ARTICLE (March 28 2010): The government of Pakistan has full intentions to implement the Value Added Tax (VAT) system with effect from July 1, 2010 as part of its commitment with the IMF. Currently, this bill is in the Parliament for discussion. The VAT bill has far reaching implications, both for the government as well as the common man.
It will impact the growth and development of industry, agriculture as well as socio-economic setup of the country. Although the whole bill warrants deeper analysis, however, what kind of goods are being under its net is a matter of common interact. This is essential as it shall directly affect the daily life and shall test the capacity of the FBR so far as collection is examined.
We can learn from the experiences of others and be wise to not make mistakes at the cost of our economy that is already dwindling. The FBR claims that the proposed VAT bill is in accordance with best international practices. If that is the case, then there is no harm in comparing different aspects of the bill to other economies.
In this report, we would like to examine the exemptions from VAT as specified in the bill and the exemptions that are currently available in most developed economies as well as specified in India, our neighbouring country. The purpose of this article is to put hold the issue in proper perspective for the benefit of the Parliament as well as general public.
In the bill's first schedule, the exemptions inter-alia are: (1) unprocessed peas, wheat and wheat flour (2) ice and water excluding those for sale under brand name (3) table salt, excluding salt sold under brand name (4) books, excluding advertisement material (5) dextrose and insulin infusions only and (6) precious metals other than a first supply of precious metal.
In the second schedule, the zero-rated supplies include such basic pharmaceutical and medical supplies as are specified by the Board. To begin with, it may be made clear that the VAT is not perfect neither perfectible. It is further added that no classical act of VAT exists in the world. It operates on the principle that no single size fits all (NSZFA).
The European Union (EU) where all member countries have VAT operates under the provisions of EU-sixth directive. It would be interesting to know what kind of the goods are exempt from the VAT or can be exempted from the VAT. The purpose of exemption is both for reducing the administrative cost as well as not taxing the poor man.
Here it may be added that in the EU countries, a poor man is a person whose annual income is less than US $30,000, whereas the person having this income in Pakistan attracts highest slab of income tax. Consequently, it implies that the exemption scope needs to be much broader than what is specified in the EU, based on the per capita income of common man in Pakistan. The relevant portions, containing the list of exemptions in the EU is reproduced as under.
EXEMPTIONS WITHOUT THE RIGHT TO DEDUCT
For socio-economic reasons, the following are exempted:
-- Certain activities of general interest (such as hospital and medical care, goods and services linked to welfare and social security work, school and university education and certain cultural services or the provision of foodstuffs).
-- Certain transactions, including insurance, the granting of credit, certain banking services, supplies of postage stamps, lotteries and gambling and certain supplies of immovable property.
EXEMPTIONS WITH THE RIGHT TO DEDUCT To take account of the place where goods and services are deem to have been consumed and hence taxed, the following transactions are exempt:
-- Intra-community supplies of goods, including new means of transport and products subject to excise duty dispatched from one member state to another. As we note from above, that supply of food items and medical and educational services and materials are exempt from VAT in EU. They have not specified items but have given blanket exemptions on all such food and health and educational services and material.
Consequently, it means that all activities relating to day-to-day life needed goods and those that are required for the socio-economic development of the society are exempt from VAT. It is interesting to note that items, which are excisable are not only exempt, but are entitled to input credit adjustment. We may add here that in all these countries tax-to-GDP ratio is higher than 20%.
The VAT successfully operates in United Kingdom for last thirty years and it is showing robust growth in Australia in forms of Goods and Services Tax (GST). It would be relevant to see what kinds of exemptions and in what manner are available in the UK and Australia.
In UK, as per the VAT Act 1994, schedule 8, group 1 specifies food of a kind used for human consumption is zero-rated. A product is 'food of a kind used for human consumption' if: the average person, knowing what it is and how it is used, would consider it to be food or drink; and it is fit for human consumption.
The term includes (a) products eaten as part of a meal, or as a snack; and (b) products like flour, which, although not eaten by itself, are generally recognised food ingredients. The above makes it clear that food for human consumption is not only exempts but is entitled to input tax credits.
The purpose again here is to tax primarily such goods, which are not essential for the daily life. And again the underline philosophy is to discourage the consumption of the non-essential items and this partially answers the criticism on VAT on being regressive tax.
Again the same sections says: "You can zero-rate all supplies of unprocessed foodstuffs such as raw meat and fish; vegetables and fruit; cereals, nuts and pulses and culinary herbs." The zero-rating as stated above clarifies that almost all the agricultural products are exempt from VAT and are entitled for tax paid on any goods and services used in their production.
The exemptions available to farm products is world over are just to attract investment in this core activity of life. However, it is amazing to note that in the proposed VAT bill by government, no such exemptions have been provided. Now let's compare the tax system in Australia. Earlier, we stated that the GST in Australia is proving a very smooth growth engine for the economy. There agriculture sector is booming. Again we may see what kinds of exemptions are available there.
THINGS THAT ARE GST-FREE:
-- Basic food, education courses, course materials and related excursions or field trips, medical, health and care services, medical aids and appliances, medicines, exports childcare, religious services and charitable activities, supplies of accommodation and meals to residents of retirement villages by certain operators, cars for disabled people to use, as long as certain requirements are met, water, sewerage and drainage, the sale of a business as a going concern, international transport and related matters, precious metals, supplies through inward duty free shops, grants of land by government, farmland, international mail.
"A farmer grows potatoes and sells them at the produce markets. The potatoes are basic food so the farmer doesn't include GST in their price. But the farmer can claim GST credits for the GST included in the price of purchases relating to potato growing, such as fertiliser, fuel and freight."
(Source Website of Australia Taxation Officer)
Australia does not only exempt agricultural products, food items and socio-economic services, but refunds or allows input credit adjustment to the supplier. This, in return keeps their cost free of any taxes hidden or otherwise. Even in one decade, since the GST was introduced in Australia, it has already become a success story and is referred to by independent analysts, Professor Bird as VAT of fourth generation.
No analysis becomes complete unless, we see the relevant system in the best democratic state (USA) and the biggest democratic state (India). As we know, there is no VAT in the US. However, in its federating units, there is un-adjustable GST. It would be relevant to see what goods are exempt from the GST in the US in its largest state (California). In grocery stores, unprepared food items are not taxed.
All other food items, including fruits and vegetables, are exempt from sales tax. Also excluded are food animals (livestock), food plants and seeds, fertiliser used to grow food, prescription drugs and certain medical supplies, energy utilities, certain alternative energy devices and supplies, art for display by public agencies, and veterans' pins.
There are many specific exemptions for various veterans', non-profit, educational, religious, and youth organisations. Sale of items to certain out-of-state or national entities (mostly transportation companies) is exempt, as are some goods sold while in transit through California to a foreign destination.
We may note that in the US, states exclusively rely upon GST, as internal revenue is with the federal government. It is for this reason that states are continuing with non-adjustable GST instead of adopting VAT. Despite such heavy reliance on GST, the list of exemption is no different from the EU, UK and Australia.
Almost all food items medicines; supplies to federal government, educational institutions are exempt from the GST. The list of exemptions in the US may be very relevant to our government as we have very strong strategic partnership with that country.
In India, the study for adoption of VAT started in early 90s when the present prime minister was its finance minister. Del Gupta published a scholarly paper on taxation system in India and advised for cautious approach towards adoption of VAT.
Subsequent to different studies, and especially constituted commission report, India is poised to introduce VAT in its all states during the current financial year, whereas in few states, it is already operative. We may add that in India, the federation has the power to tax services where as federating units are entitled to tax goods.
This bifurcation is to make federation responsible for socio-economic services. Our government is proposing exact opposite. In India, as per there VAT act following are exempt.
-- Agricultural implements operated manually or driven by animals, aids and implements used by handicapped persons, books, periodicals, and journals, electric energy, fresh milk, pasteurised milk, butter milk, and curd, fresh plants, samplings, and fresh flowers, fresh vegetables and fruits, meat, fish, prawn, and other aquatic products when not cured, or frozen, eggs, and livestock, paddy, rice, wheat, pulses, salt, and flour, sugar, textile.
India is very relevant to us as we share common economic conditions. It is much more essential for India to have higher tax-to-GDP ratio to sustain its socio-economic development. Despite these constraints, the Indian exemption list as stated above is very exhaustive. It has even exempted the supply of electrical energy and textile as well as sugar sector. None of their agricultural products are subject to VAT.
If we look into the list of exemptions in above stated countries, we will observe that food items, including vegetables, socio-economic sectors, healthcare, medical profession is either exempt or is zero-rated in developed countries. However, in the proposed VAT bill, we have restricted our exemptions to bare minimum.
The third schedule, however, provides that pharmaceutical and medical supplies as specified by the board shall be zero-rated. Here very interesting point to consider is, as per section 13, no such power is available to the Board, as it has been invested in the parliament. This is by itself an anomalous situation that needs careful study by the parliament.
Once the VAT becomes operational, almost every commodity other than peas, wheat and wheat flour shall be chargeable to the VAT. Does the FBR have the capacity to implement the collection of taxes from sales made on donkey carts? What would happen to common person in a country where 40% of its population lives below the poverty line?
Another interesting thing is that any person making sale less than Rs 21,000 per day is exempt from registration. Now question arises, how an unregistered person can recover the tax from sale of the VAT-able commodities. We may further add that Australia took more than six year to convince the parliament for the enforcement of the GST. It also did a lot of capacity building of the potential taxpayers.
In India, they constituted a commission that came out with exhaustive report as to how and in what manner the VAT needs to be levied. On the contrary, FBR has not published any material on the viability of the proposed bill except for few seminars subsequent to moving of the bill in the parliament. Since this bill shall be having far reaching repercussions, the print and the electronic media also needs to sensitise on this core economic issue.
The standing committee of the parliament where the bill has been referred should conduct public hearings as is being done routinely on every bill in the US. The country needs VAT, but its design needs to be tailored around to meet the local economic conditions. Otherwise this will be a failed attempt and will mar the current administration with their policy of taking one step forward and two steps back.
Source: http://www.brecorder.com/index.php?id=1036598&currPageNo=1&query=&search=&term=&supDate=
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