A must for making GST regime effective and efficient
Share of GST regime in overall federal tax receipts is more than 40 percent. However, this is riddled with many deviations from standard GST/VAT systems that are adversely affecting its effectiveness. Resultantly, revenue efficiency is comparably low. An important deviation in this context is the use of multiple rates of sales tax. Apart from standard sales tax rate of 17 percent, imports and domestic supplies are subject to higher and lower rates. Many costs are associated with multiple GST rates.
Efficiency and Productivity
GST collection efficiency (or C-efficiency) and GST efficiency (or GST productivity) are two important benchmarks to assess the revenue performance of a GST system. C-efficiency ratio shows how much GST is collected as percent of total consumption, while GST efficiency ratio shows GST collection as percent of GDP at given standard GST rate over a certain period of time. Since GST taxes consumption, and not GDP; therefore, C-efficiency ratio is an improved measure of GST performance.
In the case of Pakistan, C-efficiency has declined from about 32 percent in 2003 to 23 percent in 2011. This shows that not only the benchmark itself is low (when compared to other developing countries) but is also declining. For instance, C-efficiency ratio in Bangladesh increased from 22 percent in 2003 to 30 percent in 2011. Similarly, in the case of Nepal, this ratio increased from 23 percent in 2003 to 38 percent in 2011. In Sri Lanka, the C-efficiency ratio was 40 percent in 2010.
GST productivity ratio has also decreased in Pakistan from about 27 percent in 2003 to 21 percent in 2004, whereas this ratio increased from about 17 percent to 26 percent in Bangladesh and from 21.5 to 35 percent in Nepal during the same period. VAT productivity ratio was 33 percent in Sri Lanka in 2010.
Moreover, in developed countries, the C-efficiency ratio was much higher with single VAT rate; for example, C-efficiency for New Zealand (98 percent), Canada (74 percent), Chile (75 percent) and Japan (67 percent).
Read More: Standardizing Sales Tax Regime
Therefore, multiple GST rate systems cannot ensure but will adversely affect the efficiency and productivity of VAT/GST system as these two benchmarks are extremely low in Pakistan by international standards, which range between 40 and 90 percent. Average C-efficiency for Asia-Pacific is 59 percent, Europe 72 percent, Middle East/Central Asia 66 percent, Sub-Saharan Africa 48 percent and Western Hemisphere 53 percent, respectively.
Cost of Compliance and Tax Evasion
In Pakistan, GST compliance is low and further declined from 79.6 percent in 2000 to 56 percent in 2011. The total number of registered sales tax payers in various categories, including wholesalers and retailers, was 75,538 in 2000, increased to less than 100,000 during the year 2012. Fewer than half the total registered taxpayers actually file returns.
One important reason for increased non-compliance of GST in Pakistan is higher compliance cost to businesses. The time (hours per year) for paying GST is 480 hours, as opposed to world average of 108 hours, in Pakistan. On the other hand, VAT compliance cost in other developing countries – not to speak of developed countries – is much lower. For example, the VAT compliance cost in Nepal and Bangladesh in terms of time required for VAT payments is 122 hours and 162 hours, respectively.
An important reason of high cost of complying GST is the multiple GST rates. It is because rate differentiation entails the need to ensure that products are correctly categorized. In Pakistan, the gross compliance ratio (GCR) has reduced from about 36 percent in 2003 to 25 percent in 2011, with average 31 percent during this period. This ratio is significantly lower than the world average of 65 percent.
At the same time, multiple tax rate system increases opportunities for avoidance, ergo effecting an increase in the costs of administering VAT. It is empirically quantified that multiple rates tend to reduce VAT compliance and increase tax evasion. For example, using cross-country data, Agha and Haughton (1996) find that having an additional rate of VAT is associated with a 7 percentage point increase in tax evasion, and thus undermine the equity goals normally attached with multiple rates system.
Rate differentiation has also increased illegal input tax adjustments and inadmissible refunds in Pakistan. As a result, effective GST rate reduced to 3.9 percent as opposed to statutory rate of 16 percent. The extent of illegal input tax adjustment and inadmissible refunds can be gauged from the fact that percent increase in exports sale in 2011 and 2012 was 37.36 and 31.56, respectively, over the base year of 2010, while percent increase in refunds was 114.32 percent and 82.21 percent in these years.
Taxpayers exploit the multiple sales tax regimes to evade taxes through fraudulent schemes. VAT/GST fraud is a matter of serious concern for the tax administrations of both developing and developed countries and Pakistan, too, is no exception. It is the issue that has put a question mark on the superiority of VAT over other forms of consumption taxes such as retail sales tax.
The issue of sales tax fraud in terms of size and frequency is a matter of grave concern for the tax authorities in Pakistan. Import and supply of goods at reduced rate(s) could be a potential source of sales tax fraud.
GST fraud exists in a number of forms:
1. Registration of dummy units
In some reported cases, the businesses got sales tax registration by submitting documents of employees. Under such circumstances, the actual beneficiaries of refunds or input tax adjustment remained underground. Whenever records of such dummy units were subjected to examination, tax demand so created could not be collected as the amount was assessed against the poor employees rather than enriched owner of the businesses.
2. Fake import goods declaration
There are cases wherein invoices were being issued on the strength of fake/non-verifiable import goods declaration (GDs) in the sales tax returns. Thus, the whole amount of input tax adjusted by the buyers proved to be illegal and hence recoverable. In fact, the goods were being supplied to unregistered persons and invoices generated on the strength of fake GDs were being utilized for input tax adjustment.
3. Flying invoices
It has been found in certain cases that the registered persons supplied taxable goods to unregistered units but succeeded to obtain invoices from registered units involved in supply of different goods. These flying invoices are being used extensively to claim input tax or sales tax refunds.
4. Fake bank accounts
The registered persons claiming input tax on invoices of above PKR 50,000 are required to make payments through prescribed banking channels. The tax fraudsters opened bank accounts, sometimes in connivance with the bank officials, utilizing documents /signature of persons other than the actual beneficiaries. This enables the buyers to ensure compliance with Section 73 of Sales Tax Act 1990.
5. Suppression of taxable supplies
Sales tax is an indirect tax. The businesses are supposed to shift the burden of this tax to final consumers of goods and services. In many cases, the registered persons, although they charge sales tax on all supplies, don’t declare true turnover in the sales tax returns and thus evade sales tax. In other cases, many businesses declare turnover just below threshold required for sales tax registration and thus continue to operate in an undocumented economy. These businesses actually capture large share of market due to less product prices as compared to those operating under the sales tax net.