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General: The Finance Minister has laid Finance (Supplementary) Bill 2023 on the floor of the Parliament. (National Assembly and Senate) to amend certain fiscal statutes which include the Income Tax Ordinance, 2001, the Sales Tax Act, 1990 and the Federal Excise Act, 2005.

These amendments have been made to comply with the conditions laid down by the International Monetary Fund (IMF) for enhancing the tax revenues to reduce the fiscal deficit.

The primary question is whether or not the increase in sales tax rate from 17% to 18% will result in Rs 170 billion of revenues. In our view the presumption is not correct. Keeping in view the goods which are subject to sales tax especially, also including those at import stage, the amount collected is much more than that.

The Government has adopted the most crude method of increasing the fiscal revenue by increasing the rate for Sales Tax from 17% to 18%. This is the easiest but economically and socially incorrect way to collect tax.

The comparative table of rates of sales tax in the relevant economies is as under:

• Bangladesh 15%

• Canada 5%

• India 18%

• Israel 17%

• Pakistan 17%

• Singapore 7%

• Turkey 18%

• United Kingdom 20%

In countries like India and the United Kingdom the higher rates are justified for the reason that there is an across- the-board incidence of VAT.

In Pakistan, there are serious aberrations as incidence is limited to the manufacturing sector in substance. The next stages in the value chain, being wholesalers and retailers, are not registered; therefore, in effect, the value-added tax acts like a single stage excise duty being detrimental to manufacturing.

The original economic rate of sales tax was 12.5% which had been ascertained on an econometric basis. The increase over the year is totally an arithmetic and tax collection exercise.

In Pakistan there is a high incidence of collection of sales tax especially on services, etc, which is actually not deposited to the government treasury. This is quite frequent in the case of restaurants and other such goods and services. The increase in the rate will promote unjustified endowment to tax evaders. There are only around 300,000 sales tax registered persons in Pakistan.

In this situation the fundamental question is whether or not the amount of sales tax which the government has imposed on the people is actually collected. Except for registered manufacturers and importers, the bulk of sales tax is collected from the customer but is not deposited in the government treasury.

Sale of domestic textiles is one such example. Whole population of Pakistan uses textiles but the amount of sales tax collected from textile at large is negligible. In view of the above increase in the sales tax is a double jeopardy being higher cost to the customers with no effective collection for the government.

The Sales Tax Act, 1990

In the proposed bill the rate of sales tax has been increased from 17% to 18%. The bill will be effective when the proposed Finance (Supplementary) Act, 2023 will receive its ascent from the President.

The Federal Government has however issued a notification 179(I)/2023 [C No. 5/3-STB/2023 dated February 14, 2023] increasing the sales tax rate from February 14, 2023 (effectively February 15). In our opinion the notification is not valid as the Federal Government has no right to increase the general rate laid down in Subsection (1) of Section 3 of the Sales Tax Act, 1990 especially when the matter is laid down before the Parliament.

The Federal Government intends to levy increased sales from the date of the notification, which is legally not a correct position as has been decided by the Supreme Court of Pakistan in the case reported as 2022 PTD 232.

In this connection notwithstanding the general view as referred above the notification issued is limited to products other than those which are subject to tax under the Third Schedule to the Sales Tax Act, 1990 at the retail price for the reason that notification refers to Section 3(2)(b) which does not include sales tax at import stage or supplies of goods subject to Sales Tax at retail price.

It is our view that an increased rate, if any, is applicable on products subject to sales tax retail price from the date when the proposed Finance (Supplementary) Act, 2023 will receive ascent from the President. This position is completely valid for cases dealing with goods subject to sales tax at retail price; however, the government will recover the tax at enhanced rate from the date of the notification unless the same is considered ultra vires from the date of notification by any order of the High Court.

Income Tax Ordinance, 2001

Three major changes have been proposed in the Income Tax Ordinance, 2001. These are:

1- Withholding tax on sales of shares of unlisted companies:

At present transactions for sale of shares of unlisted companies are not subject to withholding tax by the acquirer. An amendment has been proposed in Section 37 of the Ordinance which requires a withholding by the acquirer for an amount equal to 10% of the consideration.

The consideration for sale is deemed to be the fair market value as laid down in Section 101A of the Ordinance. In the proposed bill subsection (4) has been referred which appears to be an error. The relevant provision is subsection (5) of Section 101A of the Ordinance.

The law as framed is not properly worded. It states

(6) the person acquiring a capital asset, being a share of a company, shall deduct advance adjustable tax from the gross amount paid as consideration for the shares at the rate of ten percent of the fair market value of shares which shall be paid……

This provision is inherently improper for the reason that fair value has been defined as value of asset without liability whereas consideration will always be after taking into account the liabilities. Under the general law the withholding cannot be specifically more than the amount at which the ultimate seller is taxable. In this case, the situation arises on account of determination of fair value without taking into account the liabilities.

Furthermore, it is practically impossible for the acquirer to determine a fair market value at the time of transaction. This is a completely absurd law where a buyer is being required to substitute the consideration to a fair market value if it is not so. The consequences, which arise on account of withholding a sum less than required, are serious therefore this absurdity has to be removed.

Secondly, if the provisions of this section are read with Section 75, 76 and 77 of the Ordinance, which are common principles, there cannot be any mandatory substitution of consideration to the fair value of assets.

This withholding provisions has been introduced for capital assets being shares of unlisted companies. In our view this provision is in addition to an already existing provision under Section 152(2) of the Ordinance which applies to cases where the payment is made to a non-resident for the sale of shares. It therefore means that this provision will only apply to cases where the seller is a person being a person resident in Pakistan.

There is a need to clarify the status of this provision in relation to Section 101A of the Ordinance where certain shares of companies outside Pakistan are deemed to be assets located in Pakistan under subsection (3) of Section 101A of the Ordinance. If this provision is treated to be applicable to such shares then the rate has effectively been reduced to 10% from existing 20%.

2- Off-market transactions in listed companies

Corporate regulations allow off market transactions in listed companies. An amendment has been proposed in the law whereby off market transactions in listed shares will not be eligible to reduce the rate of tax on capital gains which were earlier allowed to capital gain on disposal of shares of listed shares irrespective of the manner of disposal.

The amendment further states that the transaction is required to be settled through NCCPL. This effectively means that there can be disposal through stock exchanges which are not settled through NCCPL.

This means that all transactions which are not settled through NCCPL will be taxed at the rate applicable to the seller ranging from 29 to 35%, as the case may be.

In our view, this proposal is improper as the incidence of tax cannot change by the manner in which a transaction is settled. Off-market transactions of capital gain on disposal of shares cannot be discriminated against on that count.

It appears that an aberration is being made on account of certain procedural aspects where some transactions remain outside the ambit of NCCPL for withholding. There are adequate provisions in the rule that off-market transactions are valued at a fair market value for the purposes of taxation. There is no need to make a substantive aberrative amendment to plug a procedural lapse. That procedural lapse can be taken care of by certain administrative measures.

Section 37A which leads to reduced rate of tax on capital gains is applicable on disposal of securities. Securities have been defined in subsection (3) and (3A) of the Ordinance. These securities may include certain securities which are not dealt with in the stock exchange such as open-ended mutual funds and unlisted REITS.

There can be a presumption that this amendment is referring only to off- market transactions of listed companies, which are settled through the NCCPL and those securities which are not listed, but included in securities under this section would continue to qualify for section 37A of the Ordinance. In our view there is a need for a clarification in relation to the proposed amendment.

3- Advance Tax on marriage halls, etc.

An advance tax has been proposed to be collected by the owner of a marriage hall, etc, from the person who uses that facility. The rate of tax is 10% of the charges.

Federal Excise Duty

Federal Excise duty has been increased on aerated waters, juices, cigarettes and cement.

Copyright Business Recorder, 2023

Comments

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Shabir Akhtar Feb 17, 2023 08:50am
A very reasoned analysis has been made to explain the flaws in the strategy adopted to increase tax collection.
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