The contribution of services sector in overall gross domestic product (GDP) stood at 53 percent in 2007 but its contribution in overall taxes is still very negligible, resulting in serious distortions in the entire taxation system of Pakistan.
According to 'World Development Indicators-2009' report released by the World Bank, contribution of services sector in overall GDP increased from 50 percent in 1995 to 53 percent in 2007, it added. When contacted, tax experts told Business Recorder on Saturday that the services sector constitutes more than half of the value added of the economy, but it is fetching only 34 percent of the federal tax receipts.
Services sector is the most significant sector of economy by contributing more than half of the GDP. Pakistan is not an exception, the share of services sector is 75 percent in developed countries; 65 percent in Singapore, 54 percent in Sri Lanka and 52 percent in India.
Service sector is the top sector in term of its contribution in the economy of Pakistan. There is a mismatch in term of its contribution in economy viz a viz tax revenues. This is visible in case of agriculture and services sectors. Moreover, revenue productivity from services is quite low mainly due to lake of documentation, weak enforcement and audit. The tax base of services is quite narrow.
In a couple of years, an effort has been made to augment the tax base of services to some extent. For example, the Federal Excise Duty (FED) on services was extended to number of services with partial success. Actually, there is a need to expand the tax base of services in sales tax. The tax revenues from services in indirect taxes crucially depend on telecommunication. There is a need to diversify tax collection from services.
Due to constitutional issues, the implementation of broad-based sales tax on all services could not be accomplished. The inability of provinces to generate ample revenues for fulfilling their budgetary requirements has also been issue. Due this problem, some of the services relating to provinces are being administered by the FBR with nominal collection charges. Until the provinces build their capacity best choice is that federal government may continue the collection of sales tax on services.
Now it is imperative to bring more services into the Value Added Tax (VAT) mode with improved audit and enforcement. The collection of provincial services can be improved by augmenting its base under the prevailing arrangements subject to better enforcement. The FBR and provinces are already convening meetings to implement a broad-based VAT on goods as well as services.
Sources said that the small retailers below Rs 5 million thresholds are currently out of sales tax net but can be good source of revenues for the local bodies if the power of collection of sales tax is devolved to them. Generally, this threshold is exceedingly higher and no way conform to the international standards. This type of measures leads towards inefficiency and provide incentives to other sector to get out of the tax net.
Pakistan Marginal Effective Tax Rate (METR) on capital for service sector is considerably low. It implies that Pakistan is competitive in attracting investment in the service sector as far as taxation is concerned. For instance, in Argentina, 45 percent of the profit from marginal investment goes to taxation as compared to only 28.4 percent in Pakistan.
This evidence confirms that there is still ample scope for revenue generation from service sector in Pakistan. The sales tax seemed to be an appropriate tax for services but there may a uniform rate of goods and services. On the other hand, although base of FED on services is extremely limited but still there is a variation in the FED rates.
The uniformity of tax rates between sales tax on goods and services, and FED on services will help in reducing distortions and bring equity. Pakistan can also improve its tax revenues from services by expanding the scope of taxes to the untaxed services.
There is also an option to combine all the services into a service tax in indirect taxes but again there might be a number of constitutional and administrative issues. Secondly, VAT implementation on services and goods is also under consideration of the government.
There is a considerable volume of international trade in services, which should contribute to the exchequer in the form of taxes, which is paying nothing significant at present. Tax experts opined that the major reasons for low tax-GDP ratio are that some of the major sectors are out of tax net or under taxed.
Agriculture sector contributes only 0.2 percent of taxes in GDP against its share of more than 1/5th of the GDP. On the other hand, despite stellar performance by the services sector, its tax receipts have not increased accordingly. Similarly, most of taxation burden has been saddled on the manufacturing sector. This conspicuous mismatch is a hindrance in raising tax-GDP ratio of the country to the international standard.
They said that the taxation of services is a hard to tax area as many services are rendered at the distribution process or at the stage of production. Services is a difficult to tax in Pakistan as well but a well defined mechanism has to be developed to tax economic activities taking place in this sector.
Currently, the contribution of provincial services, which were made part of sales tax, has been low ie 10 percent in 2007-08. On the other hand, the share of federal services has improved substantially due to boom in the collection of telecommunication sector. The telecommunication has dominated the overall collection of sales tax on services.
Although the collection of sales tax from provincial services grew by an average compound growth rate of 16 percent from 2001-02 to 2007-08 yet there is a lack of diversification of generation of revenue from provincial services. Only 4 services constitute around 94 percent of the receipts related to provincial services.
A number of services like beauty parlours/slimming clinics/travel agents, clubs, marriage halls, laundry, caterers, etc, have contributed insignificantly over the years. On the other hand, federal services have exhibited a robust average compound growth rate of 26 percent in GST during last 8 years mainly due to vibrant performance by the telecommunication.
Referring to taxation of services in India, experts said that India has improved its collection remarkably from service tax, which has become an example for countries like Pakistan to follow it. Round 63 percent of service tax collection emanated from 10 services and remaining 40 percent has been spread on remaining services.
Like Pakistan, telephone services contributed the top collection. Surprisingly, while comparing Indian service tax top ten revenue generating services, only two categories telephone, banking and insurance services have been taxed in Pakistan. Service, tax as a buoyant tax, has not only improved overall collection of indirect taxes and total taxes but also provided impetus to improved tax-GDP Ratio in India.
Service tax in India has been the only tax in indirect taxes, which enhanced its contribution gradually in overall gross taxes. Similarly, the contribution of service tax in Indian GDP has improved from 0.1 percent in 1994-95 to 1.1 percent in 2007-08.
In line with the Indian service tax, Pakistan should endeavour to improve the contribution of indirect taxes from the services sector. It means during 2007-08, there was a potential to realise Rs 100 billion but only Rs 66 billion was actually collected. It implies that roughly, there is a further potential of Rs 34 billion in Pakistan, which could be generated additionally.
Experts said that the contribution of telecommunication has been 70 percent of total collection of services in indirect taxes in Pakistan against only 17 percent in India. This is a case of limited tax base of services as well as enforcement issue.
Interestingly, tax compliance by the taxpayers from 2001-02 has been up to the mark in services as tax returns have been regularly filed. Actual issue is the low contribution of service sector in tax revenues. The tax base of services is extremely narrow. There is an immediate need to augment the scope of services in tax net of FED in VAT mode.
The most prolific services in Indian service tax which have potential in Pakistan included business auxiliary service, goods transport agency, insurance auxiliary service, maintenance or repair services, stock broker, consulting engineers and commercial or repair service. With the passage of time, gradual extension of base would be a great source of revenue generation among the service untaxed.
For greater simplicity and distortion free system of service taxation, uniformity of tax rate is essential. The services taxed under indirect taxation are subject to varying rates. In Indian service tax, uniform rate for all the services applied. A uniform rate of 15 percent would be more reasonable all services under VAT mode, experts opined.
They suggested that in order to improve collection and enforcement, separate set up of services tax administration can be helpful. Since services generate inadequate revenues except telecommunication, attention is paid to manufacturing sector on priority basis as bulk of revenues is generated by manufacturing sector.
All the services in the net of FED and sales tax may be combined together into a new tax "Service Tax" like India. It would a serious step toward focusing on revenue generation through better enforcement and extension of base of services, they said.
One of the most striking aspects of taxation of services is its limited base. Only a portion of the services is in the tax net and the remaining is a heaven for the booming business in services sector. The issue of this higher sale tax threshold (for retailers and manufacturers) is of compelling significance for retailers and manufacturers coupled with zero rating of five major export-oriented industries.
The result of said zero rating has not been successful when viewed in the wider context including rebates payments. The low contribution by a robust segment of business should not be a criteria for tax zero rating. In these cases, extensive audits are required rather to keep them out of the net, experts said.
Like provincial governments, local governments have also been deficient in resources and mainly dependent on the finances from provincial governments. In order to manage the retailers and manufacturers below the sales tax threshold, their taxation may be transferred to the local governments. This will not only generate robust tax revenues for local government but also will exhibit better enforcement.
Experts said that the documentation of the service sector is fundamental for enforcement of taxation of services. Unfortunately, the generation of revenues from service sector except few areas has been dismal. Effective audit plays an important role in safeguarding revenues.
The data for 2008-09 revealed that apart from traditional major revenue spinners, it is encouraging that services sector has emerged as third revenue spinner of Federal Excise Duty (FED). Only six major items contributed around 80 percent of the collection during 2008-09. The collection of FED from services sector stood at Rs 17.48 billion during 2008-09 against Rs 12.41 billion in the same period last fiscal, reflecting an increase of 40.8 percent.
Among major items, cigarette has been the top most revenue generator with around 31.8 percent share in FED collection, followed by cement (15.2 percent), services (15.1 percent), beverages (9.1 percent), natural gas (5.3 percent) and POL products (3.6 percent). In absolute terms, Rs 92.8 billion were collected from major six items. Around 41 percent growth in the receipts from services is mainly due to upward revision of FED rates of banking services and insurance services.
Experts said that some of the additional "tax policy" and administrative reforms included conversion of GST into full VAT-mode, by removing aberration and bringing such sectors as "Services" and "Retail trade" under the tax net. These measures are expected to enlarge the tax-club.
On the sales tax side, major ten commodities contribute 89.3 percent of the total sales tax domestic sector during 2008-2009. The major revenue spinners include petroleum products, telecom services, natural gas, sugar, cigarettes, services, electrical energy, beverages, cement and tea. The sales tax collection from services stood at Rs 6.35 billion during 2008-09 against Rs 6.19 billion during the same period last fiscal, showing an increase of 3.4 percent.
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