We seem to have no understanding of what ails our taxation system — II

• Reducing tax collection reliance at import stage

INTRODUCTION

In my article published in this newspaper on June 2, 2021, I highlighted the heavy reliance of taxes collected at import stage in the overall tax collection of the country and summarized that many ills of the taxation system and the economy at large are the result of this situation which is a reality that cannot be ignored. It is our responsibility to remedy the situation in a gradual manner so that Pakistan can be placed within the ambit of a broad-based system of taxation.

The first part of this discourse is limited to adverse impacts of the extraordinary reliance on taxation of imports that has reached a level of 45% of total taxes collected, and is expected to increase. This amount will be around Rs 1,800 in 2020-2021 budget figures. It is reiterated that this may be the highest in the world in terms of percentage and reflects almost a complete failure of collection of due income or VAT-based taxes at the domestic level.

For many readers of subject the aforesaid discussion may look odd; however, it is better to relate to ground realities instead of making suggestions about tax collection without realizing who is paying and at what stage. This is the purpose of this series of articles.

Tax policing at import stage

On account of inefficiencies in the system, whether or not expressly accepted, there is a national consensus that there is almost zero possibility of any recovery of either income tax or of VAT, once goods imported whether raw materials, intermediary or finished, leave the ports. So collect whatever the government has to at the gate. This I call the ‘tax policing/tax bhatta’. As is evident from the table given in the following paragraphs, out of the total rupee value of imports of around Rs 7,500 billion, the government collects 25% in the name of income tax at source, VAT at import stage and customs duty. There is no policy rationale for it. It is simply the easiest and most expedient manner of collection with least effort. We all are party to this persistent corruption, however, in recent times, domestic collection has remained so stagnant that it has become virtually impossible to make any constructive change in the reliance of taxes at the import stage which is essentially negative in the real sense. I will be explaining in the following paragraphs the negative effects of the traps, and the way forward to get rid of them. We refer to the table of import-based taxation as under:

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         The table will be further analysed in the following paragraphs.
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Year /         USD Value     Pakistan       Effective   Tax                   Tax
Period         of Import     Rupee          Exchange    Collection     Collection
              (billion       Value of       rate        at Import            as a
               USD)          Imports in                 stage:         percentage
                             Pakistan                   Income tax,      of total
                                                        sales tax,       value of
                                                        FED and           imports
                                                        Customs
                                                        Rupees in
                                                        billion)
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2015-2016       45           4722            105        1282                27.2%
2016-2017       53           5584            105        1431                25.6%
2017-2018       61           6750            110        1691                25.1%
2018-2019       55           7499            135        1747                23.3%
2019-2020       44           7057            160        1755                24.9%
2020-2021
(July-April)    45           7222            160        1726                23.9%
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Primary negative impact of present import-based taxation

At the outset, it is necessary to identify the negative impacts and relevance of the present system in relation to the evolution of the economic architecture of the country. These subjects are sequenced as under:

1. On the policy side, there is an inherent conflict of intellectual interest. On the fiscal side there is an urge to increasing the value of imports and depreciate the rupee. Every increase in value of imports in dollars and every decrease in rupee value versus USD provide extra tax to the fiscal authorities without any effort. They added around Rs 400 billion out of nothing because of rupee devaluation when it happened. Whereas national interest demands a balanced foreign trade account that requires promoting exports and discouraging unnecessary imports. The question is whether or not the two segments of the Ministry of Finance namely: Finance Division and Revenue Division, are on the same page?

2. The second and the primary question of identification, use and abuse of sales tax being VAT collected at import stage. Out of the total; taxes collected at import stage of around Rs 1,800 billion the amount of sales tax collected at the import stage will reach around Rs 1,000 billion in the year to come. It will:

a. Either be adjusted against output tax on local manufacturing or sales such as petroleum, CKD, etc. This is an illusory phenomenon as sales tax return of domestic tax is required to be filed every month. This illusion has to be gradually removed. The amount collected at the import stage is either genuinely claimed as input tax or on the availability of GD on which sales tax has been paid there is an open market where GDs are bought and sold. This means that due to ineffective checks the sales tax collected on item A, which is not relatable in the manufacture of item B is claimed as input for item B. Export is another sector where such invoices and GDs are purchased. The market price of input available is around 3% whereas the benefit is 17%.

b. Passed on to the ‘consumers’ as part of the price on finished goods like customs duty. Accordingly, for all purposes it is a customs duty; or in other words, in theory there is no point in collecting sales tax at the import stage. If it is non-adjustable then it is effectively customs duty and should be so designated. Therefore it is an illusory collection that directly decreases the domestic sales tax collection and promotes undocumented fake economy.

1. The amount of income tax collected at the import stage is either final tax under the presumptive tax regime [though it has been converted as minimum tax by the Finance Act, 2019] for the reason that there is no mechanism in place to identify the trail of goods from imports to retailers. This is also a kind of customs duty. Almost all the wholesalers and retailers are effectively outside the ambit of sales tax registration therefore it is not possible to tax the importer on the profit made by the importer. I tried to tackle this by registration of wholesalers and retailers and introduction of CNIC of the purchasers. But failed. In quantitative terms it means that if out of 45 billion USD worth imports say 25% is the value of finished goods and there is an average profit of 33% then direct taxes of around Rs 55 billion which should have been received from such importers are being received from customers as indirect taxes [45x160x25%x30%]. This is the negative impact of this import-based tax on presumptive basis.

2. The other adverse impacts of this across the board tax at import stage in the nature of customs duty of around 25% are:

a. Incentives for under-invoicing especially where presumptive taxation is prevalent; and

b. smuggling adversely affects local manufacturing. In this respect, it is pertinent to state that both these menaces were rampant when the average customs duties were over 25%. This is a validly applicable argument, however, it must be understood that under the customs regime the products are effectively regulated. Higher customs duties are only for those industries where there is an organised process in place to curb under-invoicing and smuggling. In Pakistan the system works in the reverse order. There is no check on trail of the smuggled goods and under-invoiced products and incentives in direct and indirect manner are provided to eclipse the trail of movement of goods from their entity into the country to final destination. When I was Chairman Federal Board of Revenue (FBR) I introduced a system of retail price valuation for imported finished goods. This is not ideal but a reasonably effective method to avoid heavy under-invoicing of many items. It is a fact that substantial reduction in under-invoicing has happened due to this step. Nevertheless, this step is not a solution for smuggling when goods escape customs duties.

The numbers in future

In the years 2021-2022 and 2022-23 the USD value of imports are expected to be around 60 and 65 billion, respectively. If the exchange rate remains stabilized around Rs 160 and 165 in the years 2021-2022 and 2022-2023, then the rupee value of imports will be around Rs 10,400 billion and Rs 10,800 billion, respectively. The question is whether any government in the last two years of its term will be ready to take a hit on the guaranteed collection of Rs 2,500 billion and Rs 2,600 billion, respectively. The answer to this question is in the negative. Nevertheless it is my advice to the prime minister and the finance minister that a step be undertaken in this direction to reduce this reliance and this will lead to positive results for them in the next general elections in 2023.

Bringing in retail and wholesale sector

It is my personal view that unless the collaboration of importers, retailers and wholesalers against documentation is not broken, no meaningful correction in the system can be made. The risk which I will also not take even if made the helmsman is an abrupt cut of Rs 1000 to Rs 2000 billion of tax collection at import stage unless there is some assurance. On the basis of my experience and knowledge of dealing with listed companies and manner of collection of sales tax it is my suggestion that solutions given in the following paragraphs be implemented in 2021-2022 otherwise it will be now or never. This is the trap where our past leaders have placed us and it will require great efforts and national consensus to get out of the trap.

Solutions for 2021-2022 budget

Keeping in view the ground realities as referred above in the years to come, especially 2021-2022 following steps be undertaken towards correction as to reach the correct status at the end say by 2025. The steps to be taken are:

1. Exempt sales tax on raw materials and intermediates at import stage for listed companies as that would improve their cash flows and FBR will be able to apply the VAT in a proper manner. There will be almost guaranteed recovery.

2. Exempt all listed companies from withholding income taxes under Section 148 on raw materials and intermediates.

3. Increase and publicize the list of items of finished goods which are subject to sales tax at import stage. Make it mandatory that prices are placed on the packets. Like the same is done in case of cigarettes. For example, there should be public information about the price at which ‘Lurpak’ butter is imported so that a reasonable comparison can be made with the prices of ‘Nurpur’. This will also identify the conduit trading done through a tax haven near Pakistan. It will also reveal the names of countries which are dumping goods in Pakistani markets against our national interest. In the present world, wars are fought in the economic arena and not on geographical borders.

4. ‘Customs Rulings’ for import of finished goods be published at all levels.

5. National Tariff Commission be revitalized to identify dumping and other aspects related to imported products.

6. Special zones are established for ‘import substitution’ as are established for export processing. Pakistan is facing the problem of de-industrialization that leads to poverty and unemployment.

In case if any organised industry other than a listed company is ready to comply with conditions prescribed then the same should also be equated with the listed company for that purpose.

If concerted efforts are made in the manner as identified above then this country can get out of the mess that has been created for political expediencies in the past 40 years. We are determined to correct the system for our future generations.

(To be continued)

Copyright Business Recorder, 2021