Question 1: Documentation and Record Keeping; Efficacy of VAT

In Pakistan one of the main reasons that tax collection is low because the department has difficulty in
assessing the actual income of tax payers due to lack of documentation. It is seen that SMEs (Small and
Medium sized Enterprises) do not keep proper records resulting in estimation of taxes eventually
leading to litigation as taxpayers contest the guesses made by IRS. This is in part due to lack of tax
culture amongst the citizens as well as a general reluctance to part with income. In order to combat this,
many developing countries such as India have introduced VAT.

Value-Added Tax (VAT) has been defined as “a consumption tax placed on a product whenever value is
added at each stage of the supply chain, from production to the point of sale” (Investopedia) as opposed
to sales tax which is collected by a retailer at final stage of the supply chain. VAT is levied at the
difference between value additions at each stage while sales tax is levied on the final price of goods and
services at the retail stage inclusive of all value additions till that stage of supply chain. This entails
bringing all the commercial activities of a transaction involving production and distribution of goods and
provision of services under tax net thereby imposing a pre-fixed registration threshold level. As a result
documentation of every person in the supply chain becomes mandatory as those who are not registered
at any level are not in a position to claim or deduct tax paid at purchase levels. Hence, VAT promotes
economic documentation with the help of its in-built invoice based credit mechanism. It has self-
enforcing features and documents business transactions through tax invoicing efficiently addressing the
problems of cascading that consumer prices to rise since VAT is imposed on value addition.

However, it must be noted that the introduction of VAT regime for economic documentation is not
effective as its implementation can only be possible when each level of transaction and activity is known
at which the tax is to be levied. Without prior documentation, it cannot be known where VAT is to be
enforced resulting in the regime being ineffective. Thus, it can be said that VAT cannot bring about
documentation and GST will continue to be levied in Pakistan until the transactions can be properly
traced. Moreover, the same is reinforced by the International Chamber of Commerce’s policy guideline
‘ICC Best Practices and Guidance on VAT Implementation’ that states pre requisite of documentation as
the key features of an efficient VAT regime.

Furthermore, application of VAT should ideally involve a single rate or zero rating. However, in Pakistan
as per Sales Tax Act 1999 multiple rates are prevalent listed in Eighth and Ninth schedule. This is in
addition to other tax rates such as extra tax or further tax. Thus, at this point in time Pakistan has both
VAT and GST with VAT applying with various rates in general and GST applying on imports and items
listed in the Third Schedule. In comparison, India’s taxation system is based on VAT because of their IT
system allowing each transaction to be registered and linked up. Though Pakistan developed multiple IT
systems such as CREST and STRIVE in order to ease implementation of VAT, there still exist many
methods such as fake and flying invoices resulting in tax evasion and so in Pakistan VAT regime can be
introduced on all levels when there is complete automation and data collection.