THE Finance Bill 2015 presents a few important proposals that have critical implications on provincial revenue collection.
The critical adjustments from the point of view of the provincial tax authorities are the amendments in the Sales Tax Act 1990 (which were last amended in July 2014), regarding toll manufacturing, withdrawal of sales tax on specific services, and sales tax input adjustments on services.
According to the Finance Bill 2015, toll-manufacturing is manufacturing of goods belonging to another person and the transfer or delivery of such goods to the owner or to a person nominated by him. This implies that part of manufacturing activities is sub-let by the actual manufacturer to a third party.
This subletting of manufacturing activities and the subsequent issue of who has the right to collect taxes has been a conflicting issue between the federal and provincial tax authorities. The provincial authorities consider toll-manufacturing or sub-contracting as a service and claim the right to charge sales tax at their standard rates. Meanwhile, the Federal Board of Revenue (FBR) considers this as a goods manufacturing activity.
This proposal covers the SRO1125(I)/2011 dated December 31, 2011, which imposes and revises to 2pc as conversion charges on the toll-manufacturing of five sectors — leather, textile, carpet, surgical and sports goods. After the establishment of provincial revenue authorities, quite a few companies have recently started paying their taxes on toll-manufacturing to them. But some are still paying to the FBR.
With the recent amendment in Section 2 Clause 33 (1) and (d) of the Finance Bill 2015, toll-manufacturing is to be brought under the domain of the FBR. This amendment in the Sales Tax Act 1990 will adversely affect the provinces’ tax revenue collection, as it will now be claimed by the federal tax authority.
The proposed amendments in the Sales Tax Act 1990 will adversely affect the provinces’ tax revenue collection, as it will now be claimed by the federal tax authority
The amendment in the Capital Territory (Tax on Service) Ordinance 2001 in the Finance Bill 2015 proposes withdrawing the levying of the sales tax on banking and insurance services, franchise, telecom, non-banking financial companies and restaurants by the provincial authorities.
These services will now be taxable under the Federal Excise Act 2005 in the wake of this amendment. The extension of the sales tax on services in Islamabad by the federal government as well as the tax’s withdrawal on the above-mentioned services will have severe negative implications on provincial revenue mobilisation.
Another proposal in the budget is the addition of a clause ‘j’ in Section 8, Sub-section 1 of the Sale Tax Act 1990. This suggests that the sales tax on services paid to the provincial tax authorities by manufacturers will not be considered for an input tax adjustment by the FBR. This, again, will have critical implications on provincial revenue collection as well as on growth and prices.
For instance, let’s say a manufacturer produces a good at a price of Rs100, with inputs costing Rs30. He pays Rs4.8 (16pc GST on services) to the provincial tax authority and Rs12.2 at 17pc GST (Rs17 - Rs4.8) to the FBR after input adjustment as per the VAT tax system. Hence the estimated total sales tax on the good comes to Rs17, resulting in a retail price of Rs117.
Now, the new amendment will enhance the producer’s overall tax liability to the tune of Rs4.8 to the provincial authorities and Rs17.82 (17pc of Rs104.80) to the FBR. The total price of the good will now rise to Rs122.62, against Rs117 earlier — a 4.8pc jump.
This has implications for inflation as well as on the tax incidence on the final consumer due to double taxation, which deviates from the basic VAT system. The tax incidence will vary with the relative share of services in the production of goods.
More practically, will the producers compromise with this forced price hike or will this lead to tax evasion? It is more likely that the FBR’s revenue generation will pick up without any input tax adjustment, but provincial sales tax collection on services will likely decline due to the prevalent corporate culture, where unethical practices are not uncommon. This will accelerate the culture of under-invoicing, invoice-buying and cash dealings etc.
These proposed changes in the Finance Bill 2015 are more likely to have a strong negative impact on the collection of provincial taxes. They will make provincial tax authorities less effective in terms of collecting revenue, and revert to the pre-18th amendment tax system.
At this stage, it seems that the principal consideration of Finance Minister Ishaq Dar and his team is on enhancing federal sales tax revenues without paying any attention to its adverse effect on provincial revenue generation.
The authors are associated with the Applied Economics Research Centre, University of Karachi.
Published in Dawn, Economic & Business, June 29th, 2015
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