World Bank 'recommends' VAT on all stages

[Naveed Yaseen]

ISLAMABAD (September 12 2009): The World Bank (WB) has proposed extension of value-added tax (VAT) to each and every stage of production and distribution chain, including the retail stage. According to WB recommendations, specified in the Pakistan Tax Policy Report, 'Tapping tax base for development', the FBR has given sales tax exemption to five leading export sectors, which could not be termed as 'zero-rating'.

The design of a modern VAT is guided by the principles of external and internal neutrality. The external neutrality ensures that the tax burden on domestic consumption is the same irrespective of the origin of the goods or services consumed. It also ensures that the government receives tax revenue from domestic consumption.

External neutrality is achieved by applying the destination principle, which is currently the preferred jurisdictional principle for value-added taxes. This involves taxing imports at the same rate as domestically produced goods or services; and zero rating exports.

Internal neutrality ensures that consumers bear the same tax burden on all consumption and that taxpayers are taxed in the same way irrespective of the business structure adopted or the way in which supplies are made. It is best achieved by a broad based tax applied to all goods and services, all types of taxpayers, and all types of transaction at a single rate.

In particular, internal neutrality in the legal design of a VAT requires minimal use of multiple rates, exemptions and zero rating. There is also need of broad coverage of taxpayers by using broad concepts of 'taxable activity' and 'taxable person'. The application applies to each and every stage in production and distribution chain, including the retail stage. A broad input tax credit mechanism is designed to ensure that each taxpayer pays taxes only on its value added and a broad and inclusive concept of 'taxable value' so that the burden as a percentage of consumption closely approximates the rate of tax.

The FBR suspected the fraudulent processing of tax refunds from the five export sectors because net GST collections from these sectors were not only negative - as it may be expected for exporters under zero rating - but far more negative than could be reasonably expected. FBR solved this problem by suspending all tax refunds to these sectors while at the same time exempting these sectors from filing GST returns.

Therefore, even thpugh the FBR refers to this policy as 'zero rating', properly speaking, the five sectors were exempted and not zero rated. That is, the five sectors gained the exemption from filing GST but also lost the right to get refunds on GST taxes paid on their inputs incorporated in the exported products, the WB added.

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