Trust is the key to VATs success

The provincial government of Sindh is at odds with Islamabad over the collection of taxes. Reportedly, a senior official from the provincial assembly walked out of a meeting to record his protest - creating a premise for the view that FBR must take care not to hurriedly push the bill before all stakeholders have come to an agreement.
According to the agreed upon draft legislation, revenues from services are the domain of the federating units while tax on goods is to be collected by the central government. But while Sindh is adamant in its stance, the other three provinces have agreed to let the centre collect tax on services on their behalf against a fee.
Unless all parties involved believe in the benefits of the law, its success is going to be fairly limited. Industry professionals stress the need for harmonization of expectations. Businessmen must be consulted to assess effects of implementation, for without their support, this law could easily fall flat on its face.
Apportionment is a process used to allocate refund credits. In the draft law, there is no clear explanation of how service taxes are to be credited against tax paid on goods purchased earlier in the chain. The dynamic becomes more complicated with the provincial and central governments coming into play. Lessons from various economies reveal that VAT tends to create inflationary pressures, especially in cases where the law is complex, documentation isn thorough and automation isn effective.
For example, when Germany rolled out VAT prices rose by only 2.5 percent. On the other hand, Argentina saw an increase of 350 percent in the price of certain goods while Turkey saw an upward movement of 140 percent. Now, imagine the quantum of price hike in an ill documented economy such as Pakistans.
Record keeping is the foundation of a successful VAT implementation. All economic agents will be required to maintain books of accounts and provide tax invoices. Without such records, tax refunds are not going to be issued. This might prove the biggest challenge as significant portions of the economy are in the informal sector.
To top it all off, the proposed bill gives FBR officials the power to make arrests for noncompliance. While it sounds like a good deterrent, the business community feels that the power could be abused by revenue officials. A senior revenue expert explained that laws need to be drafted without assuming criminal intent.
Across the border, in India where the state level VAT has existed for some time now, the implementation of an integrated VAT has been delayed past its April 2010 launch date, so that confidence in the law can be garnered from all parties concerned. It might be helpful to learn from their example to avoid birth defects in the law.