In India, sales tax from services has grown geometrically with 35 times increase since 1995, while it is stagnant, or rather gone down, in Pakistan where services sector contributes over 52 percent of the GDP.
According to State Bank of Pakistan (SBP) annual report, the lower rate of 'service tax' in India has encouraged voluntary compliance. Union government imposed a 'service tax' in 1994, initially on three services, at the rate of 5 percent, which was subsequently increased to 8 percent from May 14, 2003, and further increased to 10 percent in 2004-05.
'Service tax' collection in India has shown steady rise since its inception. The tax collection has grown manifold from Rs 4.10 billion to Rs 141.34 billion during 1995-05 showing 35 times growth.
In India, there has also been a substantial growth in the taxpayer base. The number of persons liable to pay 'service tax' increased from 3943 in 1995 to 774,988 in 2005. The number of services in its net has gradually increased to 71. Indian government has also extended credit of 'service tax' and 'excise duty' across goods and services. The collection of 'service tax' took a jump from Rs 78.9 billion in 2004 to Rs 141.34 billion in 2005, while the number of assessees expanded from 403,856 in 2004 to 774,988 in 2005.
SBP repeatedly referred to the India 'service tax' system, which remained a successful experience as compared to Pakistan where services sector on the whole remains under-taxed.
In Pakistan, the number of registered service providers expanded from 32,697 in 1997 to 163,188 in 2004. The number of registered persons has gone down 29.5 percent to 114,952 persons on June 30, 2005 due to revision in the exemption threshold for retailers and manufacturer's turnover. The number of sales tax registered persons is already small and has gone downward due to policy measures. The CBR should bring more services into the sales tax net instead of withdrawing those already liable to sales tax, says SBP annual report.
During 2004-05, sales tax/CED collection on services amounted to Rs 27.9 billion. The main chunk of Rs 20.4 billion came from telecommunication services. Other services contributed Rs 3.6 billion to the total sales tax collection of Rs 240 billion, while retailers and wholesalers paid a very small amount of sales tax of Rs 3.3 billion.
From the Indian experience, it can be seen that the case for such a new levy at a reduced rate, which can be gradually enhanced, is not only based on sound reasoning but has also been practically demonstrated to be effective.
According to SBP annual report, Pakistan has withdrawn the Provincial Sales Tax on services provided/rendered by beauty parlours, slimming clinics, laundries and dry cleaners and marriage halls/lawns. This was done due to collection of negligible revenues from these services. However, considering the revenue potential of services sector, and to ensure fairness and equity in the tax system, it is appropriate if the CBR focuses on enforcement to tax this sector effectively. Policy measures, such as withdrawal of the sales tax on these services would only make the tax system more inequitable and inefficient.
Sales tax in Pakistan is based on the mode of value-added tax (VAT). One of the objectives of
VAT is that the tax should apply unexceptionally to all economic entities. Therefore, excluding services from this regime creates distortions and is against the spirit of a VAT mode tax, report maintained.
SBP recommended that the government has the policy option to amend item No 49 of the Federal Legislative List so as to provide for levy of sales tax on services or introduce a new entry in federal legislative list for introducing altogether a new tax on services as has been done in India. Another option is to extend provincial sales tax on remaining services including real estate, except residential rent, health and education.
As per SBP report, the Central Board of Revenue (CBR) needs to gradually bring more services into the sales tax net rather than withdrawing those already subject to sales tax.
Services with huge revenue potential, presently outside tax net, include legal services, renting/leasing, engineers, stockbrokers, private schools/universities, banking, finance and doctors. In this regard, it is important to formulate a clear strategy for extending the GST net to services.
Presently, service sector is being taxed in the following three manners: Services subject to central excise duty (CED); services subject to CED which is collected as if it were sales tax; and services subjected to provincial sales tax.
SBP has pointed out that the reasons for this piecemeal and ad hoc approach are rooted in the legislative provisions of the constitution of Pakistan.
The Federal Legislative list (Item No 49 of the Fourth Schedule) of the Constitution provides for levy of tax on sales and purchases of goods, but not on services.
The Sales Tax Act, 1990 is accordingly applicable only to supply of goods. Services are, therefore, considered to be a Provincial subject. In case of eleven services, Provincial Ordinances were promulgated.
According to the SBP report, there appears to be no sound reason for keeping other services out of the tax net. Because consumption of services varies considerably with income, inclusion of services in the tax base has substantial revenue and distributional implications.
If any area of consumption is untaxed, other spending must be taxed at a higher rate to raise a given amount of revenue and this accentuates the distributional impact of any exclusions.
Moreover, the importance of services sector and its share in the GDP, which is likely to increase over time, calls for bringing it into the sales tax net. Finally, the extension of the GST net on services is also supported by cross-country experience where it has provided enormous scope for resource mobilisation and expansion of sales tax base.
The extension of the sales tax net will significantly improve the tax/GDP ratio, the report said.
While extending the GST net to services, it must be borne in mind that services have been traditionally difficult to tax. A system based on voluntary compliance would best suit the taxation of this sector.
The rate of tax is an important factor in inducing voluntary compliance as in services the input tax adjustment may not be able to neutralise the impact of the tax. It is well established that the service sector, with high value-added at the principal stage of production, is the one that could least benefit from the VAT.
Further, the degree of compliance is in proportion to the applicable tax rate, especially for developing countries where a considerable quantum of business is carried out informally due to a variety of reasons such as illiteracy, lack of documentation as well as weak enforcement by the tax authorities, SBP annual report added.
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