As we draw near to yet another budget, it is most appropriate to consider how Pakistan can move towards a fairer and just tax regime to boost exports
The period between fiscal years 2013 and 2016 has seen Pakistan’s exports falling by almost USD 4 billion. During the same period and given the same global market conditions, countries such as Bangladesh, India, and Vietnam witnessed increase in export market share of those commodities in which Pakistan once held a respectable ground. Even the market access facility, provided by the European Union, United States and countries with which Pakistan has free trade agreements, is not able to help dwindling exports.
Agreed that energy shortages and high cost of energy do play a role in increased cost of doing business faced by Pakistani exporters, however despite the energy shortages between the fiscal years 2011 and 2013 exports did manage to hold between USD 24 to 25 billion. If global market conditions and energy do not fully explain the nosedive in exports, and we already have a low interest rate milieu which could encourage borrowing at least in theoretical terms, and the government also claims to have announced a Kissan package and textile export packages, apart from the already provided measures under Strategic Trade Policy Framework; what then explains the downfall in exports?
Could it be because: overtime the incentives for traditional exporters to invest in their competitiveness have declined and therefore despite low lending rates borrowing for non-traditional exports remains subdued; existing small and medium enterprises (SMEs) supplying locally are not graduating in to become exporting entities; new entrepreneurs are not entering manufacturing sector and hence the limited product and market diversification (a view also shared by State Bank of Pakistan); unlike China and India, Pakistan was not successful in luring foreign direct investment in traditional and non-traditional exporting industries.
The above mentioned questions may find some answers in a survey by Sustainable Development Policy Institute (SDPI), which informs that almost 35 per cent of Pakistani firms feel that you only get intrusion and harassment by being a formally registered business entity in Pakistan. The state has not been able to establish a transparent competition and tax regime which may be termed a fair and just social contract. Unfortunately, the Panama Papers episode further diminishes the trust and confidence over state’s intentions to move towards a fair society.
Moving towards a more comprehensive value added tax can provide a second best solution of dealing with cascading, besides also providing improved documentation of the overall economy.
The above-mentioned survey also explains why it is hard to convince firms to take risk, experiment with new ideas and scale up to generate exportable surplus in Pakistan. A key issue is that our tax regime including tax policy, tax administration and tax culture are contributors to less than desired performance of businesses and particularly exports?
So, is the tax regime preventing new SMEs from becoming larger and exporting entities? There is a significant difference between the answers to this questions from government versus private sector.
The government actually believes that there are no taxes on exporters in Pakistan — an argument with which the private sector disagrees. The key reason for disagreement is the difference in interpretation of zero-rated regime. The business community believes that zero-rating, like in other parts of the world, should imply ‘no tax no refund’. However, in case of the past and current government, zero rating has meant that an exporter should file their due tax and then apply to Federal Board of Revenue (FBR) for refund — something which has given rise to human interface, corruption and delays in release of refunds in turn also creating a liquidity crunch for the exporters.
Under a system where even zero rated firms end up paying direct and indirect taxes, it is harder for new SMEs and startups to grow as monthly filing of tax return which includes hiring a complete accounting and internal audit department may not be something which they can afford. The annual audit by revenue authorities will be an additional burden on their expense statement requiring them to also hire specialised services of accountants who can justify the taxes statements and refunds. The introduction of advance tax further burdens the balance sheet of nascent businesses as one cannot use the savings until the year end.
It will immensely benefit all stakeholders if a structured public private dialogue is convened to look into the future objectives of zero rating mechanism in Pakistan. Do we want this only as a short term instrument to secure export receipts? Or should we use this as an instrument for long term competitiveness and bolstering knowledge economy. If the answer is latter then perhaps depriving exporters of input tax adjustment (on key inputs such as packaging) is not reasonable. Similarly, not allowing adjustment on imported stationary, books and laboratory equipment to be used in education and skill development is also not justified. A recent example is how customs and regulatory duties killed the livelihoods of thousands of low cost book sellers seen in places such as Khori garden, Karachi.
Perhaps, it will also be of benefit if some consolidation of refunds mechanism, already suggested in the report of Tax Reform Commission, may be implemented. This is essential as currently exporters are seen visiting the FBR for sales tax on input refunds, provincial sales tax on services refunds (until 2013), income tax refunds, receipts against income tax credit section 65B & E, duty drawback, pending sales tax deferred refunds and refunds against section-66. Also, it will be a good idea to reduce the human interface and perhaps allow an IT-enabled system to determine and process refund releases, thereby closing the doors of rampant corruption at the tax authorities.
It is precisely due to the above-mentioned reasons that Pakistan remains in the list of countries with higher number of taxes per year. According to the World Bank’s Ease of Doing Business Data, Pakistani businesses during 2016-17 face 47 different taxes. What makes the task of forecasting business expenses more difficult is the plethora of withholding taxes which are almost same or in some cases more than the overall taxes applicable on a business.
Second, State Bank of Pakistan’s own research indicates a significant amount of imported content required to manufacture Pakistani exports. It is good that Pakistani business are allowed to source the most economical raw materials from anywhere in the world to process exports. However, even this source of competitiveness has also been compromised due to the complex structure of taxation on imported goods.
Pakistani imports are subject to a three-tier customs duty structure; general sales tax (GST) with standard rate of 17 per cent and another slab of 5 per cent, import regulatory duty, and excise duties. There is usually no minimum thresholds for imports often seen in other countries and justified on grounds of food security, education, or even to help new startups.
Interestingly, the most recent introduction of regulatory duties was not part of the annually announced budget and rather slapped in the middle of the fiscal year without a mandatory debate in the parliament or being a formal part of Finance Act. Such instances of ‘mini budgets’ add to the uncertainty around Pakistan’s tax policy and prevents businesses from scaling up.
Due to the complexity of input invoicing under the current GST regime in Pakistan, a ‘cascading’ of the indirect tax is observed — again leading to a rise in cost of compliance for both businesses and individuals. This implies that even a small change in the rate of GST can lead to an inter-sectoral tax expenses (tax on tax) which is higher than the actual GST rate. This ‘tax on tax’ in the case of raw materials, intermediate goods and other inputs leads to production contraction through decreased availability of working capital and consumer spending. During the medium term marketing and distribution, margins of the private enterprises are negatively affected.
Thus, in overall terms tax authorities also end up with lower revenue collection as incentives for production are hurt. Moving towards a more comprehensive value added tax can provide a second best solution of dealing with cascading, besides also providing improved documentation of the overall economy.
Finally, now that the provinces have their own tax revenue authorities, which are ambitious to raise own revenues, exporters face the burden of filing tax returns, making payments and facing audits of multiple provincial sales tax authorities, boards of revenue and provincial excise departments apart from the FBR. These costs can only be reduced if tax rates and income sources on which rates are applicable may be decided by the provinces themselves, however only a single tax return should be filed once all revenue authorities are integrated, and collection of tax should be sole task of a single collection company.
We now have example from India which is trying to introduce a single tax return form at both Central and State levels. Only a more coordinated structure of federal-provincial taxation in Pakistan can bring down the compliance costs and for this it is important to constitute an inter-governmental tax working group which should meet on a monthly basis to implement the above mentioned measures and also remove any instances of double or multiple taxation on same income source of businesses.
As we draw near to yet another budget, it is most appropriate to consider how Pakistan can move towards a fairer and just tax regime. Like in most efficient tax systems, the fiscal regime should transition towards: a) broadening of direct tax base with lesser reliance on regressive withholding taxes, b) reforming indirect tax rates through simplification and reduction in GST rates, removal of federal-provincial multiple indirect taxation, phasing out of federal excise duty, and putting in place a more transparent customs duty structure, c) ensuring a more balanced tax contribution by all sectors of the economy i.e. agriculture, industry and services and removal of tax exemptions which cannot be justified on scientific or welfare grounds, and d) expediting tax administration reforms at both federal and provincial levels.
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The opinions expressed in this article are the author's own and do not necessarily reflect the viewpoint or stance of SDPI.