Budget 2014-15: Reforming sales tax system – II

During 2003-2007, one tax official used different techniques to issue illegal refunds in several cases without any check by any agency. It was found that the accused official during his appointment as Commissioner Income Tax (CIT), Companies Zone-II, Lahore was involved in corruption. Details collected by an intelligence agency revealed that the official deliberately issued bogus refunds of Rs 19.211 million to an electronic company in 2003, 2004 and 2005 despite the fact that tax record was tempered by changing figures/important documents. The examination of record also showed concealment of basic facts of the case and flouting of statutory provisions and legal requirements. The official deliberately drafted wrong cases showing misstatements to give legal backing to the bogus refunds. In another case, the official issued bogus refund of Rs 33.99 million to a company for the tax year 2004. The objections raised by the lower income tax officials were ignored to issue bogus refunds. According to sources, the accused official was also given additional charge of Commissioner of Income Tax Zone-A, Lahore for 2-3 weeks in June, 2007. During this period, illegal refunds were issued in 37 cases involving over Rs 50 million by committing serious violations of law. In all 37 cases, violations in interpretation of law were so blatantly committed that they were clearly visible even on initial scrutiny of documents. The Board initiated disciplinary proceedings against the official under the Removal from Services (Special Powers) Ordinance 2000. He not only survived but got promotion in Grade 21!

— In 2006, FBR suspended three senior income tax officials of Karachi, who sanctioned Rs 138.460 million fake refunds on bogus tax deduction certificates issued by some stock exchange members. FBR constituted a high-level committee headed by Mukhtar Ahmed Gondal, Director General, Large Taxpayer Unit (LTU) Karachi, to probe this mega tax fraud. The Director General Intelligence and Investigation recommended to the Board that immediate action be taken against a former commissioner of Income Tax, Companies Zone-IV, Karachi; ex-Additional Commissioner Companies Zone-IV, Karachi and Ex-DCIT, Companies Zone-IV, Karachi. The FBR was also to obtain tax record from Regional Tax Office (RTO), Karachi, for fixing responsibility on PRAL, stock exchanges and identification of banks. On the findings of the DG Intelligence, the FBR initiated disciplinary proceedings against the suspected income tax officials. The DG Intelligence apprehended that Board’s immediate attention was needed in this regard, otherwise its negative fallout might cause irreparable loss in meeting the revenue target. FBR found that the former officials of Enforcement Zone, Companies-IV Karachi used illegal ‘tax deduction certificates’ issued to some stock exchange brokers for claiming refund. The Vigilance Wing of DG Intelligence detected that the three ex-income tax officials of Companies Zone-IV caused huge loss to the exchequer by issuing bogus income tax refunds to hundreds of individuals during 2006-07. The involved officials issued illegal refunds to individuals who were out of the Companies Zone-IV, Karachi, jurisdiction. FBR sources said the illegal refunds were issued in such a manner that all the ingredients of an organised tax fraud were properly managed. The DG Intelligence had detected that refunds were issued on the basis of certificates u/s 164 of Income Tax Ordinance, 2001 to selected brokers/individuals for trading in shares. Under the law, members of the stock exchanges were not authorised to issue such certificates. The individuals whom refunds had been issued did not fall under Enforcement Jurisdiction of Companies Zone-IV, Karachi. The National Tax Numbers (NTNs) of these individuals were in serialised sequence, pattern of tax years was identical, refund cheque numbers were in serialised sequence, dates of refunds were identical, whereas members/brokers issued unauthorised certificates to individuals/brokers under section 164. Interestingly, refunds were issued to individuals, who were residents of other cities/stations and their particulars do not match with the NTN.

— In 2001-2002, a total of 300 cases were detected in Karachi, involving an amount of Rs 1080 million; in Lahore, 136 cases involving Rs 159 million and in Faisalabad, 109 exporters perpetrated a loss of Rs 265 million in term of revenue shortfall.

The above list is not exhaustive but is just a tip-off the iceberg. The increased numbers of refund scams and unfettered tax evasion confirm that nothing has changed in FBR even after taking loans worth millions of dollars for reforms (sic). It is worth noting that after the World Bank funded Tax Administration Reforms Programme (TARP), FBR has been making tall claims about its automation efforts. All the chairmen of FBR, who headed the apex revenue authority for the last 15 years, have been assuring the public from time to time that after introduction of automated procedures in all the departments, the possibilities of tax fraud had been effectively countered. But the facts and figures show that since 2005 when computerized processes were introduced, the incidences of tax frauds increased substantially as compared to the days when manual procedures were in vogue. This means that before going for automation, neither system analyses were properly conducted nor quality and training of human resource employed was assured. The number of tax scams surfaced since 2001 and huge quantum involved testify to the fact that there is a complete failure on the part of FBR to implement pre-emptive measures against tax frauds.

The tax evaders, their advisers and dishonest tax officials together constitute a mafia that has made Pakistan a haven for tax dodgers and plunderers of national wealth. The tax officials holding key posts are posted on the recommendations of their political masters and not on merit. The unholy alliance between the tax evaders and tax officials design and implement policies for “mutually-beneficial” relations. The outcome is a total destruction of our socioeconomic system (we are witnessing ever-increasing rich-poor divided, chaos and lawlessness).

The existing sales tax system is so defective that it is either benefiting corrupt officials or fake exporters at the cost of genuine exporters and the national exchequer. The only solution to end this mafia is that all sales tax refunds should be adjusted against the refinance scheme through the State Bank of Pakistan. This will certainly not be acceptable to the tax bureaucracy as they will lose control over things and the speed money on which they are thriving will disappear.

If the government is not ready to replace the existing value added tax with single stage sales tax, it can still plug the revenue leakage through the following measures:

— The claimant may get refund of excess input through a credit system on furnishing of guarantee.

— Set off of VAT in credit mechanism must cover person’s own tax liabilities, such as corporate income tax or withholding tax, import tax and all kind of other taxes.

— Special refund procedure should be devised for those taxable persons who are directly or indirectly involved in the preparation and use of fake or falsified invoices and some intelligence reporting is available against them and proper court permission is obtained on the basis of such information.

The fact that the tax authorities have to protect the revenue against fraud and abuse of refund system should not have a negative impact on taxable persons acting in good faith. Even if it is true that the actual refundable amounts claimed should be established before any refund is granted, it is not sufficient justification for inordinate delays and cumbersome bureaucratic procedures. A balance should be attained between administrative procedures needed to prevent possible revenue fraud resulting from malpractices of certain taxable persons with the connivance of tax officials and the related financial disadvantages that these practices cause to the bona fide taxpayers.

FBR during the last many years has failed on all fronts – in meeting revenue targets, broadening of tax base, implementing Value Added Tax (VAT), increasing share of direct taxes to the extent of 50% of total revenue collection and improving tax-to-GDP ratio. Tragically, tax-to-GDP ratio in 2012, the last year of extended World Bank funded Tax Administration Reform Project (TARP), dipped to 8.2% from 10.6% in 2005 when the programme started!

The World Bank in its report, “Implementation, Completion and Result Report” on TARP observed that “the current narrow-base of general sales tax (GST) in Pakistan remained almost entirely unchanged throughout 2005-2012, despite efforts to overhaul the indirect taxation structure by introducing a reformed GST featuring few exemptions and wide coverage of goods and services”.

The report while highlighting the poor performance of FBR noted that “different from other sources of tax revenue in Pakistan, administration of GST entails a full-fledged operation of major FBR functionalities, including: registration, monthly tax return processing, collection, refunds, audit and enforcement. GST operation also integrates joint efforts from both internal revenue administration and customs since GST import tax is collected at the borders and zero-rating is targeted for export operations, besides other activities”.

The World Bank for evaluating FBR’s overall performance during the TARP used GST administration as an indicator. The result compiled is highly disappointing – GST productivity turned out to be only 23 percent, compared to an average ratio of 34 percent worldwide. According to the World Bank, “the estimation covering the project life reflected an overall decreasing trend during 2005-06 to 2010-11 suggesting feeble tax administration efforts throughout the reform period”. Shockingly, throughout the reform implementation period, there was “a declining performance in both tax policy and administration”. Even during the economic boom (2005-08) GST productivity index “showed a rather declining trend despite modest buoyancy gains in FBR revenue collection, signaling relatively poor tax administration performance amidst relatively favorable overall economic conditions”, says World Bank.

The World Bank concluded that “during the economic crisis period and subsequent years (2008-11), GST productivity index declined at a higher rate compared to FBR tax-GDP despite a swift turnaround in project implementation and concomitant positive trends in some outputs by the last two years of project life”. The report while pinpointing out weak compliance levels, lackluster results in reform implementation, especially those related to short term actions aimed at curbing evasion through more effective enforcement actions by the final year of project implementation, noted “performance from 2008 onwards, far from the project’s objectives envisioned at the outset”. This is the sordid story of tax reforms in Pakistan even when enormous funds – over 100 million US$ – and best professional advice was available.

Not only did FBR fail to implement tax reforms, there were unprecedented increase in tax frauds that were not taken into account by the World Bank in its report – Acts of deceit and frauds, Business Recorder, July 31, 2011. On 8 July 2012 it was reported in the Press that FBR was on the verge of signing off on a massive waiver of Rs 47 billion on outstanding taxes for five cellular service providers, but the move was intercepted and foiled by National Accountability Bureau (NAB). Earlier, the Federal Tax Ombudsman (FTO) pointed out evasion of customs duty of billions of rupees in ‘missing containers scam’ for which report was specifically prepared on the direction of the Supreme Court. Yet another one was unlawful interpretation of section 153 by FBR waiving minimum tax of 6% payable by service providers for which FTO directed action against the responsible persons, but matter as usual is lingering on.

In short, the businessmen and corrupt tax officials have proved that even a tax like VAT is as susceptible to evasion and fraud as any other tax. In other countries it succeeded as they had efficient tax machineries capable of cross-checking a large number of invoices through an elaborate computer system, which is a pre-requisite for the successful implementation of VAT. This is precisely what is lacking in Pakistan. The performance of the special auditors appointed under section 32A of the Sales Tax Act 1990 is equally disappointing. In fact, they have emerged as another class of extortionists, who are more interested in minting money than acting as good professionals. The reports prepared by them, where deals were not stuck, speak of either incompetence or arbitrariness. The corruption, which was previously confined to government officials, have now spread to professional bodies, courtesy an ill-advised decision to delegate essential State functions to private institutions, which have their own vested interest and proven record of protecting tax fraud through fictitious audit extended to business houses. It is really a pathetic state of affairs.

Successful enforcement of VAT requires an elaborate system of book-keeping, involving numerous computations, at each level of production and, therefore, may prove very cumbersome for the taxpayers. It calls for additional and efficient administrative efforts to check and cross-check the paperwork done by the taxpayers. VAT requires both a collection and a refund mechanism. Apparently, both collection and compliance costs have a tendency to increase. We have neither good audit practice nor efficient tax machinery and yet the FBR’s stalwarts (sic) are hopeful to implement VAT in Pakistan. They perhaps live in a fool’s paradise.

The problems of tax administration are very acute and complex in Pakistan. Our tax machinery is one of the most inefficient, incompetent and corrupt in the whole world. Admittedly accounting practices in Pakistan are least developed, partly due to very low literacy rate. It is much simpler for firms to file returns of gross turnover than the value added returns which require, inter alia, accounts of taxes paid on inputs. This problem is further compounded because of the preponderance of small-scale producers and sellers in less developed economies. These constraints deprive VAT of its theoretical advantage of automatic cross-checking to discourage evasion. Lack of proper recording of transactions and the unmanageable number of small taxpayers engages the administration in a futile exercise of hide and seek. This problem can partly be solved by extending the VAT system to wholesale stage only and exempting sectors dominated by small-scale production. For further simplification, VAT may be restricted to the manufacturing stage. Exclusion of retail and wholesale stages would significantly reduce burden on the administration without, at the same time, interfering in the working of the tax since they come at the end of the production chain.

This is the state of affairs of our much-cherished VAT system, which was introduced with the tall claims of bringing revolution in tax mobilisation and economic prosperity in Pakistan. In just few years, it has proved to be yet another source of speed money in a society.

(Concluded)

(The writers, lawyers and Adjunct Faculty at Lahore University of Management Sciences (LUMS), are partners in law firm, Huzaima & Ikram (Taxand Pakistan)