then VAT on goods and services.
In Bangladesh from 30 June 1982 to June 30 1991, a combination of a sales tax and a business turnover tax applied. The Value Added Tax Act of 1999 abolished the Sales Tax Ordinance of 1982 and the Business Turnover Tax Act 1982. The VAT legislation effective from July 1, 1991 has the following features:
· It is based on consumption.
· It uses the invoice or tax credit method designed to tax the consumer goods rather than the capital goods.
· It applies on imports and not exports.
· A single-stage VAT on importation and manufacturing at uniform rate of 15% and services.
· VAT for whole-sellers and retailers is optional.
· It is applicable to all goods except some unprocessed agricultural products and listed services.
· Exports are zero-rated.
· VAT is levied at the time of supply of goods and services.
· Cottage industries are exempt from it.
· Tax paid on inputs is creditable against output tax.
· Luxury and socially undesirable goods are subject to supplementary duties at different rates ranging from 10% to 300%.
It has partially replaced the excise tax on the domestic production and has completely replaced the sales tax on imports. The taxpayers are required to register before commencement of business. Each taxpayer is required to submit a tax return for each tax period (each calendar month) within twenty days of the month following the tax period. Records have to be retained and made available for inspection on demand for a period of six years from the end of every tax period. VAT for services is paid through monthly returns.
On 1st April 1994, tax on services and goods was introduced in Singapore. It was implemented without any resistance or reluctance from the taxpayers. This tax on goods is not VAT, but a simple General Sales Tax payable at retail level @ 3%.
In a country, where literacy rate is as high as 97% and development is one of the best in Asia, there was no desire to introduce Value Added Tax (VAT) on goods. The Government of Pakistan, in fact, under immense pressure from the IMF, has been trying to impose VAT, which is neither suitable to our peculiar conditions, nor a model followed by two very developed countries of Asia, i.e., Japan and Singapore.
There is 7% VAT on retail trade in Thailand (In 2001 it will increase to 10%). VAT was introduced in Thailand in 1992. Now VAT is a main income for the government. Country’s economy started picking after levy of VAT.
The Malaysian government introduced 5% service tax on goods and services some 10 years back. The taxes on various goods and services were progressively extended from time to time. At the same time income tax was progressively reduced. Small businesses having a turnover of less than RM30 k to 500k were exempt from imposing and collecting the tax. Further tax was paid on a receipt basis and paid once in 2 months. Where debts were not collectible after due legal recourse the tax is waived. There will be a gradual shift from income tax to service tax to encourage people to earn and pay tax as they spend. The range of products and services will be increased together with the rate of tax. The gradual shift from income tax to service tax has encouraged investment thereby contributing to the economy through employment etc.
Country has a Value Added Tax on goods and services. It came into operation in 1998. Prior to its introduction, sales tax @ 8% on goods was introduced in 1982, a large number of small traders are not concerned with VAT as only those having an annual turnover in excess of Rs. 4.0 million have to register with the VAT office. Sales tax of 5% was introduced in 1982. VAT rate is presently at 10%.
There is no sales tax or export duty. Import and excise duties are, however, imposed on certain articles.
A VAT is charged on transfer of imported and manufactured goods and the provisions of services. The normal rate is 10% that may be reduced to % or increased to 15%; further, special rates of output VAT, ranging from 1% to 8.2% may also apply.
Various exemptions and deferments apply.
The excess of output VAT over input VAT is paid by the 15th of the following month. A monthly VAT return is required to be lodged by the 20th of the following month. Procedures are prescribed to claim a refund of overpaid VAT. An administrative penalty of 2% of the VAT imposition base is imposed under certain conditions.
Sales tax on luxury goods is levied at the rate of 10%, 20%, 25% and 35% on imported and domestically produced luxury goods as stipulated by the Ministry of Finance. This tax is single-stage tax levied ether on the transfer by the manufacturer or on importation into the customs territory of Indonesia. Exports and certain imports are exempt. This tax is levied in addition to VAT.
The VAT regime in the Philippines, effective from 1 January 1988, is governed by Title IV (Value Added Tax) of the National Internal Revenue Code (hereinafter NRIC), as amended by Executive Order No. 273 (hereinafter EO No. 273). With effect from 1 January 1996, the Expanded VAT Law (Republic Act No. 67716) extended the scope of VAT to most services and the sale or lease of real property.
Generally, all persons who, in the course of their business, sell goods or render services subject to VAT are required to register as VAT taxpayers if the aggregate amount of their actual or expected gross sales or gross receipts exceeds PHP 200,000 for any 12-month period.
VAT is levied on the sale, barter or exchange of goods within the Philippines, the importation of goods into the Philippines and the rendering of services within the Philippines. VAT is imposed at the rate of 10%. However, various transactions are either zero-rated (for example, export sales) or exempted.
The comparative study of above countries shows that the levy of VAT/GST in Pakistan has unnecessarily made a controversial issue. This tax was introduced successfully in a number of undeveloped countries without any difficulty. In Bangladesh, Indonesia, Philippines, Thailand and Mauritius even VAT was imposed without any difficulty. In fact, the IMF policymakers never bothered to do any homework before forcing the Pakistan Government to introduce VAT type tax. Secondly they did not elicit the opinion of tax experts and made no effort to secure consent and consensus of the business community. They tried to follow the European model of VAT in Pakistan without realising that the same cannot be implemented at one go in a highly undocumented economy and that too through a corrupt and inefficient tax apparatus.
It is not possible to implement VAT in Pakistan at one go because of various reasons, especially due to the following:
· Lack of tax culture
· Poor tax administration
· Problem of widespread illiteracy,
· Lack of monetisation
· Poor accounting practices
A long-term policy plan is required to successfully implement VAT regime in Pakistan. It cannot be enforced in isolation, without improving the overall tax culture, level of education and implementation of major tax reforms.
[i].. VAT is a specific turnover tax levied at each stage in the production and distribution process. In its purest form VAT is a tax on all final consumption expenditures for the supply of goods and services. Although VAT ultimately bears on the individual consumption of goods and services, liability for VAT is on the supplier of goods or services. VAT is a percentage tax levied on the price each taxpayer charges for the goods or services it supplies. VAT normally utilizes a system of tax credits to place the ultimate and real burden of the tax on the final consumer and to relieve the intermediaries of any final tax cost. VAT is calculated by applying the applicable rate at a taxable stage to the appropriate taxable base of goods or services; it is then reduced by the VAT (as indicated on the invoices delivered to the purchaser), which has directly affected the cost of the various elements constituting the price of goods or services. In Pakistan there are substantial deviations from this pure form of VAT (as in vogue in Europe and some other developed industrial societies), because of exercise of various tax rates, exemptions and concessions for certain goods and services and specific provisions governing importation and exportation. It is therefore not VAT but VAT-type tax in Pakistan.
[ii].. During the first seven months (July-January) of the current fiscal year, CBR collected a gross sum of PKR. 100.581 billion in sales tax comprising PKR. 49.671 billion in import-related sales tax and PKR. 50.910 billion in domestic sales tax. After refunding PKR. 17.282 billion, the net collection was PKR. 83.299 billion. This included PKR. 49.642 billion in import-related goods and PKR. 33.657 billion in domestic sales tax. Last year, CBR mopped up a gross amount of PKR. 76.071 billion in sales tax, but after a refund of PKR. 13.836 billion the net collection in sales tax was just PKR. 62.235 billion. The actual potential of this tax in Pakistan is not less than PKR 400 billion. This confirms the point of view that at present it is a high tax on a narrow base, whereas it can yield better result if it becomes a lower tax on wider base.
[iii].. The total number of registered taxpayers under this tax regime is just 91,000, out of which 25,000 has not paid any tax during the last six months. About 10,000 did not file any return at all! About 16,000 are those who were registered but did not have taxable turnover or have closed down their business since registration. VAT cannot be enforced unless a proper audit system is ensured. At present CBR is conducting audit of only 1.2 per cent of registered persons, whereas the minimum requirement set by IMF is 25 per cent.