Indirect taxation: moving towards controlled self-assessment

After reviewing the amendments made in the Sales Tax and Federal Excise Law, I would second the statement made by the Minister of State for Finance that the tax policies of the government have been consistent over the years. Yet indeed, the 'inconsistency' has been 'consistent'.
One of the proposed amendments introduced in the sales tax reminds me of the infamous controversial 8th amendment introduced in the Constitution of Pakistan, which had an alphabet "B" in the end. One would remember the said amendment had tarnished the entire framework of the Constitution. Interestingly in this budget an identical amendment has been introduced in the sales tax law having same alphabet "B" in the end which is expected to put similar damage to this tax law.
The brief tale of inconsistency starts from surprise change in 'time of supply'. This change, though of positive nature, came after hundreds of cases went into litigation and finally the Supreme Court of Pakistan upheld the departmental stance on the issue.
Besides, discarding of sales tax and federal excise return with a premature draft, dumping of adjustment notes and advice mechanism, U turn in refunds policy, more hassles in maintenance of business bank accounts, rescinding special procedure for commercial importers and retailers and change of mindset in mechanism of dispute resolution are the other features of the Bill. However, as a major deviation from modern VAT principles, minimum value addition has been made mandatory across the board.
The amendments, by and large, more focus towards discretions of the revenue authorities. Coherent with last year, the focal point is more on revenue collection rather than facilitation. This time an idea has been coined to provide legal cover to the withholding of genuine taxpayers money for over 14 months.
OUR COMMENTS ON THE SIGNIFICANT AMENDMENTS, THEIR IMPACT, RESULTING PROBLEMS AND AREAS OF IMPROVEMENTS ARE DISCUSSED BELOW:
AMENDMENTS IN SALES TAX ACT 1990
1. ADJUSTABLE INPUT TAX SECTION 8B:
a) As a most surprising, deplorable and unwarranted move, the Bill proposes to restrict input tax beyond 90% of the output tax for a particular tax period. The credit of 10% balance will be available to only corporate taxpayers if, alongwith annual audited accounts, a certified statement by the company's auditors is furnished confirming value additions less than 10%.
We reckon the proposed scheme as a camouflage, highly unjust and malafide in nature. Infact, through this scheme, the government proposes to impose the mandatory value addition of 10% to all the sectors of economy which uptill now was applicable only to commercial importers. Now, while on one hand, the special procedure applicable to commercial importers has been removed form the law, yet on the other hand, the same condition of minimum value addition of 10% has been made mandatory to the entire chain of registered persons by making it a part of the main statute.
This, in our view, is nothing but negation of modern VAT theory and an attempt to control the self assessment mechanism, which is the essence of any VAT law. Besides, it also contradicts and undermines the various landmark judgements from superior judiciary wherein input tax has been held to be a vested right of the taxpayer. It is pertinent to note that no scheme of refund of balance 10% input tax has been announced for registered persons not operating under the corporate set-up.
With the above amendment, in case of corporate taxpayers, the balance 10% input tax shall remain with the government for over 14 months for no fault on the part of the poor taxpayer. It is amazing to note the government does not pay any thing over and above the principal sum of refund, if it keeps taxpayers money with it for a particular period of time. However, if the taxpayers don't pay on time, they are made subject to default surcharge.
Nevertheless, if it be so, then we strongly suggest a corresponding amendment may be made in section 67 thereby allowing interest on delayed refund for 14 months to the taxpayer, though at a low rate of 6% pa, ion case auditors certificate confirm value addition of less than 6%. Further, rules may be issued regarding allowability of refund to non corporate registered persons.
b) The entire input tax paid on acquisition of fixed assets is proposed to be an admissible deduction in 12 monthly equal instalments. We reckon sometime back, this provision was in the statute whereby input on fixed assets was adjustable in 60 monthly instalments. This time limit was brought down to 25 instalments vide Finance Act 1994. Now the same is sought to be revived in this Budget.
In our opinion, the amendment needs to be revisited by the Board as it does not carry the definition of 'fixed assets'. We are mindful of the fact that asset capitalisation policy differs from company to company depending upon its size, nature of work, life of subject asset, materiality level and economic benefits associated with the use thereof. All such factors shall have a bearing and impact on the input tax claimed by the taxpayers under this head of account.
c) Certain major aspects regarding the proposed certification by the auditor vis-a-vis balance 10% input tax have also been left unanswered. Firstly, the scope or the format of desired statement has not been specified. Secondly, there could be instances when the auditor, due to any reason, may not be willing to undertake such assignment.
The Bill is silent on this issue as well. Further, by virtue of sub section 3 of section 8B read with clause (i) of section 2, it is apparent that the desired statement would need to be furnished by the auditors within 2 months alongwith audited accounts. This seems to be an impractical assumption since the audit seldom ends up in 2 months from the close of financial year. The mechanism of adjustment of 10% input tax, as referred in section 8B(3) is also missing as there is no column in the proposed return for such adjustment.
2. MONTHLY RETURN
SECTION 26:
The Board has proposed a new draft of monthly sales tax and federal excise return in lieu of all the various types of tax returns that are in vogue at the moment. A perusal of such proposed return reveals the following inconsistencies:
a) The proposed mechanism calls for segregation of admissible input tax in 2 components, ie, input tax attributed to 15% taxable supplies and input tax related to 0% supplies. No formula has, however, been specified for such division.
b) It is understood that there are certain indivisible/common inputs which cannot be divided so easily. For example, input tax relating to electricity, telephone, gas, etc may not be classified with either of the above businesses. The proposed return does not elaborate upon this practical aspect.
c) The situation in case the registered person indulges in exempt supplies besides above, has also not been dealt in the proposed Bill.
d) The proposed return suggests that the input tax credit on electricity and gas shall only be available to manufacturer. We do not find any legal backing for such assertion.
e) No column is available regarding adjustments made under section 9 read with rules thereof
f) No column is available in the return for adjustment of federal excise duty collected in sales tax mode, ie, excise paid on telephone bills.
3. REFUND OF INPUT TAX SECTION 10:
The Bill seeks to substitute the existing section 10 with a new provision. This proposition only speaks about the input tax paid by the registered person on taxable purchases during a tax period and not the adjustments that may arise under section 9 of the Act read with rules thereof. We consider it a drafting mistake which should be catered on immediate basis.
Secondly, the provision suggests payment of refund to the taxpayer "if the input tax...exceeds the output tax on account of zero rated supplies/export". It is understood that in all cases involving zero rating/exports, the chunk of input tax shall remain higher than the output tax, which is 0%. It is suggested that drafting of the law may also be looked into from this aspect as well.
The amendment read with the "Salient Features of Excise/Sales Tax Amendments", separately issued by the Board, suggests from now onward, the scope of tax refund is being limited to zero rated supplies/exports only. We consider it as a highly uncalled-for move since restricting genuine refunds to other bonafide taxpayers would be a great injustice with them.
4. RECORDS
SECTION 22(1A):
In another amendment sought to be inserted in section 22, the Board has been empowered to prescribe maximum number of business bank accounts which would be solely used and declared for making or receiving payments in terms of purchase, sale and making payment of due tax from such accounts.
The registered persons are already obliged to declare their business bank accounts to their respective Collectorates. In place of existing mechanism, the proposed amendment is expected to only add to the taxpayers' miseries particularly for those businesses which carry on business through a number of branches/distributors across the country. Even otherwise, the proposal does not make sense in the wake of enhanced powers sought in section 30 and 30E vide proposed SRO 471(I)/2007 whereby besides the Collector, the Directorate General of Intelligence and Investigation and his subordinate authorities can also conduct audit, investigation, adjudication, etc of the taxpayer's records.
5. AUDIT CERTIFICATE BY CHARTERED ACCOUNTANTS
SECTION 22(4):
Through another amendment, a new sub section is proposed to be inserted in section 22 whereby corporate taxpayers would be required to submit a certificate by their auditors 'certifying payment of tax due'. This certificate is to be filed alongwith audited accounts of the company.
In our view, the proposed amendment has serious dimensions which need to be thoroughly studied and debated especially with the Institute of Chartered Accountants of Pakistan (ICAP) before it could be implemented. To our mind, the following areas need to be studied:
a) It must be understood the certification of 'tax due' tantamounts to a special audit on the part of statutory auditors. The fact as to whether ICAP would agree upon the proposed responsibility in the present shape is yet to be ascertained. Further, the taxpayer's cost of special audit is expected to increase a lot because of the minute nature of the assignment.
b) The requirement of a certificate may be changed since the assignment is more of an 'agreed upon procedures'.
c) No scope of work, terms of reference, format or time line of such certificate has been prescribed by the Board.
d) Delay in making timely discharge of tax liability demand payment of default surcharge in terms section 34 of the Act. Sometimes, genuine and bonafide taxpayer facing liquidity problem, opt to delay the tax payment and make payment after sometime alongwith default surcharge and penalty. The proposed amendment is silent on the role of the auditor and resulting reporting when the payment is deliberately delayed not because of evasion but due to liquidity problems or financial modelling.
e) The proposed sub section 4 of section 22 requires 'the payment of tax due by the registered person'. We suggest the amendment may be modified and after the word 'by' the words "or on behalf of" should also be added thereby facilitating the taxpayer to make/arrange payment of tax due through his banker, supplier or any other third party.
6. TAX CREDIT NOT ALLOWED
SECTION 8(1)(A):
By virtue of a major shift in policy previously claimed with respect to taxpayer facilitation, the words "for the manufacture or production of taxable goods or" appearing in section 8(1)(a) are proposed to be removed from the provision.
The aforesaid words were added in the section vide Sales Tax (Amendment) Ordinance 2001. Prior to this change, input tax was admissible to the extent that the same is used for the purpose of making taxable supplies, ie, supply of taxable goods.
The word 'supply' is defined in section 2(33) to mean sale, lease or other disposition of goods. It is important to note a sale can only be affected when the subject goods are in final shape and ready for sale. Thus, we understand, prior to the aforesaid amendment in 2001, input tax was admissible to the extent of goods sold out or to be sold (finished goods) and no adjustment was available for semi finished goods.
It was in this backdrop that the words "for the manufacture or production of taxable goods or" were added in the section thereby extending the scope of input tax adjustment to partially finished goods or work in process (WIP). This contention also finds strength from a judgement announced by Lahore High Court in year 2003.
Now, the law has again been reversed to the position of pre 2001. In our opinion, this amendment will have far reaching but negative impact on the taxpayers and may also result in enhanced litigation/disputes between the taxpayer and the department.
7. TIME OF SUPPLY
SECTION 2(44):
The proposed amendment seeks to address the long outstanding demand of the taxpayers for removal of tax at the time of receipt of advance. This change in legislature has occurred after hectic litigation between the department and the registered persons over non payment of sales tax on advances. So much so, the department had also won the case at the Supreme Court of Pakistan which had declared tax on advances to be legal and valid.
However, corresponding provision governing time of supply in case of taxable services has not been changed. Accordingly, a service provider rendering taxable services is still exposed to tax at the earlier time of rendering of services or the time when any payment is received for his services.
Further, the Bill is silent on adjustment of sales tax paid on advances prior to 08 June 2007.
8. INPUT TAX ON SERVICES
SECTION 2(14)(E):
Since the promulgation of tax on services sector, the issue of admissibility of input tax paid thereon has been a corner of debate. Initially the Board issued various clarifications wherein input tax charged by customs agents was declared to be valid for adjustment/refund purposes. Later on, the scope of admissibility was also extended to other services subject to certain conditions.
Now the Bill proposes to amend the definition of input tax by inserting the input tax levied under Provincial Ordinances therein. With this amendment, overlapping provisions previously appearing in Special Procedure for Taxable Services have been omitted. Accordingly, it is hoped the issue has finally been settled and henceforth all inputs paid by a taxpayer on acquisition of taxable services would be admissible against his output tax liability.
9. JOINT AND SEVERAL LIABILITIES OF REGISTERED PERSONS
SECTION 8A:
Through the Finance Act 2006, a new section 8A was introduced which fixes joint and several liability for payment of sales tax on both buyer and seller, if the buyer of a taxable good is in knowledge or has grounds to suspect that partial or full sales tax of the subject goods would not be paid by the respective supplier. Further, according to the proposition, this liability can be imposed in case the buyer has identical reasons for any previous or future supply received by him.
The industry alongwith the tax practitioners have since been demanding removal of this severe, illogical and unwarranted proposition. It was hoped that the current budget would bring positive amendments in the section, if not altogether removed. On the contrary, a proviso is sought to be inserted in the section which empowers the Board to exempt any transaction or transactions from the application of section 8A.
We reiterate our previous submissions that keeping in view the impractical and cumbersome implications of the provision, section 8A may be removed from the statute.
Even otherwise, the provision seems to be not properly placed in the Act. Being a penal provision, this section is suggested to be replaced from its current position and inserted after section 36 of the Act.
10. COTTAGE INDUSTRY
SECTION 2(5A):
Vide amendment in section 2 of the Sales Tax Act 1990 (the Act), a new definition of 'cottage industry' has been proposed in the Bill. According to such definition, a manufacturer whose annual turnover from taxable supplies made in any tax period during the last twelve months ending any tax period does not exceed Rs 5,000,000 or whose annual utility (electricity, gas and telephone) bills during the last twelve months ending any tax period do not exceed Rs 600,000, shall be classified as Cottage Industry and accordingly shall be exempted from sales tax by virtue of corresponding amendment introduced in 6th Schedule to the Act.
We understand that the intention of the proposed amendment is to enlarge the tax net and is a welcome step. However, it is not clear as to whether telephone bill shall include mobile telephone or not? Secondly, the amendment is also silent as to whether the utility bills shall be taken into consideration with the respective levy of sales tax or not? Further, probably due to drafting mistake, the 6th Schedule links the said exemption if 'total turnover' does not exceed Rs 5 million whereas according to the definition, the criteria of 'taxable turnover' has been specified.
11. ALTERNATIVE DISPUTE RESOLUTION COMMITTEE
SECTION 47A:
Amendments have been sought in section 47A whereby no ADR committee would be formed in cases where FIRs have been lodged under the Act, criminal proceedings initiated or where interpretation of question of law having larger revenue impact is involved.
Settlement of disputes through the ADR mechanism is now practised all over the world. In Pakistan, this scheme was launched in the year 2004 and, except for certain technical and operational problems, is working well. If applied in its true spirit, ADR can become a sound and effective tool for dispute resolution without recourse to a Court of Law.
In this backdrop, the restriction placed upon its scope in cases involving interpretation of question of law having larger revenue impact is unfair and would discourage the taxpayers to opt for ADR for resolution of their tax related disputes. It is, therefore, suggested that the amendment be done away with.
By virtue of sub section 4 of section 47A, the Board is empowered to accept or reject the recommendations of ADRC. We understand this is the biggest threat confronting the success of the whole scheme and recommend that the old law binding both the department and the taxpayer, in case of unanimous recommendations by ADRC, should be restored.
In line with sub section 5, we are of the view that necessary amendments may be introduced requiring Courts/Tribunals, where the case preferred at ADRC is otherwise sub judice, to put its judicial proceedings in abeyance till the matter is finally disposed off by ADRC. This is likely to provide a clear picture of the proceedings and conduct by parties to the Courts/Tribunal and help effective disposal of the case.
12. RETAIL PRICE
SECTION 2(27):
The Bill seeks to add the word "duties" in the definition of 'retail price' thus making it compulsory for the manufacture of 3rd Schedule Items to add the quantum of duties in their price. However, surprisingly, the corresponding definition of "duty or duties" has not been specified in section 2. We suggest the ambiguity should be removed forthwith failing which the application of the proposal would be dependent upon individual interpretation as to whether a combination of customs duty, federal excise duty, etc or only a part thereof would need to be included in the manufacturer's retail price.
13. PROCESSING OF REFUNDS AT LARGE TAXPAYERS' UNIT
SRO 465(I)/2007:
As a positive step, the proposed refund rules provides sanction of refund claim within 3 days from filing thereof and submission of equivalent amount of bank guarantee. This procedure is applicable to taxpayers' registered with Large Taxpayers Unit (LTU).
In terms of rule 6 thereof, in case LTU treats the refund or part thereof to be inadmissible, the same shall be recoverable within 7 days by encashing bank guarantee to that extent. We are of the view that LTU must not proceed unilaterally against the taxpayer and proper show cause notice and consequential adjudication proceedings must be undertaken in terms of sections 11 and 45, before the encashment may be made.
14. INADMISSIBLE INPUT TAX
SRO 464(I)/2007:
The Bill seeks to amend SRO 490(I)/2004 dated 12 June 2004 by restricting the input tax paid on supply of electricity and gas to residential colonies of registered persons.
It may be pointed out that in recent judgements, the superior judicial forums had allowed the input tax credit attributed to supply of electricity and gas to residential colonies of registered persons. Hence, we view the subject amendment as a move to negate and undermine those judgements and deprive the benefit of input tax credit to the taxpayers.
15. AMNESTY SCHEME
SRO 463(I)/2007:
An amnesty scheme has been introduced in the Bill which provides remission of default surcharge and penalties if the taxpayer, against whom any tax liability exists, pays off the related principal tax before 30 June 2007.
Going by the wordings of the SRO, it appears that the benefit of the amnesty may only be applicable to liabilities that have been adjudged by the departmental adjudicating authorities and not beyond. In other words, no amnesty would be available if any principal tax liability is determined/upheld by the higher appellate forum(s).
Secondly, the amnesty shall be available to taxpayers who failed to discharged their tax liability or claimed inadmissible input tax, etc due to any reason except 'tax fraud'. It is suggested that this condition may be done away with since in many cases, the show cause notice contains allegations of tax fraud without any tangible basis. Consequently, such registered persons would not be able to avail the amnesty which, otherwise, they are entitled to.
AMENDMENTS IN FEDERAL EXCISE ACT 2005
1. SUPPLY
SECTION 2(23A):
A new definition of the term 'supply' has been proposed in the Bill. According to the definition, supply shall include sale, lease or other disposition of goods and shall include such transaction as the Federal Government may notify in the official Gazette from time to time.
We understand that the aforesaid definition is identical to the one existing in Sales Tax Act, 1990. However, there is need to insert the words "for consideration", after the words 'goods' appearing in the proposed definition. In the absence of such words, we are afraid that self consumption of excisable goods may also tantamount to 'supply' and consequently we may encounter identical litigation in the excise regime as have been witnessed in the sales tax side with respect to 'supply'.
2. SCOPE OF DUTY
SECTION 3:
The Bill proposes to align the excise law with sales tax law. With this intention, definitions of 'dutiable goods, dutiable supply, dutiable services and supply' have been introduced in the statute. Through various identical amendments, the scope of federal excise is sought to be changed to sale from clearance.
Analysing the subject amendments vis-a-vis the other intact provisions of the FED Act, we find that section 3 has not been amended which even today requires payment of duty on goods produced or manufactured. On the other hand, the word 'clearance' is sought to be substituted with the word 'supply' in the remaining provisions of the law. This anomaly, if not corrected immediately, is expected to trigger major disputes between the department and the taxpayers.
It may be noted duties under Federal Excise Act 2005 (FED Act) are levied in terms of section 3 thereof. Section 3 determines the scope of duty and thus is the charging provision of the FED Act. In line with various case laws pronounced by superior courts, we understand that all the other provisions of any fiscal law are dependent upon the 'charging' section and therefore termed as 'machinery' provisions. In this backdrop, we suggest that charging provision of FED Act may suitably be amended to align the scope of levy from clearance to supply as has been proposed in the machinery sections of the law.
3.STOCK ADJUSTMENT:
Although the scope of duty has been shifted from clearance to supply, yet no procedure has been prescribed for adjustment of duty paid stock at various sales outlets/warehouses of a taxpayer. The Board should clarify the treatment that should be given to unsold duty paid stock as on the date of change in legislation.