THE tax reform commission is expected to propose a single-digit sales tax on a no-refund, no-adjustment basis in the upcoming federal budget 2015-16. The proposal is on an ad-hoc basis, pending full enforcement of the value added tax mode.

Most tax officials think that a single-digit sales tax could be a stopgap arrangement for 2-3 years, though not a permanent solution. The present system is marred by distortions that lead to lower-than-potential revenue collection.

Set up last year, the commission — headed by Masood Naqvi, a chartered accountant — is expected to submit its interim report by end of the month.

Naqvi also believes that a single-digit sales tax can help the government pocket a few extra billions, but it is not a permanent solution.

The ultimate goal is an effective value added tax (VAT) model, he remarked, and added that the existing sales tax regime is full of distortions and shortcomings. But he was not willing to divulge some details of the proposal, but said his commission will submit the report to the government this month.

The real issue is: will a reduced sales tax rate encourage tax compliance. And is the government sure that the revised rate will lead to growth in revenue?

Then, the minimum requirement for the implementation of a single-digit rate is automation, which at least links the transactions with the banking system.

The effective sales tax is being administrated at multiple rates, with a host of exemptions and zero-ratings. While creating administrative difficulties, this also increases the cost of compliance for registered persons

Meanwhile, the registration of fake companies is turning out to be the easiest way of making quick money in major cities. But the Federal Board of Revenue’s (FBR) only response has been to blacklist them or suspend their registration.

The second important point is the narrow tax base, as 80pc of sales tax revenue comes from just 10 products. The broadening of the tax base and increasing tax compliance is the real challenge. There are only 0.161m registered sales taxpayers. It further shows that 43pc of the sales tax taxpayers are also non-filers.

The imposition of sales tax in VAT mode, given the sizable informal economy, could mean that major collection would come from imports. In case of the consumption tax, purchasers in the informal economy could not claim input tax credits.

The VAT in its current shape has also been proved to be more vulnerable to high-profile frauds. The issue is whether the FBR has the system to provide systemic refunds. Attempts have been made in the past to introduce an automated refund system, but they were fraught with scandals.

An indicator that shows the performance of a sales tax regime in a country is the net effective tax rate, or the net revenue gains. In Pakistan, the net revenue gains from the sales tax is around 5pc. A net revenue gain of less than 8pc is considered below the international benchmark. Low revenue gains are the outcome of both a defective system and malfunctioning administration.

The sales tax in VAT mode has been in place since 1996, but it was gradually distorted with amendments to benefit certain sectors. Things started getting worse when the workforce dealing with sales tax was delinked from the job in 2009. The sales tax collection was handed over to the income tax department, which lacked the required skills.

So training the existing staff is the most important factor, and the commission needs to take care of it.

At the same time, to ensure further revenue gains, the government will have to introduce a single-digit sales tax of around 8pc. The determining of this rate is not an easy exercise and may become counterproductive.

Internationally, the VAT rates range between 11pc to 19pc. The VAT rate in Bangladesh is 15pc, India 12-15pc, Sri Lanka 12 pc and Nepal 13pc. Most academics term 15pc as an ideal VAT rate. While VAT rates seem high on the face of it, their actual impact on the end consumer is lesser because the tax is charged on the value added to the product and not to its actual price, as is the case in Pakistan.

The sales tax in its present form was introduced at the standard rate of 12.5pc; this rate was effective from 1990 to 1995. Currently, the standard rate is 17pc. But the sales tax is being administrated at multiple rates, with a host of exemptions and zero-ratings. While creating administrative difficulties, this also increases the cost of compliance for registered persons.

During the stopgap arrangement of a single-digit sales tax, the government will have to make a serious effort to end fake/flying invoices and document the economy. These are the prerequisite for the VAT system. Tax officials estimate that refund payments of Rs100-200bn are made to bogus companies against fake and flying invoices in a year. And these fake refund claims have been rampant for the past many years.

To eliminate these malpractices, the tax reform commission will have to come up with a strong recommendation to minimise cash transactions.

Published in Dawn, Economic & Business, April 27th, 2015

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