Policy to bridge the Sales TAX Gap 

Sales tax is the most significant source of Pakistan’s budgetary revenue. In 2017-18, total sales tax collection on goods and services was Rs. 1,715 billion. However, the sales tax gap, which is the difference between the actual tax collection and the amount that would have been collected if every taxpayer was fully compliant, is an enormous threat to government finances. 

There could be numerous reasons or factors responsible for this sales tax gap. Generally, the source of sales tax gap could be attributed to exemptions, concessions, reduced rates, zero rates on domestic supplies and some other deviations from the standard sales tax policy. Sales tax revenue losses, as a result, are attributed to tax policy gap. The other sources of this gap are attributable to weaknesses in the tax-enforcement mechanism. The tax authorities are not always successful in tracing potential taxable persons and to get them registered for the purpose of sales tax. The potential taxable persons are also reluctant to get themselves registered under the sales tax statute for one reason or another. More importantly, the tax authorities do not possess enough resources to identify registered taxpayers who are underreporting taxable supplies or claiming input tax on fake and flying invoices, and, hence, remitting less than due tax to the national exchequer.

The estimated loss of sales tax revenue due to sales tax exemptions and related expenditures during 2018-19 was Rs. 598 billion—about 4.4% of GDP of Rs. 13,570 billion. More importantly, tax expenditures tend to reduce tax base and make tax system non-neutral among agents of economy, add complexity to the tax system and tend to increase compliance costs and risks for businesses and increase cost of collection to tax authorities and cost of compliance to registered taxpayers.

A special scheme in the form of zero rating for manufacturers, exporters, importers and wholesalers (but not retailers) operating in five designated sectors, including  textile, carpet, leather, sport and surgical, remained enforced from 31 December 2011 until 30 June 2019, though in different versions.

Although standard sales tax rate is 17%, reduced sales tax rate remains applicable on different domestic supplies as well as imports, such as 2% on supplies of fertilizers, 5% on agricultural machineries and capital goods for transmission line projects, 7% on the importation of seven types of poultry machinery, including machinery for preparing feeding stuff, incubators, brooders, insulated sandwich panes, poultry sheds, evaporative air cooling systems and evaporative cooling pads, 8% on white crystalline sugar, 10% on soybean meal, plant and machinery not locally manufactured, cheese, butter and ingredients for poultry and cattle feed, 12% on import of LNG/RLNG and on supply of RLNG and 16% on the supply of rapeseed, sunflower seed and canola seed when imported by solvent extraction industries, etc.

Similarly, apart from exports, zero rating is allowed on numerous other goods. Some of the domestic supplies and imports subjected to zero rate included cotton seeds and oil, plant, machinery and equipment, uncooked poultry meat, milk and cream, trucks and dumpers, vessels for breaking up, and polyethylene and polypropylene for the purpose of local manufacturing of mono filament yarn and net cloth, etc.

Effective from 1st July 2019, legislative changes in the sales tax statue have been introduced through the Finance Act of 2019 to make sales tax system broad, essential for revenue mobilization throughout the production chain, to make it uniform for all sectors of economy and all taxable persons, to ensure neutrality so as all goods face the same level of tax regardless of where they are manufactured and to enhance efficiency by reducing cost of tax collection and tax compliance.

Some of the legislative changes aiming at reducing the sales tax gap are provided hereunder:

1. The definition of cottage industry is amended to mean a manufacturing concern that fulfils each of the following conditions:
2. doesn’t have an industrial gas or electricity connection;
3. is located in a residential area;
4. does not have a total labour force of more than 10 workers; and
5. annual turnover from all supplies does not exceed PKR 3 million.
6. All Tier-1 retailers have been required to integrate their retail outlets with FBR’s computerized system for real-time reporting of sales. The Finance Act provided that in case a Tier-1 retailer does not integrate his retail outlet in the prescribed manner, the adjustable input tax for a tax period shall be reduced by 15%. Tier-1 retailers include:

(a) a retailer operating as a unit of a national or international chain of stores;

(b) a retailer operating in an air-conditioned shopping mall, plaza or centre, excluding kiosks;

(c) a retailer whose cumulative electricity bill during the immediately preceding 12 consecutive months exceeds PKR 600,000;

(d) a wholesaler-cum-retailer, engaged in bulk import and supply of consumer goods on wholesale basis to the retailers as well as on retail basis to the general body of the consumers; and

(e) a retailer whose shop measures 1,000 square feet or more in area.

2019. National Tax Number (NTN) or Computerized National Identity Card (CNIC) is now required to be mentioned in tax invoice in respect of supply to unregistered persons. Such requirements have been made effective from 1 August 2019. However, an exception from such requirement has been introduced for supplies made by a retailer where the transaction value inclusive of sales tax does not exceed PKR 50,000, if sale is being made to an ordinary consumer. The term ‘Ordinary Consumer’ has also been explained in the Finance Act as a person who is buying goods for his own consumption and not for the purpose of re-sale or processing. In case, it is subsequently proved that CNIC provided by the purchaser was not correct, liability of tax or penalty shall not arise against the seller, in case of bona fide sale;
2020. Pursuant to SRO 694(I)/2019 of 29 June 2019, the FBR has rescinded SRO 68(I)/2006 of 28 January 2006 (entitlement to the solvent extraction industries to deduct the entire amount of input tax paid on import of rapeseed from the output tax charged on supply of oil extracted); SRO 480(I)/2007 of 9 June 2007 (Sales Tax Special Procedures Rules 2007); SRO 660(I)/2007 of 30 June 2007 (the Sales Tax Special Procedure (Withholding) Rules 2007); SR0 769 (I)/2009 of 4 September 2009 (Zero-rating of polyethylene and polypropylene for the purpose of local manufacturing of mono filament yarn and net cloth); SRO 1125(I)/2011 of 31 December 2011 (Zero-rating of major export-oriented sectors); SRO 398(I)/2015 of 8 May 2015 (providing reduced rate of 5% on LNG imported for servicing CNG sector and fertilizer produced by using imported LNG);
2021. All Sales Tax General Orders (STGOs) granting zero-rating on supply of electricity, gas, diesel, furnace oil and coal have been rescinded via STGO 100/2019 of 29 June 2019; and
2022. Pursuant to SRO 698(I)/2019 of 29 June 2019, the FBR has implemented automated system of sales tax registration by amending sub-rules (2) to (9) of Rule 5 of the Sales Tax Rules 2006 (STR). Under the amended STR:

(a) an applicant having national tax number or income tax registration will be able to login to the online system and will require to upload the following information and documents: bank account certificate issued by the bank in the name of the business; registration or consumer number with the gas and electricity supplier; particulars of all branches in case of multiple branches at various locations; GPS-tagged photographs of the business premises; and in case of a manufacturer, also the GPS-tagged photographs of machinery and industrial electricity or gas meter installed. Upon furnishing above documents, the system will register the applicant for sales tax, which is a prerequisite for: filing sales tax returns; issuing sales tax invoices; and claiming tax credit or refund.

(b) After registration, the applicant or an authorized person will have to visit a National Database and Registration Authority (NADRA)’s e-Sahulat centre within a month for biometric verification. In case of failure to visit or failure of biometric verification, the registered person’s name shall be taken off the sales tax Active Taxpayer List (ATL). Under Rule 12A of the STR, a non-active taxpayer shall not be entitled to file goods declarations for import or export; issue sales tax invoices; claim input tax or refund; or avail any concession under the Sales Tax Act 1990 or STR. Moreover, no person shall make any purchases from non-active taxpayer and no input tax credit shall be admissible on the strength of invoices issued by such taxpayer.

(c) in case of a manufacturer, the FBR may require post verification through field offices or an authorized third party. In case, the field office, during post-registration scrutiny, finds that any document provided is not genuine or is fake or wrong, it may request through the system to provide the missing document within 15 days, failing which the registered person shall be removed from the sale tax ATL.

The writer serves as Additional Director of Intelligence and Investigation (IR), Federal Board of Revenue.