Making VAT work

LAHORE: In Pakistan, tax collection and reporting mechanisms are complex and decentralised that has made income tax collection a very challenging job. The provinces collect GST on services that is not properly reported to the Federal Board of Revenue (FBR).

Under the VAT regime, the FBR that collects sales tax on goods can find out the annual turnover of a company or individual based on the sales tax deposited. If the sales tax on a manufacturing sector for instance is 15 percent and the company over the year deposits Rs150 million as sales tax, then its gross turnover would be Rs915 million.

The FBR would then ask the company to come up with documented expenses after deduction of which the net income tax would be assessed. In case of services, the data from the provinces is sketchy and sometimes it is not passed on to the FBR. Thus, an assessment of gross turnover on many services is not possible.

Globally, countries with similar mechanisms have devised remedies to improve the accuracy of income tax assessments based on value-added tax (VAT) or general sales tax (GST).

They implement an integrated tax information system that connects the federal and provincial tax authorities and improves the accuracy of tax assessments. This system allows seamless sharing of tax collection data between the federal and provincial governments, providing a more accurate picture of an individual or firm’s tax obligations. This system is in place in Pakistan but is not operating smoothly.

Revenue authorities should utilise advanced data analytics and automation tools to analyse the data collected from various sources. This can help identify discrepancies and patterns that might indicate underreporting or tax evasion. Automated systems can flag cases that require further investigation, streamlining the process for tax authorities.

Another way is to collaborate with third-party entities such as banks, financial institutions, and large service providers to cross-verify reported income and transactions.

This approach can provide an additional layer of verification and make it more difficult for individuals or firms to manipulate their reported data.

Improving taxpayer education and awareness programmes can encourage voluntary compliance. When taxpayers understand their obligations and the benefits of accurate reporting, they are more likely to cooperate with tax authorities.

Introducing incentive programmes that reward taxpayers for accurate reporting and timely payments can also encourage individuals and firms to comply with tax regulations and maintain accurate records.

It is imperative to strengthen penalty and enforcement mechanisms for tax evasion and underreporting. Harsher penalties can act as deterrents and encourage taxpayers to report their income and transactions accurately.

Moreover, the least the state could do is to standardise reporting formats across provinces to make it easier to collect and analyse data. This would help streamline the process of aggregating and comparing data from different sources.

The authorities must encourage collaboration and information sharing between federal and provincial tax authorities. Regular communication and collaboration can lead to more effective strategies for identifying discrepancies and enforcing tax compliance.

Given the complexity of the situation, reforms should be introduced gradually to allow for adjustments and refinements over time. This can help minimise disruptions and resistance to changes.

Trust in the revenue authority can be created by ensuring transparency in the tax assessment process. Making the public aware of the steps taken to improve tax assessment accuracy and curb tax evasion can build trust and cooperation.