ARTICLE (April 19 2010): A Value Added-based sales tax to be introduced in Pakistan effective from July 2010 if the bill to that effect is translated into an act of the Parliament. The Federal Board of Revenue (FBR) has posted on its website the VAT legislation proposed through the bill to replace the present sales tax with a view to maximising revenue from this major source of indirect taxation.
Pakistan is in dire need to enhance its tax revenue. The composition of revenue shows that there has been more reliance on indirect taxes (Customs duty, Federal Excise and Sales Tax) rather than the direct tax (income tax or wealth tax). In the 2008-09 financial year, the tax administration (Federal Board of Revenue) collected about 1208 billion rupees as tax revenue. This included about 405 billion rupees in the form of sales tax (collected under the Sales Tax Act, 1990). There is a huge potential of expanding not only sales tax, but also consequential income tax if collection of sales tax is enhanced.
Pakistan has been cognisant of its low tax-to-GDP ratio, which is dismally straggling around 9%. No one could argue the importance of a raise in its tax-to-GDP ratio. It has set upon a host of reforms, stretching over a decade's time to optimise revenue. Now it has decided to improve phenomenally by introducing value-added tax (through proposed bill named Value Added Tax, 2010) by replacing the existing Sales Tax Act, 1990 and sales tax on services introduced by the federating units. Whether this radical shift in the paradigm shall materialise, the tax administration in particular and the government in general is to be tested by time. However, certain areas may be deliberated to make this shift direct to the best interests of the country.
Before analysing the modalities envisaged through the proposed bill, it is deemed appropriate to have a fair idea why the ratio of revenue to the GDP diminished from over 11% in six to seven years earlier to the present 9%. It is evident that over the years (in recent past) this ratio has registered a decrease.
The factors contributing to this downward trend include the following:
-- The economy did register increase in the last decade, though the pace of growth has slackened owing to the law and order situation faced by the entire country in the aftermath of the "war on terror". The investors feel insecure to invest in the country, as they cannot properly project the yields from the new enterprises.
-- The projects having long gestation period have particularly been unattractive enterprises to the investors not only of the foreign origin, but also the local ones.
-- There has been phenomenal increase in investments in neighbouring countries like India and Bangladesh. Because of better business-friendly environment, these countries have attracted such investments as well as would have been made in Pakistan, had there been congenial law and order situation. Agro-based industry is one of the sectors, which otherwise provide Pakistan a comparative edge over its neighbours and other South Asian countries.
-- The expansion of the economy, though itself not upto an appreciable level, has been without relative increase in quantum of tax revenue.
-- There is a huge "parallel economy" of undocumented sector. Owing to lack of proper documentation, the "unorganised sector" does not make proper records of transactions. Resultantly taxes are not deposited in proportion to the business done or the profits gained.
-- The "tax culture" has still not taken roots in the ethos of the society. The tax evader is not looked down upon. The high rates of taxes could be excuse for evasion or at time avoidance, yet even the holders of public offices do not care for tax payments and proper accounting for their incomes. If the society as whole disdains tax evasion, the level of non-payments might dwindle to a sizeable level in spite of other administrative loopholes in the tax administration.
-- Owing to loopholes in the system of tax administration and lack of objective enforcement across the board, the compliant taxpayers have time and again been burdened with additional taxes and duties while the delinquent ones have not been strictly pursued.
-- Probably, this lack of enforcement by tax administration has been outcome of an "audit free" environment to the taxpayers registered with the department and an avowed lethargy towards broadening the tax base.
-- Additionally, a host of exemptions have also paved the way for a "spree" for seeking exemption on one plea or the other.
-- Zero-rating of local supplies of certain sectors has also diminished sales tax collection from these sectors.
Ambitious outreach:
The proposed legislation on the VAT by replacing the present sales tax laws is not a step forward to bring improvement to the existing system of sales tax collection, but a paradigm shift completely doing away with the existing legislation and replacing it with a new one.
The salient features of this shift are mainly as follows:
-- The coverage of the VAT is to be extended to both goods and services;
-- It has been presumed that the federating units shall toe the line of action envisaged in the Federal VAT bill;
-- The exemption regime has been drastically slashed. It appears as if the business community has agreed to it so as to ensure voluntary compliance.
-- Sector-based zero-rating has also been proposed to be done away with. The experience of massive refunds to the exporters is to be witnessed again on abolition of zero rating to their supplies.
-- The cover of zero-rating in case of local supplies of export-based sector has also been proposed to be abolished. It is not clear whether the stakeholders shall accept this scheme with an open heart.
-- Medley of excise duty is there, though conceptually the VAT and excise duty ought not to be treated at par.
Option of steady progress:
If the scope of sales tax in Pakistan is strengthened, it can deliver more revenues. Perhaps, the people, especially the business people, have started to understand and accept the sales tax. The tax itself did exist but in 1990 it was patterned on a VAT system in that it contained a host of provisions aimed at allowing input credits, taxation on the basis of consumption, refunds to exports, neutrality to profit and loss etc. However, its scope is limited to goods under the Sales Tax Act, 1990 under item 49 of the Federal Legislative List under Fourth Schedule to the Constitution of Pakistan.
Selected services were given "sales tax treatment" through different measures enumerated below:
-- As the Federation cannot levy sales tax on services under Sales Tax Act, 1990, the tax cover was extended to the selected services through the Federating units (provinces and the Islamabad Capital Territory), which brought them to dales tax. Hotel services, advertisement on TV, subject to certain exceptions, attract sales tax at the rate of 16% through provincial ordinances of sales tax on services.
-- The provisions of Sales Tax Act, 1990 are applicable for enforcement of sales tax on advertisement on TV and other services brought to tax by the federating units on uniform pattern and have been entrusted to the FBR for collection.
-- Levy of duty of excise on services is within the constitutional power of the federation stipulated under item 44 of Part I of the said schedule. It may be appreciated that the federation alone is competent to legislate on the matters stipulated under the Federal Legislative List. In exercise of the aforesaid constitutional powers, the Parliament legislated Federal Excise Act, 2005 (rescinding the Central Excise Act 1944). Certain services, including telecommunication services, are liable to duty of excise by virtue of Section 3 of the said act. The said levy is excise duty and the same collected in sales tax mode in terms of Section 7 of FED Act, 2005 read with SRO 550(1)/2006 dated 05.06.06.
Addressing constitutional constraints
The March appears not only hasty, but also not free from risks on counts, inter alia, the following:
-- Levy and collection of sales tax on goods is within the constitutional jurisdiction of the federation in terms of item 49 of Part I of the Fourth Schedule to the Constitution read with section 3 of the Sales Tax Act 1990. There is a constitutional constraint on the federation to levy sales tax on services. Levy of duty of excise on services is within the constitutional competence of the federation stipulated under item 44 of Part I of the aforesaid schedule to the Constitution read with Section 3 of the Federal Excise Act 2005.
-- Distribution of constitutional powers between the federation and federating units also converge on certain very significant areas to be deliberated upon at length before shifting to new legislation. In particular electricity, gas and telecom, have been contentious issues. It may be appreciated that electricity and gas are goods respectively classifiable under PCT Headings 2716 and 2711. The federation is competent to tax them under item 49 of Federal Legislative list of the Fourth Schedule to the Constitution as mentioned above. If the provinces also tax electricity, it shall be undue encumbrance upon the consumers.
-- Issues relating to taxation of distribution of collection to the headquarters of the entity or to its branches where tax accrued need to be addressed.
-- It has been envisaged that the informal sector, especially the retailers, would come to the tax-fold easily. This is an over-ambitious assumption.
-- The special procedures, which had been introduced because of the administrative exigencies, have been done away with altogether. Their absence may curtail revenue optimisation.
-- A host of issues shall also crop up in administration as well as in payment of tax due.
They may include:
(i) Accounting for the revenues under different types of taxes shall be a highly difficult task as inter-tax adjustment has been allowed.
(ii) In short span of time, the people cannot be educated about the modalities of new laws.
(iii) The informal sector cannot be shunted out by simplification of legislation at the cost of the revenues as well as the competitive disadvantage to the organised sectors.
(iv) Input adjustment matters, especially because of general payment as per practice in vogue, must be taken care of.
(v) Other administrative issues like return filing where there a number of locations where services are provided, have to be resolved.
(vi) Late payment and penalty issues need to be addressed.
However, there should be no haste in outright rescinding the existing sales tax laws. They could be fine-tuned in the short run. After addressing the constitutional constraints, further improvements could be brought. Pakistan is a federation, comprising Federal Capital (Islamabad Capital Territories), provinces, Fata and Pata. Our proposed legislation has been made without aptly taking into consideration this texture of the federation. It is, therefore, viewed that the stakeholders be taken into confidence. The FBR may hold conferences and seminars with the business community, the trade bodies, chambers, chartered/cost and management accountants and tax lawyers. There must be deliberations by the Parliamentary Committee, which should debate and discuss diverse dimensions of new legislation and its harmony with the proposed legislation to be made by the federating units (provinces/ICT) as well as areas having special status like AJK and Gilgit-Baltistan. It is imperative that input of the stakeholders is procured with open mind so that their legitimate interests are aptly guarded.
(The writer is Chairman of Karachi Branch, Council of ICMAP.)
Source: http://www.brecorder.com/index.php?id=1047008&currPageNo=1&query=&search=&term=&supDate=
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