Sales tax administrative functions in Pakistan: Reflections on the problems

Abstract

In this article, the author makes an assessment of the sales tax administration in Pakistan with respect to certain areas including registration, filing, payment, invoicing, refunding and auditing, and suggests policy recommendations for making sales tax system practically effective and efficient. The paper also examines the administrative disputes that have emerged due to the splitting of the sales tax base between the federal and provincial governments. Finally, empirical analysis is carried out to examine the revenue performance of the sales tax administration.

Notes

1 Pakistan is a federation consisting of the federal government and four provincial governments (Punjab, Sindh, Khyber Pakhtunkhawa and Balochistan).

2 As per the Constitution of Pakistan, the levy of taxes and duties is the function of the legislature which can only be levied by an Act of Parliament.

3 “Imposition” means the fixation of a rate or a duty or a tax. It is the first stage of the enforcement of a fiscal statute.

4 The assessment and collection are machinery provisions, which enable the liability to tax and are the second and third stages of the enforcement of fiscal statute.

5 See Bilal Hassan and Tapan Sarker, “Reformed General Sales Tax in Pakistan” (2012) International VAT Monitor 417–421.

6 Budget Speech by Mr Ehsan Ul Haq Piracha, Minister of State for Finance, 7–6 (1990) [PTCL 1990 Jour.88 (at 108)].

7 Over the years, frequent changes have been made in the sales tax system through statutory regulatory orders (SROs) that are the source of secondary sales tax legislation. Various governments have issued nearly 1,900 SROs to grant special rates and tax exemptions for the benefit of specific taxpayers and sectors. See Muhammad Ziauddin, “Decent Capitalism”, The Express Tribune (Lahore: 5 March 2014), available at <http://tribune.com.pk/story/678899/decent-capitalism/> (accessed on 2 March 2014).

8 See Federal Board of Revenue Year Book 2012–13, available at <http://www.fbr.gov.pk/ShowDocument.aspx?Actionid=3783> (accessed on 24 January 2014).

9 According to Diamond and Mirrlees (1971), the tax system should maintain full production efficiency even in a second-best environment. The theorem permits taxes on consumption, wages and profits but precludes taxes on intermediate inputs, turnover and trade. See Michael Carlos Best, Anne Brockmeyer, Henrik Jacobsen Kleven, Johannes Spinnewijn and Mazhar Waseem, “Production vs Revenue Efficiency with Limited Tax Capacity: Theory and Evidence from Pakistan”, available at <http://personal.lse.ac.uk/spinnewi/PakistanCIT.pdf> (accessed on 15 February 2014).

10 For example, some goods are taxable at reduced rates and some at rates higher than standard rate. Similarly, besides exports, some local supplies are also zero-rated. Likewise, in addition to the value of supply as a base for taxation, certain goods are taxed on the basis of fixed capacity rather than on value of supply. Furthermore, the taxpayers cannot claim input tax adjustment beyond 90 per cent of the total output tax and also cannot claim input tax on purchase of building materials, office equipment, office furniture and other goods which are not an integral part of taxable supplies.

11 See Hassan and Sarker (n 5).

12 See Richard M Bird and Pierre-Pascal Gendron, “The VAT in Developing and Transitional Countries” (Cambridge University Press, 2007), 128.

13 For details of the project, see <http://w.w.w.worldbank.org.pk/external/default/main?menuPK> (accessed on 10 January 2014).

14 See Wollela Abehodie Yesegat, “Value Added Tax Administration in Ethiopia: A Reflection of Problems” (2008) eJournal of Tax Research 145–168.

15 See entry 49 of Part I of the Federal Legislative List in the Fourth Schedule to the Constitution as amended under the 18th Amendment Act 2010 which reads—“taxes on the sales and purchases of goods imported, exported, produced, manufactured or consumed (except sales tax on services)”.

16 See Ehtisham Ahmad, “The Political Economy of Tax Reforms in Pakistan: The Ongoing Saga of the GST”, Working Paper 33 (LSE Asia Research Centre).

17 The Sixth Schedule to the Sales Tax Act 1990 contains a list of goods that are not chargeable to sales tax.

18 US$1 = PKR 99.80 (as at 13 June 2014).

19 At present, there are three LTUs and 18 RTOs in Pakistan.

20 See Section 14 of the Sales Tax Act and Sales Tax Rules 2006 made for the purpose of registration.

21 Scanned copies of following documents including (a) Computerized National Identity Card (CNIC) of all owners, members, partners or directors, as the case may be; (b) in the case of a company or registered association of persons (AOP), the registration or incorporation certificate; in the case of a partnership, the partnership deed and statement of affairs; bank account certificates issued by the bank, in the name of the business; lease or rent agreements, if the premises rented, along with the CNIC of the ownership documents of the premises, such as registered sale deed; latest utility bills (electricity, gas, land-line telephone, and post-paid mobile); a list of machinery installed, in the case of a manufacturer; and GPS-tagged photographs of the business premises, machinery installed (if any), and the electricity meter and gas meter, as the case may be, must be submitted along with application.

22 Pakistan, “Economic Survey of Pakistan 2006–07″ Government of Pakistan, <http://www.accountancy.com.pk/docs/economic-survey-of-pakistan-2006-07.pdf> (accessed on 12 March 2008).

23 Section 26 of the Sales Tax Act 1990 provides for filing of returns.

24 Nil filers are those that conduct business, i.e. sales and purchases, during the tax period but whose payment of sales tax is nil.

25 This includes taxpayers that are claimant of refunds and carry forward input tax.

26 Include taxpayers whose output tax exceeds input tax and are required to pay the differential amount to the national exchequer.

27 In a case where tax paid in the previous 12 months is nil, the minimum tax liability is calculated on the basis of the monthly average of the sales declared by the registered person for the last assessment year. In a case where the minimum tax liability cannot be determined in the manner given above, it will be determined taking into account three or more of the following factors, including location of the business, type of business (wholesale, retail, etc), item produced/supplied, number of persons employed, capital invested in the business, amount of utility bills (phones, electricity, gas and water) and production capacity of machinery installed. Section 33(1) provides for penalty in case the taxpayers fail to file returns.

28 Section 11(6) of the Sales Tax Act 1990 provides for presumptive assessment of sales tax non-filers.

29 All taxpayers are required to issue a serially numbered tax invoice containing the following particulars: (a) the name, address and registration number of the supplier; (b) the name, address and registration number of the recipient; (c) the date of issue of invoice; (d) a description and the quantity of goods; (e) the value exclusive of tax; (f) the amount of sales tax; and (g) the value inclusive of tax. See Section 23 of the Sales Tax Act 1990.

30 Fake invoices are issued by dummy firms, existing only on paper. Such firms either show input against fake purchases or imports or issue invoices to registered persons enabling them to get illegal input tax adjustments and refunds.

31 Flying invoices are usually issued by importers, wholesalers and dealers that sell goods to one taxpayer (unregistered and end consumers) without invoices and issue invoices to another taxpayer (registered) without supplying goods. In case of flying invoices, tax is actually paid to the government treasury whereas in case of fake invoices, tax is not paid.

32 See Pedone 1982 cited in Casanegra de Jantscher 1990 . See also Clemens Fuest and Nadine Riedel, “Tax Evasion and Tax Avoidance in Developing Countries: The Role of International Profit Shifting”, (2010) Working Paper 10/12 (Oxford University Centre for Business Taxation).

33 See Best, Brockmeyer, Kleven, Spinnewijn, and Waseem (n 9).

34 See Edmiston and Bird, 2004 . See also Joel Slemrod and Shlomo Yitzhaki, “Tax Avoidance, Evasion and Administration”, in Handbook of Public Economics, volume 3 edited by AJ Auerbach and M Feldstein (Elsevier Science, 2002) 1425–1442.

35 The Commissioner Inland Revenue, an officer of grade 20 and the Federal Board of Revenue (FBR) are empowered under Sections 25 and 72B of the Act to exercise authority independently for selection of taxpayers for the auditing of its affairs.

36 See Casanegra de Jantscher, “Administering the VAT” in Malcolm Gillies, Carl S Shoup and Gerardo P Sicat (eds), Value Added Taxation in Developing Countries (World Bank, Washington DC, 1990) 171–179.

37 Case No W.P.5047/2012, Lahore High Court, Lahore.

38 See Section 33(5) of the Sales Tax Act 1990.

39 Section 2(37) of the Act provides the definition of “‘tax fraud”.

40 See Jantscher (n 36).

41 The Ministry of Law & Justice Division has given an opinion that the business of hotels, restaurants and caterers cannot be confined to services only as these businesses are also engaged in manufacture/supply of goods (food) as well.

42 A number of taxpayers are filing appeals before the Federal Tax Ombudsman (FTO) for removal of hardships of undue delay in getting sales tax refunds. See, for example, complaint filed by M/s Mima Knit (Private) Ltd, Karachi.

43 The measure of “effectiveness” as C-efficiency can deviate from the benchmark of unity due to non-compliance and/or deviations from uniformity of the tax structure applied to consumption. See Joshua Aizenman and Yothin Jinjarak, “The Collection Efficiency of the Value Added Tax: Theory and International Evidence” (2008) Journal of International Trade and Economic Development 391–410.

44 See Richard M Bird, “Value Added Taxes in Developing and Transitional Countries: Lessons and Questions’, ITP Paper No 0505, International Tax Program, Rotman School of Management, University of Toronto (2005).

45 The author's calculations are based on data obtained from the Annual Reports of FBR, State Bank of Pakistan, Economic Surveys of Pakistan (2007–2008, 2011–2012) and Development Indicators, World Bank.

46 Liam Ebrill, Michael Keen, Jean-Paul Bodin, and Victoria Summers, “The Allure of the Value-Added Tax”, (2002) 39 (2) Finance and Development 42–43 <https://www.victoria.ac.nz/sacl/centres-and-institutes/cagtr/working-papers/WP82.pdf> (accessed 15 February 20140.

47 Richard M Bird, and Pierre-Pascal Gendron, “Is VAT the Best Way to Impose a General Consumption Tax in Developing Countries?”, (2006) Asia-Pacific Tax Bulletin 290.

48 See Ebrill et al (n 46).

49 See Ebrill et al (n 46).

50 See Mark Gallagher, “Benchmarking Tax Systems”, (2005) Public Administration and Development 125–144.

51 See Hassan and Sarker (n 5).

52 See Andrew MC Smith, Ainul Islam and M Moniruzzaman, “Consumption Taxes in Developing Countries—The Case of the Bangladesh VAT”, (2011) Working Paper No 82, (Centre for Accounting, Governance and Taxation Research, Victoria University of Wellington, New Zealand).