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VAT model for Pakistan
09-09-2009, 12:18 AM,
VAT model for Pakistan
<center><b>VAT model for Pakistan </b></center>
<i>ARTICLE (September 08 2009)</i> Tax revenue, all around the world, is a major source of financing the expenditure side of the budget, particularly its development component. Taxes irrespective of the fact whether they are direct or indirect, squarely depend upon the economic structure of the country; the level of development of the country, ie the degree of its industrialisation and the growth of its modern services sector; share of its agriculture sector in the GDP, level and composition of employment of the working age population, particularly women, the pay structure and the amount of salaries/wages.

Nevertheless, enforcement and collection of taxes are directly proportional to the modernity and effectiveness of the tax administration which in their turn, depend upon the system and policies of government, particularly the fiscal and monetary policies; the legal framework of taxes; the use of information and communication technology (ICT), transparency of all its processes; involvement and co-operation of stakeholders, particularly human resources of the tax organisation and taxpayer.

Our tax structure rests on two columns, ie direct tax and indirect tax. Sales Tax is an important constituent of indirect taxes, along with customs and federal excise tax. Our sales tax and federal excise tax are collected through the VAT mode. It is multi-stage tax. At every stage of production and distribution, including sale, a person has to pay the tax only on the value addition made at that stage.

The credit of tax already paid on inputs/purchases is allowed against the sales tax collected from the (next stage) buyer, however, if the difference is a positive figure, it is paid to the government, but if the balance appears in the red, refund is paid by the government. Yet, being an indirect tax, it is a charge, primarily on the (local) consumer, hence the purchasing power capacity of the local populace is of paramount importance. Any design of the VAT must take this factor into account.

The success and volume of the collection of sales tax, ultimately depend upon the income of individuals or households on the one hand, and on simplicity and least regressiveness of the tax, on the other hand. The size of the subsistence sector and the informal economy, both in the rural and urban areas are of immense importance. It is here where the experts of the IMF, World Bank and that of the OECD flunk and falter.

They have conducted lots of researches and prepared working papers, but none of them addresses the issues of the economic structures of the developing/backward countries. On the other hand, although efforts have been made by many a developing country, yet a befitting model still has to be developed for developing countries. All existing models are variants of the European model with certain deviations.

The VAT model cannot be made a success by tax managers alone, it heavily depends on policy, planning and vision of the economic managers. VAT being an indirect tax is a regressive tax. It is neither a substitute, nor replacement of the direct tax, rather the main challenge for economists and tax designers is to mitigate its regressiveness and make it consumer-friendly to encourage private consumption, which is regarded nowadays, a main tool for the stimulation of the economy, which in turn, contributes towards an increased volume of VAT collection.

<b>HISTORY OF VAT</b> Although, the VAT was conceived in Japan and France in the early 1950's, it was first implemented in Brazil in the early 1960's. As regards the European Union countries, the history of VAT could be divided into two phases the period before 1993 and the period after 1993, ie the period of market integration after the Maastricht treaty of European Union.

The first-ever, two VAT Directives were adopted on 11 April 1967. However, later on, on 17th May 1977 the Sixth VAT Directive was adopted that established a uniform VAT coverage in the European community. Although, amendments were made to this Sixth VAT Directive. However, it continued till the recast VAT Directive was adopted on 1 January 2007 effective till to date.

Studies have been made in respect of the major OECD countries regarding their standardisation and differences. The USA is the only OECD country that does not have VAT at the federal level. The study of other major countries, including Australia, Canada, France, New Zealand and United Kingdom shows that not only the VAT rates differ from country to country, but there are certain differences.

The difference, mainly, are on account of exemption and zero-rating of goods and services and on account of thresholds of registration and multiple tax rates. Deviations are also on account of treatment of consumer essentials, for example in New Zealand, food and healthcare is taxed at the standard rate of 12.5%, whereas in the UK, these are zero-rated.

The New Zealand 'model' has a larger tax base for VAT, with less exemption. The treatment of the public sector, non-profit and charitable entities in Australia and New Zealand are the same as that of the private sector. The differences are also on account of financial services and insurance and treatment of real estate sector. In Australia and New Zealand, even books and cultural services are taxed. In Australia, religious services are zero-rated, however, New Zealand taxes them at the Standard rate of 12.5%.

On the other hand, the federal structure of a country poses another problem for the uniformity of the VAT within the same country, for example in Canada, there is slight difference on this account between provinces that leads to enforcement issues as well. India has braved lots of problems on this account and after many years of discussion and deliberations, she has announced in July, the budget this year to launch VAT at the Union level as GST (goods and services tax) from 2010.

In Pakistan, contrary to those countries having federal fiscalism, there is only one central tax organisation. Enforcement and collection of sales tax are not distorted by the provincial boundaries of the provinces. Yet, redirection and distribution of these taxes are important political issues for the federation. Nevertheless, both aspects, although having some overlapping effects are two different issues and require to be dealt with as such.

As regards the compliance risk and enforcement issues, fraud is a major risk particularly in European Union countries. Carousel fraud is the leading one in the EU, particularly in the UK. Other types of compliance risks are missing trader fraud, failed business, underreporting cash transactions, fraudulent refunds, misclassifying purchases and fictitious or altered invoices. In Pakistan, flying invoices, missing traders, sales to unregistered persons and fictitious refunds have been pestering challenges for the FBR.

<b>MODEL FOR DEVELOPING COUNTRIES</b> More than a dozen studies, conducted and papers prepared by the IMF, World Bank, government organisations of USA, OECD and European organisations have been checked, but one yet has to find out one that tries to understand the enforcement of VAT in the backdrop of backward economies, having a blend of undocumented, informal, comprador and black economy components.

None of the studies have ever tried to develop a legal framework and methods to use this tax as a tool to increase private consumption at the retailer stage or at least mitigate the regressiveness of this tax. None of these studies and researches have even been successful to come up with a viable plan and strategy to address the issue of fraud, even in Europe, where carousel fraud and missing person fraud are challenges for VAT enforcement.

<b>PAKISTAN</b> Although, Pakistan, conceptually, has one of the most modern system of taxes, including its legal framework and administration, however, implementation of the system poses great risks and failures. Issuance of SROs, without much deliberation and haste leads to many a complication. Haste symbolises a syndrome and is a major cause of policy and enforcement problems. Underlying causes include lack of political vision, lack of tax professionalism and intellectualism and prevalence of colonial and a comprador mindset of the bureaucracy.

<b>WHAT MUST BE DONE?</b> A four-pronged strategy should be adopted to develop an indigenous model. On the one hand, a thorough study of the economic structures and level of development of the economy should be conducted by genuine economists particularly having tax background. On the other hand, supply chain of distribution and sale should be understood and documented. Third, a cadastral map of location of retailers should be developed showing roads, locality, and streets - big and small ones.

A system just like the GPS for retailers should be developed so that any outlet could easily be located, even on computer. Fourth, a tax design should be developed, which does not have any exemptions, zero-ratings, reduced rates and refunds, for these add to, not only to the complexity of the tax design, but also to the enforcement issues.

If incentive/compensation to supplier or consumer is to be allowed on certain goods and services, it should be paid to the relevant utility, in case of supplier and in case of individual consumers to educational institutions in lieu of fees of their children or to the related utility. It is fundamentally a new concept and requires a lot of further meditation, however, innovation on this account, as well, might salvage us.


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