Difference between VAT & GST/Sales Tax

In recent weeks there is lot of discussion and debate as to what is the difference between Value Added Tax (VAT) and General Sales Tax (GST) in the context of Pakistan.  The issue has further been confused by statements emanating from the government high ups who are insisting that VAT is to be introduced w.e.f 01.07.2010 which will replace the so called GST. Multiple opinions have surfaced most of which are misplaced and unwarranted.

This article intends to dissect the difference if any, between the two and to give a clearer picture of the whole issue.

VAT is recognized by various names in the world. It is generally known as Value Added Tax (VAT) whereas in Australia & New Zealand and in some other countries, it is known as Goods and Services Tax (GST). In one of the countries in Africa, it is known as General Consumption Tax (GCT) as well. VAT/GST is generally imposed on goods and services and in reality there is no fundamental difference between the two, although certain practices may vary from country to country. In fact, one of the advantages of VAT/GST is that it can be imposed with equal ease on both goods and services.

When sales tax was imposed in Pakistan under the Sales Tax Act, 1990, it was intended to be in VAT mode except that it was not imposed on services and was also not extended to retail stage. However, since Pakistan did not had any experience of VAT at that point in time, many features of the old Central Excise Act/Sales Tax Act, 1951 were retained.  In 1996, an effort was made to bring sales tax of Pakistan at par with VAT/GST of Europe & Australia etc. Most of the provisions derived from the Central Excise Act were, therefore, done away with and an effort was made to ensure that the tax was a self-assessed, audits & accounts based tax and in VAT mode. Its name, however, remained sales tax. Pakistan is probably the only country in the world where sales tax denotes a VAT. There is reason & rationale behind it. In 1989, when the Sales Tax Act was being drafted, its first proposed name was Goods & Services Tax which was immediately changed to General Sales Tax (GST) on the realization that sales tax on services was a provincial subject. However, before the bill could be moved in the legislature, it was decided that name should remain sales tax, so that taxpayers resistance to a new tax could be minimized, The argument was that taxpayer population was already aware of a tax known as sales tax since the creation of Pakistan. Therefore, it could be successfully argued that no new tax was imposed. Meanwhile, however the word “GST” had gained currency in common parlance. Inspite of the fact that Sales Tax Act, 1990 does not at all use the word “GST”, it has frequently been used by common taxpayers as well as by tax experts and professionals. It was in fact used to refer to the normal tax regime of 15% (or 16% as the case may be) vis-à-vis fixed tax schemes to make a differentiation between the two. Since 2000, generally fixed tax schemes have been abolished but the word GST has continued to be used.  Legally speaking GST is a non entity in Pakistan.

The point to be made here is that Pakistan’s sales tax is a value added tax. The IMF broadly defines VAT as “A broad-based tax levied on commodity sales upto and including at least, the manufacturing stage, with systematic offsetting of tax charged on commodities purchased as inputs ­­­­­­– except perhaps on capital goods – against that due on outputs.” (The Modern VAT by Liam Ebrill, Michael Keen, Jean-Paul Bodin, and Victoria Summers published by International Monetary Fund Washington, D.C 2001).

Pakistan’s sales tax fully complies to this definition. The writer is, therefore, of the view that unnecessary stress by FBR on introduction of a Value Added Tax is misplaced and out of context. Their emphasis is perhaps due to extreme pressure from IMF, World Bank and other donor agencies who want Pakistan to adopt value added tax of a model which they consider the best. But this has to be understood that there is neither a so called best VAT model nor there is any standard VAT recipe. There are considerable differences in VATs of various European Union countries inspite of Sixth Directive issued by EU. Similarly, there are lot of differences in VATs of other developed and developing countries.

The question is why so much interest from IMF and World Bank for adoption of VAT of their liking?

There are certain reasons which need to be understood and appreciated.  First and foremost is that our sales tax is on goods only and does not extend to services, which even otherwise is a provincial subject.  Then there are certain deviations from the so called standard VAT practices.  The standard advice is that VAT should have a single rate and a zero rate.  On the other hand we have many rates e.g. 16%, 18.5%, 21% and 25% in case of CNG stations. Then there are special schemes, for example, for mild steel re-rolled products. There are certain products which are taxed on the basis of retail price; although the tax is collected from the manufacturers. There are wide spread exemptions and domestic zero rating on textiles and other export oriented sectors.  The IMF and World Bank are of the view that these exemptions/zero rating have narrowed down the tax base which in turn results into lower tax to GDP ratio. In a nut shell they are of the view that Pakistan’s sales tax is a bad model of VAT which should be discarded and abondoned in favour of better VAT models of Europe, Australia, New Zealand or Canada etc.

There are two approaches to do it. IMF/World Bank had adopted a radical approach.  They want us to discard the present in one go and adopt the so called best VAT model.  In the process they want us to have VAT on services through provinces, single rate and a zero rate with no special schemes, abolition of exemptions and domestic zero rating etc. They want a clean break from the past and want us to have a new VAT Act. This is an imprudent advise from IMF and reflects their typical mind set developed in the European context.  VAT in Pakistan is altogether a different ball game. During my discussion with my friends in the department I have been jokingly telling them to ask the IMF/World Bank representatives to come to Pakistan for their meetings, instead of calling the said meetings in safe heaven of Dubai.  They don’t have the courage to tell them. These IMF officials also do not have the courage to come to Pakistan for meetings. For them it is a dangerous country and in this dangerous country they want to introduce a VAT at par with the European model. Their approach is absolutely removed from reality and reflects mind set of rulers forcing conditions on subjects. They are bent upon imposing their sweet will on us. Unfortunately, Government of Pakistan and FBR high ups don’t have the conviction to oppose all this.  In all probability, they are buying their time.

The saner and prudent advice has come from persons who have experience of VAT under the Sales Tax Act, 1990 and who are aware of the short comings of the said Act. Every body will agree that exemptions should be removed, domestic zero rating should be discontinued and other bad features of Sales Tax Act should be done away with. Generally, the advice would be that sales tax on goods as well as on services (through properly negotiated settlement with the provinces) is required.  It not only requires time, patience, negotiations, discussions, bargaining with provinces and all relevant stakeholders but also understanding of the ground realities.  Unfortunately that has not been done nor is intended to be done. Everything is being rushed in an unprecedented haste.  Why use the word “VAT” and why not use the word “sales tax” and bring this sales tax at par with the standard VAT practices? A part of the opposition to VAT can be overcome by just retaining the name of sales tax.  Then the exemptions should be withdrawn with a human face and domestic zero rating should be withdrawn with prudence and with a strategy aimed at seamless refunds for exporters.

Apparently, the Pakistan tax administration and wizards are under intense pressure. They want a VAT of IMF/World Bank at any cost imposed on Pakistan. They must be aware that there will hardly be any difference between VAT and sales tax of Pakistan patterned on VAT model but they do not have the conviction to say it loud and clear.

May God give them the courage and conviction.

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