THE Financial Action Task Force has once again grey-listed Pakistan for not taking sufficient measures against money laundering and terrorism financing. One of the FATF’s major areas of concern remains the lack of financial coordination between federal and provincial authorities, creating major lacunae in the documentation of the economy.

Value Added Tax, a powerful tool for such documentation, works on the principle of neutrality. It is a multistage tax; its incidence has to be passed upon the ultimate consumer of goods or services, neutralising the effects of tax on businesses, paid at each stage of input and output adjustments. So far, 165 countries have witnessed VAT operations. Pakistan is one of them, and is undergoing constant reformation of its tax system thanks to international donors and political will.

The world over, VAT on goods and services is generally administered by the same authority. In Pakistan, however, a hybrid system has evolved, in which it is bifurcated between the provinces (services) and the centre (goods). Since the 18th Amendment devolved services tax, the provincial revenue authorities (PRAs) are facing numerous challenges, including deficient legislative measures, lack of human resources, absence of appropriate paraphernalia and insufficient coordination with the Federal Revenue Authority (FBR). Sindh took the lead with the Sindh Sales Tax on Services Act, 2011; Islamabad Capital Territory, Punjab and Balochistan followed suit in 2011, 2012 and 2015 respectively; whereas Khyber Pakhtunkhwa relies upon the KP Finance Act, 2013.

In the administration of the provincial VAT, a number of organisational issues and legal disputes have surfaced. A taxpayer is entitled to adjust the tax paid (inputs) during the purchase of taxable services or supplies, from the (output) tax payable on such services or supplies. In case input is claimed by a PRA’s taxpayer on goods purchased in his business, its adjustment is allowed by that PRA on behalf of the FBR. Conversely, when an adjustment is claimed by FBR’s taxpayer on purchase of services, its adjustment is allowed by FBR on behalf of that PRA. Previously, where a taxpayer was engaged in both supplies and services there was no question of bifurcation of input tax as it was administered by one authority under one law. Currently, five mutual claims of cross-input adjustment surface, requiring lengthy, manual reconciliation.

The country lacks an equitable and justifiable VAT system.

As a principle of prudence, automated revenue systems may allow such cross-input adjustments irrespective of the fact that manual reconciliation exercises are conducted after certain intervals. The principle of origination and termination of service/supplies is also relevant when there is cross-provincial rendering of services/supplies. For instance, electronic and print media advertisements are booked in one jurisdiction but viewed in all jurisdictions. Apportioning revenue shares in such circumstances is very difficult. It may be settled if we understand that a service is deemed to be consumed wherein it absorbs into the GDP of the population, but the lack of consensus among PRAs on this (given the peculiar geographical contiguities and size of economies of each federating unit) may involve further challenges. In the case of goods, deductions at the import stage may inflate the revenue of certain PRAs.

National service providers contributing a lion’s share to the revenue pie — telecommunication, oil, and banking sectors — are distinctively registered under all PRAs. The cost of doing business thus increases when they have to register and file a declaration for each statutory jurisdiction. Currently, PRAs have no mechanism to reconcile or verify their declarations, thus creating the risk of tax avoidance. The solu­­tion lies in filing harmonised declarations for all RAs. Similarly, res­­­taurants, toll activities, etc, are treated as service providers by PRAs whereas the FBR brackets them as manufactures of goods. These are just some of a long list of issues.

The magnitude of the repercussions on revenue was perhaps not anticipated at the time of devolution of the sector. Unfor­tunately, as a result, a crippled VAT system has evolved whereby the absence of a regulatory mechanism has hurt the provinces, especially the poorer ones. Even the best tax policies of PRAs would fail in the absence of an equitable and justifiable VAT system.

These issues, if not addressed soon by the incumbent government, may further create a sense of deprivation and alienation among the already marginalised federating units. Being lineal decedents, PRAs have to look to FBR to provide support in expertise and human resource capacity building. A coordinated federal-provincial system, with a structured central policy, is the only possible intervention for the current idiopathic toe walking of provincial VAT.

The writer is an officer of the Inland Revenue Service, currently working as additional collector, KP Revenue Authority.

Published in Dawn, August 29th, 2018