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Worn out approach to tax collection

April 01, 2013

Federal Board of Revenue (FBR) logo. — File Photo

With the country facing  huge revenue shortfalls as well as a widening budget deficit, the Federal Board of Revenue is resorting to desperate, yet conventional measures, to narrow down the revenue gap.

As usual, it has chosen to tax existing taxpayers, instead of trying to broaden the tax base.

Only one per cent of the country’s 180 million-strong population pays taxes. As a result, Pakistan has one of the lowest tax-to-GDP ratios in the world, at nine per cent. Yet, the Federal Board of Revenue (FBR) is taking ad-hoc steps, like changing tax rates and making insignificant adjustments to shore up revenues.

Pakistan did not accept IMF recommendations for tax reforms. Though recommended by the Fund, it did not apply a single rate of 16 per cent of sales tax and do away with multiple rates, which were creating distortion and leading to corruption in revenue collection. Domestic pressures prevailed.

In this scenario, the FBR withdrew the zero-rated regime for five export-oriented sectors, and introduced a two per cent sales tax for them, with effect from March 1, 2013.

In their meetings with the business community, the FBR high-ups explained that during the first six months of this fiscal year, the revenue board paid refunds to the tune of Rs6 billion, against gross collection of Rs1.1 billion.

The officials said that there was negative revenue collection during this period from the textile sector alone and if they allowed the practice to continue for another six months, the government would end up paying Rs12 billion in fake refund claims against Rs2 billion in expected revenue collection.

The FBR officials also argue that nowhere in the world are local sales of any category, including goods and services, exempted from sales tax, except for exports.

But even then, exporters have to pay sales tax, and then get refunds. Contrary to this, the GST system, which is vogue in Pakistan under VAT mode, does not tax local sales of textiles and five other major export sectors.

According to official estimates, if the government imposes sales tax on these sectors, it would be able to collect around Rs400 to Rs500 billion in taxes.

A major chunk of this would come from the textile sector.

However, industry leaders refute these claims, and say that around 80 per cent of cotton that is processed and converted into yarn, and other value-added products, are exported, and only 15 to 20 per cent are locally consumed.

Mohammad Jawed Bilwani, a leader of the value-added sector, said that the FBR is trying to dodge exporters by giving wrong facts and figures. When the FBR says a zero rated regime for exports, it means that we initially have to pay sales tax, and then get refunds, he said.

The FBR has thrice introduced a refund system in the past, and each time it had caused huge revenue losses to the government, said Bilwani. The system promotes corruption through fake and ‘flying invoices,’ and billions of rupees are claimed, and ultimately paid, in refunds.

Therefore, said Bilwani, the industry believed that to avoid such losses, the FBR should not collect sales tax on exports.

The purpose of the notification 1125 of 2011 was to encourage registration in sales tax, as it gave incentives by treating registered persons at the zero-rate, while the unregistered were required to pay a five per cent sales tax, he asserted.

But even at that time, industry leaders had advised the government to keep the sales tax rate low, so that it did not encourage corruption. However, the FBR bureaucracy did not agree.

Bilwani said that the problem will not be resolved by the new notification (SRO 154), as unscrupulous elements, with the connivance of revenue officials, will again resort to using fake and ‘flying invoices’ to claim tax refunds.

The only way out of this is for the FBR to introduce automation in its system so that no direct interaction takes place between taxpayers and tax collectors.