THE power to tax transactions involving goods is currently vested with the federal government, whereas revenues from the taxation of services accrue to the four provincial governments.

Sindh started collecting the general sales tax (GST) on services from July 2011, followed by Punjab from July 2012 and Khyber Pakhtunkhwa from August 2013. The Balochistan government has yet to start collecting the GST on services.

Under the existing arrangements, the efforts by provincial authorities to entrench sales-tax collection on services are not free from problems, leading to a surge in vertical and horizontal issues in the taxation of services.

Composite supplies consist of components that are characterised as services as well as goods. For example, hotel accommodation services also include supplies of food (goods). According to provincial tax authorities, a service shall remain and continue to be treated as a service whether it involves any use, supply or consumption of any goods either as an essential or an incidental aspect of service.

Internationally, services provided by restaurants are treated as services for the purpose of value-added taxation. The charges subject to tax assessment essentially include the cost/price of the foodstuff served as essential components of meals in restaurants.

Furthermore, these are also classified as services in Pakistan’s customs tariff and were adopted in the Federal Excise Act 2005.

Nonetheless, the FBR’s field formations insist upon the realisation of the federal GST from restaurants involved in the making and supplying of food.

Composite supplies are currently evaluated on the nature of the contract: whether the contract is for the supply of services or for the supply of goods or both (mixed contracts). In case of a mixed contract, its purpose is taken into consideration. If the purpose is to provide a service wherein the supply of goods is also incidently or essentally a part, the taxpayer is considered as supplying a service.

Examples of mixed contracts include paint work, construction services and commissioning and installation services etc. In such cases, the business enterprises have to issue invoices that must include a figure for the sales tax on services.

Contracts for the supply of goods, where services are also an incidental or essential part, are under the FBR’s domain.

For streamlined practices in regimes like BTB, audit, enforcement and system-based oversight, the sharing of data between provincial revenue authorities and the FBR is inevitable. However, no mechanism for such sharing of data has been designed, which is not only causing hardship for the taxpayers but also resulting in considerable revenue leakage.

Meanwhile, the provincial revenue authorities differ over the mode of collection of sales tax on services, i.e. whether it should be on the basis of ‘origination’ or ‘destination’.

In the case of B2B cross-border services, the Punjab Revenue Authority (PRA) charges GST on a reverse charge basis, which is not acceptable to the Sindh Revenue Board (SRB). Sindh is adamant that the sales tax on B2B services should be charged on the principle of ‘origination’.

Punjab and KP argue that services received or consumed in their jurisdiction should be subjected to their sales tax, while Sindh says services originating in its territory should be subjected to its sales tax even if they are delivered or consumed in other provinces.

This issue has caused difficulty in relation to the taxation of different types of services as a large number of taxpayers have approached the courts seeking relief because they are being double taxed and their cost of doing business has increased, resulting in loss of competiveness.

Sindh also argues that the taxation of services on the basis of ‘destination’ raises issues about enforcement and the audit of taxpayers registered in the province.

The PRA argues that the taxation of services on the basis of ‘origination’ is against the universal practice of VAT because VAT functions on the basis of ‘destination’ at the national level. That is why the European Union agreed in 2004 that for the purpose of VAT, the union would be taken as one country.

Furthermore, the importing country imposes tax on a destination basis. Therefore, if the taxation of services is based on ‘origination’, it negates the principle of economic justice.

The sales tax system in VAT mode must be made more workable for businesses. A simpler, more transparent GST system is essential to relieve businesses from the considerable administrative burden and to encourage cross-border trade. This, in turn, will be good for growth.

But the current sales-tax regime is imposing an unreasonable compliance burden on small- and medium-sized enterprises, which do not always have the resources necessary to deal with the administrative burdens on cross-border transactions and therefore shy away from engaging in cross-border business.

There is considerable loss of revenue owing to the dispute between the provinces over the mode of collection. Second, the monitoring system of the provincial tax authorities is not sufficiently effective so as to capture each and every taxable service due to their limited financial and administrative resources.

Third, there is a lack of an effective mechanism to determine the true value of services, particularly those of composite supplies. Fourth, as the sales tax system has become more complicated, it has resulted in significant revenue losses due to frauds, as they tend to occur more when cross-border transactions are involved.

There is a need to clarify the transactions that can be taxed as supplies of goods or of services, and composite supplies must be split between supplies of goods and those of services.

In addition, there are gaps and overlaps between the authority of individual provinces to tax cross-border services. Provincial tax authorities must be strengthened by encouraging them to share their databases with each other to block revenue leakage.

Published in Dawn, Business & Finance weekly, November 23rd, 2015