Zero-rating regime

Pakistan is one of the countries having a very low Tax-to-GDP ratio. International institutions such as IMF and World Bank have been urging the government to mobilise its resources to enhance tax revenue base and bridge the growing trade deficit significantly.
Without taking tougher decisions, it has been generally contended, national exchequer could not be provided with ample funds needed not only for national security but also for development. However, the imposition of new taxes, or raising the level of existing ones is opposed not only by the opposition parties but also by the allies of the federal government because of hardships faced by general public.
Accordingly, the move to introduce Reformed GST through an act of Parliament could not go through. Still the government was hard pressed to impose taxes not only to get more revenues but also to fulfil international obligations to secure further loans. Hence, the federal government acted by moving the matter through promulgation of presidential ordinances.
With a view to enhancing tax revenues, the Federal Government through Finance Amendment Ordinance 2011 promulgated on 15th March 2011 and a few notifications took certain measures to widen the scope of (a) Sales Tax under Sales Tax Act, 1990; (b) Income Tax under Income Tax Ordinance, 2002 and (c) Excise Duty under the Federal Excises Act, 2005.
Amongst these measures, limiting the zero rated regime under the Sales Tax laws is one of the major steps where both high hopes have been attached and where challenges of huge magnitude also stare the government and economy in the face. There are many significant issues emanating from the changes in zero rated regime of Sales Tax.
The statutory zero rated regime has not been disturbed in the recent legal change, though changes in the two notifications SRO 509(I)/ 2007 and 549(I)/2008 clipping of Zero Rated Regime of Sales Tax have been made. In particular, the changes in export oriented zero -rated regime made effective by SRO 231(I)/2011 dated 15th March 2011, amending SRO 509(I)/2007 have posed far reaching implications for the near future. These are discussed in the following paragraphs.
The five export-based sectors cater for the major chunk of exports of Pakistan including (a) textiles; (b) carpets; (c) leather products; (d) surgical instruments; and (e) sportswear.
These sectors and their basic raw materials were zero rated over five years back to curb non-genuine refunds on the one hand and to save the exporters from financial crunch attendant upon blockade of their revenue on inputs used in these exports. In particular, phenomenon of "flying invoices" was massively slashed, if not completely eliminated with introduction of zero-rated regime. However in the zest for facilitating exports, the local supplies of these items were also "zero-rated".
This zero rating was a conscious decision on the part of government and loss attached to it was generally considered as cost of facilitation. It is evident that certain sectors which primarily cater for the local consumption like master batches, pigments, starch and a host of chemicals having multiple uses also found room in the zero rating regime.
Resultantly the government lost a heavy chunk of revenue even from organised sectors. With slashing down the zero rating regime concerning five export-oriented sectors, the local supplies or imports (other than those related to export of goods falling in the aforesaid SRO) have been brought under the Sales Tax cover of 17%.
Another notification SRO 549(I)/2008 deals with zero rating of supplies and imports. This notification has been amended through SRO 230(I)/2011 dated 15th March 2011 in such a way that the zero-rating regime in terms of revenue has been curtailed.
Under the said amendment machinery has been ousted from the ambit of zero-rating. Resultantly the industry shall first pay tax at import or purchase stage and then shall gradually adjust input tax. This measure shall enhance their cost, though the Federal exchequer is likely to gain from this doing away of zero-rated regime available to purchase or import of machinery. Certain high hopes have been attached to these changes in the regime of zero rating of Sales Tax. The significant areas having healthy signs are as follows:
(a) There shall be an increase in the number of goods fetching substantial amount of Sales Tax after aforesaid change in the Zero-rated regime. In principle, this step is moving forward to make the Sales Tax laws of Pakistan conform to norms of a modern Value Added Tax.
(b) As the ruling government could not get through with the Reformed GST or "Modern VAT", in the parliament it moved ahead to limiting of zero rating regime through executive authority. The measure appears to be a sagacious step towards extending the Sales Tax regime without a possible political opposition.
(c) A major distortion has been curtailed though not eliminated through slashing down the zero-rated regime.
(d) Major contributors to revenue through measure shall be local supplies and imports (other than those for subsequent exports) of textile, footwear, machinery and carpets.
(e) In addition, goods using multiple uses have also been envisaged to be in the tax regime. Ideally this change is an encouraging one for enhancing tax revenue projected to a level of Rs 50 billion. It is hoped that there shall be a substantial increase in tax revenues by this limiting of zero-rating regime.
Though limiting the scope of zero rating through above mentioned measures is a step to boost revenue, yet there are certain areas which have crept in the apparently hastily drafted SRO. The said areas need immediate redress. A close reading of the amending SRO also leads to a host of serious repercussions briefly enumerated below:
(a) The step has not been welcomed by the industry. There is an apprehension that there shall be a substantial increase in prices in the domestic market, which is highly pressed.
(b) Not only disapproval is evident, but there is a likelihood of massive agitation. The probability of such agitation especially from the textile sector, shall be high because the stakeholders were not taken into confidence before introduction of these taxing changes.
(c) Even the exporters are likely to suffer because of the complex market mechanism particularly inseparability of transactions at different processes for local and export sales.
(d) The organised sectors making local supplies as well as exporting goods shall likely to account for payable tax on local supplies. In their case depending upon the share of local supplies vis-à-vis exports, the quantum of their input tax shall be slashed down and they still may be out side the rigors of seeking and getting Sales Tax refunds, they shall be at disadvantage as compared to the less organised sector claiming exemption on account of cottage industry or suppression of sales.
(e) It shall be difficult to determine particularly at the import stage where sales or imports shall be for subsequent exports. It is evident a large number of commercial importers do operate in the market. If they import "otherwise zero-rated goods", it shall be next to impossible to determine at the time of clearance which portion of their sales/imports shall go to exporters or exports. Hence a grey area shall unfold to the attraction of the unscrupulous elements.
(f) With the phenomenon of "uncertainty of future" transactions, discretion at the hands of the functionaries of FBR and other government departments engaged in audits shall increase. Such discretion has been discriminately wielded over the years. It operates against the norms of transparency. Taxpayers, generally the compliant ones, are likely to undergo this disturbing process at the hands of government functionaries working at will.
(g) The cost of goods falling in the sectors excluded from the zero-rated regime shall increase. There is likelihood of protests from the business community of even the organised manufacturers and traders.
(h) There has been an element of harshness to the masses. With change in the zero rating regime even the second hand clothing have been brought under the Sales Tax (@ of 17 to 19%), causing heavy cost to the poorer segments of the society. Had this area been addressed, the poorer segments of the society would have been cared to some extent without a heavy loss to the national exchequer.
(i) The area of neglect of the poor is also evident when availability of zero-rating on expensive stationery and dairy products is juxtaposed to its denial in case of clothing (including even the second hand clothing).
In view of the foregoing, the government must reconsider the measure of extending Sales Tax but slashing down the zero-rating regime. It is recommended that the federal government must revisit the challenges affected by the amendment in the zero-rating regime. People are swayed by concerns. If the government timely responds to them, they would end their agitation and would work for not only their own businesses but also for the economy of the country.
There should be independent analysis of benefits and costs of these changes. The government should take immediate action in this direction. Otherwise the opposition and agitation would multiply. It is therefore necessary that the government takes input from all stakeholders (business community - exporters, manufacturers, chambers and trade bodies, tax lawyers and field formations of FBR).
The action in this regard must be taken at the earliest to correct actual or conceptual wrongdoing and to rebuild the trust of the people in the government. When decisions shall be made through a process of consultation they shall bring voluntary compliance and acceptance. This measure shall help the government optimise the benefits of extending the scope of Sales Tax in a reasonable manner and to address operational hardships as well. This shall also help it bridge not only the trade deficit but also the trust deficit, which is currently running high among the business community as well as the general public.