WORKSHOP ON SALES TAX CORE CONCEPTS

WORKSHOP ON SALES TAX CORE CONCEPTS BY TAX BAR ASSOCIATION, KARACHI ON JULY 22, 2005 By SYED SHABBAR ZAIDI, FCA PARTNER A.F. FERGUSON & CO.

SCOPE OF TAX Combination of Levies • Sales Tax under the present state is covering the incidence (direct or indirect) under: • The Sales Tax Act, 1990; • The Provincial Sales Tax Ordinance; and • Federal Excise Act, 2005. • Accordingly, its scope has in effect been extended, from the ‘Traditional’ tax on ‘Goods’ to ‘services’; if included. • There is a need for legislative correction / consolidation to this effect. • The future issue relates to VAT or ‘Services’.

SCOPE OF TAX Combination of Levies (Cont’d) • In principle, Sales Tax is payable on: • Import of Goods (Like Import Duty) • Supply of goods • However, by virtue of introduction of the concept of Minimum Value Addition (MVA) on ‘Importers’ and ‘Retailers’ there is a principle deviation to this effect for: • Importers with the levy of 10% tax on as deemed value addition at import stage. • Retailers where tax is being charged on ‘Purchases’ rather than sales. Legislative corrections are required. • Now, in these circumstances, sales tax law in the present form is the combination of VAT and certain ‘Presumptive VAT’. This distortion is creating economic disparities.

TAXABLE ACTIVITY • This concept has generally been overlooked. In principle, tax incidence, should only arise when the person is engaged in ‘taxable activity’. A ‘supply’ (disposition of goods) with a broader meaning being undertaken by a person not engaged in taxable activity is not taxable. Nevertheless, there had been apparent overlappings on this matter. An example of the relevance of this provision is ‘supply of goods’ by a person engaged in exempt activity. For example, sale of scrap etc. by tax exempt industries such as ‘Pharmaceuticals’ etc. or provision of paper whilst delivering copies of ‘Accounts’ by the audit firm.

REGISTERED PERSON • Tax incidence under the law arises for a ‘Registered Person’ only. It is so primarily for the reason that in principle, the tax operates on a VAT principle. If any other meaning is adopted then there would be no limitation on ‘inputs’. • Illegal sales are in effect outside the ambit of sales Tax Act. • Practical issues arise where a person is registered compulsorily with ‘Retrospective Effect’ whereas supplies were made by that person during the period when such a person was not registered. This issue arises from the ‘Proviso’ to section 2(25) of the Act.

TAXABLE SUPPLIES • This definition requires an amendment to the effect that under the present definition as laid down in section 2(41) incidence is related to category of supplier viz. importer, manufacturer, wholesaler, distributor or retailer. Now with the extension of scope to all sectors, such identification has become irrelevant. • In practice, after the extension of the scope of tax there is no reason to relate the incidence to such persons. We have to adopt the definition stated in UK VAT. In fact, the amendment, introduced in 1998 has now become irrelevant.

ZERO-RATING • This concept relates to situation where the legislature intends to allow ‘refund’ for the tax borne by the person with no incidence for the supplier itself. In general, this applies to ‘Exports’, however, under the law any category of supply can be treated / deemed to be zero-rated [Section 4(c) of the Act]. • In the Federal Budget 2005, local supplies of the five export oriented industries have been zero-rated. These industries are: • Textile • Leather • Sport Goods • Surgical Products • Carpets

ZERO-RATING (Cont’d) • This is a unique concept. Underlying rationale, is to reduce the incidence of misuse of ‘invoices’ as bulk of the production from such industries was being ‘exported’ and there was a ‘high’ probability of misuse of invoice. • In principle, this should remain a ‘Stop-Gap’ arrangement.

EXEMPTION • This concept is totally distinguishable with zero-rating. In this situation, a class of ‘goods’ fall outside the ambit of taxable supply. Exemption is not to a person. However, certain activities have been (can be) exempted under the Sixth Schedule to the Act. Exemption under the law is restricted to specific goods. • Under the present law exemption could arise through: • An entry in Sixth Schedule to the Act (here the relevance is of the PCT heading) • Notification under section 13 of the Act • There is a relationship between ‘Taxable Activity’ and exemption.

GOODS AND TAXABLE GOODS • Under the present law, all imports and supply of all the goods are subject to Sales Tax. The term ‘goods’ has been defined to include any kind of ‘movable property’. This definition has infact excluded only ‘immovable properties’ from the ambit of sales tax which is restricted to ‘land and building’ only. Plant and machinery is deemed to be a movable property. • Within this context, ‘electricity and gas’ are treated as ‘goods’ for the purposes of levy of sales tax. • Supply of all goods are taxable under the Act unless exempted. Zero-rating is a taxable incidence. • Sections 7 and 8 relating to claim of input tax and restriction thereof, under the present situation, however, extend to input relating to ‘services’. This is a beneficial provision.

SUPPLY • ‘Supply’ as defined under the Act has wider connotation then ‘sale’. It includes all kinds of disposition of goods. • There is a principle confusion with reference to inclusion of the term ‘lease’ in that definition. At present leasing both in the form of Finance and Operating lease fall outside the scope of supply. However, there are specific basis of taxability for Hire Purchase Transaction. This ambiguity is required to be sorted out. ‘Hire Purchase Transaction’ have to be taxed at the time of agreement. • Concept of Islamic mode of financing, where there is notional supply needs to be sorted out. Substance has to prevail over form. • Supply under the law, can only arise where there is a sale for ‘consideration’. Accordingly, the matter of ‘Free Samples’ need to be sorted out.

SUPPLY (Cont’d) • There is, however, an extension of the definition of supply to include putting to private, business or non-business use of goods produced or manufactured in the course of business. This provision requires practical application. This provision is restricted to the situation where a product taxable is ‘used’ by the manufacturer, for example, provision of cooking oil to factory workers; use of ‘bagasse’ in the manufacture of sugar etc. This aspect is, however, required to be distinguished with supply of goods without ‘consideration’ like free sample. At present this fine distinction has not been identified.

TIME OF SUPPLY • Time of supply is the period where the incidence of tax arises. It is either the delivery of goods or the receipt of advances for that supply whichever is earlier. Thus, there is a deemed concept of supply on ‘receipt’ of advances for that ‘supply’. • The issues requiring clarification are: • Consideration for ‘part’ supply • Transaction for ‘Hire Purchase Agreement’ (cash flow issues) • Withdrawal of ‘exemption’ (a concept of deemed supply) • The newly prescribed ‘Rules’ for Advances are required to read ‘positively’. This issue relates to the matter of claim of ‘input tax’ for the supply deemed prior to delivery of goods.

VALUE OF SUPPLY • Value of supply in general is the Actual Sale Price. There is no concept of comparison with / substitution to the open-market price, except in special circumstances. • Concept of open-market price or fair value arises in the case of: • Where the part of the supply is in kind; • Transactions with associated parties; provided other considerations are fulfilled; • Supply on instalment basis along with the mark up. • Discount are allowed to be deducted from the value of supply in all situations, even if the value of supply is the Retail Price as laid down under section 3 of the Act.

VALUE OF SUPPLY (Cont’d) • There is no inherent right to substitute the ‘actual’ price to the open-market price. Sub-section 2(46) is in fact a positive provision. • In case of ‘Toll Manufacturing’ if the goods being supplied are exempt, however, the processed goods are ‘taxable’ then the value of processed goods would be the sale price of the processed goods irrespective of the kind and nature of unprocessed goods supplied. • The concept of value of supply with reference to products covered under the ‘Third Schedule’ is the retail price at which such goods will be sold by the ultimate consumer. The difference between the value of supply for the next chain of distribution will arise through ‘Discount’ adjustments.

TAX FRAUD • The concept of tax fraud emanates from the principle of ‘mens-rea’ being an ‘intentional act’, however, the universal problem of identifying a distinction between ‘intentional’ and ‘un-intentional’ act, is practically impossible. • This issue has become more relevant after the amendment in Finance Act, 2005 where ‘Default Surcharge’ (Additional Tax) for tax fraud situations is substantially higher (Double). • Present definition is too over stretched and in effect, every case of tax non-compliance may fall into the ambit of a tax fraud case. • The solution lies in adopting the UK concept of ‘Serious Fraud’ legislation.

TAX PERIOD • Under the present provisions of law, ‘Tax Period’ is the period of ‘one month’ for which return is due on 15th of the following month. • Tax period is relevant both with reference to output and input tax. Irrespective of the right to claim input tax in the following periods (eleven), the inherent right to claim input tax only arises with reference to that borne in that period. Thus, in principle, there is no concept of ‘Timing’ of input tax over the tax periods. This matter has become all the more relevant with the limitation of right of carry-forward excess input tax.

WORKSHOP ON SALES TAX CORE CONCEPTS