LONG the darlings of the new economy, mobile phone companies today find themselves caught in the taxman’s noose. Over the past 5 years, the telecoms have quietly carried on their booming business untouched by the myriad dysfunctions, such as the circular debt or rising non-performing loans, that set in on Pakistan’s business environment with the onset of recession in 2008.

Untouched, that is, until today. Today a spectacular tax liability of Rs 47 billion has been hoisted upon the industry, and all appellate powers within the tax bureaucracy have upheld the order that created this liability. When one section of the tax bureaucracy tried to nullify the full impact of this mammoth tax bill, it found itself attacked ferociously from the National Accountability Bureau (NAB), castigated harshly and recommended for departmental action by the Appellate Tribunal of Inland Revenue, and the officers’ names placed on the Exit Control List. Clearly somebody somewhere wants this liability to stand.

For their part, the telecom giants have knocked on every door that they can. They have written to the prime minister asking him to restrain the ferocious zeal with which NAB has inserted itself into the whole affair. They have prodded the regulator — Pakistan Telecommunication Authority (PTA) — which has largely slept through the whole affair, into playing a more active role. They have filed a petition with the Islamabad High Court (IHC) seeking a stay on the Appellate Tribunal’s order. They have pleaded with the now former Chairman FBR to not include arrears and ‘default surcharges’ when calculating the final liability, on the plea that the law allows revenue neutral `arrears’ to be excluded and exempt from any penal charges. Thus far, their efforts have been to no avail.

What exactly is the issue?

The FBR contends that the telecom giants, who contribute almost Rs120 billion in annual revenue to the government, second only to the oil and gas sector, “inadvertently and as a general practice, did not pay FED on interconnect service”.

‘Interconnect service’ is when you make an 'off net' call (see diagram). Since an off-net call travels partially along the network of another operator, that party charges your operator a fee for carrying your call to its destination. The FBR contends that that fee is liable to tax since it is a service provided by one party to another, and have calculated that the total owed by the telecoms on account of failing to pay this tax since 2007 comes to about Rs45bn. The telecoms don’t disagree; they just argue that the tax is already being paid by the subscriber, the final user of the service.

In its order which upheld the FBR’s view, the Appellate Tribunal dwelt at length on the question of how the FED is to be applied to interconnect charges. The result is a judgment sewn together in a patchwork manner, relying on items like an SRO here, a clause from the Telecom Deregulation Act there, definitions from the Customs Act of 1969 of all places, and miscellaneous judgments from Canadian and English courts to define what the word `levy’ might mean in this instance.

The order shows clearly how the tax authorities are struggling with the myriad ambiguities that have arisen in our tax code as it tries to use 20th century concepts to deal with 21st century transactions.

A clearer legal picture on how interconnection charges are to be treated under a consumption tax regime can be seen in an example from Australia.

The Australian GST contends that “[w]hen the supply of an interconnection service is made between two telecommunication carriers … the supply is made to the carrier but provided to the subscriber.”

From here the law becomes clear, and requires no recourse to antiquated legislation from the 1960s. Legislation that is well conceived will clearly specify `place of supply’ rules, as well as the party upon whom the liability falls. In the Australian case, which is closest to ours in the sense of being a consumption-based tax, domestic interconnection charges are liable for tax under GST, but the liability falls on the subscriber to whom the supply is provided.

Taxable revenue?

Do the telecoms end up making money out of interconnect charges? In India, for example, the regulator sets the interconnection charges at 15 paisa per minute on the premise that interconnection charges are for 'cost recovery' only and not for profit and requires the operators to disclose how much money they are collecting through interconnection charges.

In Pakistan by contrast, interconnection charges can be as high as 75 paisa per minute, and there are no disclosure requirements on the operators. Are the telecoms recovering more than just their costs from these charges? If so, a case for an income tax can be made, but trying to get at that income stream through the powers contained in the FED runs the serious risk of creating a fiscal absurdity.

Complicating the picture further is the arrival of the provinces. Punjab and Sindh have both passed enabling legislation to collect sales tax on services for themselves, including the telecoms.

Some voices argue that the latest move on the FED on interconnect is an attempt on the part of the federal government to lock in part of the telecoms tax revenues before they are devolved to the provinces. But in other background conversations with telecom company executives, the words 'blackmail' and 'corruption' come up quite quickly.

There is little doubt that the apparent motive behind the government’s zeal to pursue this matter grows out of its growing hunger for revenues. The Tribunal’s order makes reference to its obligation to “safeguard the economic interests of the state” in its conclusion.

But it would be more reassuring if the government pursued its thirst for revenues through the hard road of tax reforms, or even a one-off measure like a 'crisis tax' like they’ve done in Hungary, instead of resorting to such an extraordinary administrative prerogative.