Finance Bill 2021: Annexures to Finance Bill 2021

Jun 29, 2023

SUMMARY OF TAX EXPENDITURE 2021

Tax Expenditure Report 2021 for federal taxes, based on data pertaining to FY 201920, amounted to an estimated Rs. 1,314.27 billion. Tax expenditure in sales tax amounted highest at Rs. 578.46 billion (44% of the total), while in income tax amounted to Rs. 448.05 billion (34%), and in Customs, to Rs. 287.77 billion (22%). In last fiscal year 2019-20, FBR’s tax collection was Rs. 3,997.4 billion. Hence, tax expenditure to total collection ratio comes to about 33%, and tax expenditure to GDP ratio stands at around 3.2%.

The tax expenditure estimates are unadjusted amounts, meaning that elimination or repeal of a specific exemption would not necessarily produce the rupee amounts cited in this report. Actual receipts would depend on enforcement, taxpayer compliance, effective dates of legislation repealing the exemption, exact wording of any legislation, taxpayer’s behavior, and some other economic factors.

This report briefly outlines federal tax exemptions and concessions. These descriptions do not grant rights or impose obligations; rather, the tax laws and rules made thereunder determine actual tax liability. Each estimate is based on the best information available from public and private sources, including FBR’s database. It would be exceptionally burdensome on taxpayers to require detailed reporting of transactions corresponding to each of the exemption sections and clauses. No such detailed reporting is imposed by statute or rules. Consequently, tax returns do not contain data sufficient to estimate the value of all exemptions and exclusions.

Estimation requires identification of pertinent, useful data available from various external sources. Where exemptions identified in tables have not been estimated, it is because requisite data does not exist or have not been identified and acquired from an external source.

Tax Exemption under 5th Schedule (Zero rated Items)

Under Section 4 of the Act, goods exported, or the goods specified in the Fifth Schedule; supply of stores and provisions for consumption aboard a conveyance proceeding to a destination outside Pakistan as specified in section 24 of the Customs Act, 1969 (IV of 1969); such other goods, as the Federal Government may specify by notification in the official Gazette, whenever circumstances exist to take immediate action for the purposes of national security, natural disaster, national food security in emergency situations and implementation of bilateral and multilateral agreements are charged to tax at the rate of zero per cent.

Under section 13 of the Sales Tax Act 1990, supply of goods or import of goods specified in the Sixth Schedule are, subject to such conditions as may be specified by the Federal Government, are exempt from tax under the Act. The Federal Government is empowered to issue exemptions whenever circumstances exist to take immediate action for the purposes of national security, natural disaster, national food security in emergency situations and implementation of bilateral and multilateral agreements, by notification in the official Gazette. Exemptions can be on any supplies made or imports, of any goods or class of goods from the whole or any part of the tax chargeable under the Act, subject to the conditions and limitations specified therein.

Under section 3 (2) (b), Federal Government is empowered to declare that in respect of any taxable goods, the tax shall be charged, collected and paid in such manner and at such higher or lower rate or rates as may be specified, subject to such conditions and restrictions as it may impose, by notification in the official Gazette.

B. Nature of exemptions and concessions

In sales tax act, concessions are granted broadly by three ways: i.e. Zero Rating,

Exemptions, and reduced rates.

In some cases, product based concession is granted under sales tax act, for example, in case of food and grocery items, certain products are exempt or have reduced rate of sales tax. It may get tricky because these exemptions can then have rules within rules.

Prepared foods and ready-to-eat food items may be exempted or have reduced rate whereas the same items if sold under brand name may not have the concession.

Under the Act certain products that are intended to be used for in-house consumption, for use of a specific organization are given tax concession. Typically, this is where, the end consumers are not liable to be taxed, or intended to be given tax concession.

Diplomats, diplomatic missions, diplomatic organizations, non-profit organizations or government agencies often are not required to pay sales tax. This concession in the form of zero rating or exemption is extended to these national and international agencies.

C. Suggestion for further improvement of Sales Tax estimates

The reporting and calculation of tax expenditures estimates may be improved through:

Legal Enactment

In previous estimates it was suggested that in sales tax act, concessions are granted broadly by three ways, i.e. zero rating, exemptions, and reduced rates. The sales tax return of any registered person may not be considered as true and valid return, without mentioning exempt supply, if any. This will help in computing the exemption incidence when exempt supplies are made by various registered persons in supply chain.

Administrative Measures

Industry-ratios and/or standardized minimum value addition formulas may be issued, with the consultation of major industries, to have more accurate and rational estimates, and so that exact extent of value addition in each industry can be estimated.

Engagement of Experts and Internees

Various expert, working in the universities may be engaged to develop a broad based consultancy and opportunities may be provided to young university graduates to apply various statistical tools on the data for improvement in reporting and calculating tax buoyancy

Training of the Team

The team engaged in SPR&S may be trained in National and International well reputed institutes for understanding and opting international best practices.

a) Statutory rates of Customs Duty (CD), Regulatory Duty (RD), and Additional Customs Duty

(ACD) have been taken as benchmark rates. Customs related exemptions / concessions are generally sector based.

b) While making calculations, any deviation from statutory rates has been considered as

exemption / concession.

c) Period of study is FY 2010, i.e. July 2019 to June 2020.

d) Report is based on figures in respect of customs duty exemptions given under chapter-99 (Rs.12,635 million). FTA/PTAs (Rs.34,210 million), 5th Schedule to Customs Act, 1969 (Rs.137,418 million) and exemptions given under other SROs (Rs.55,877 million) including export oriented exemption/concession SROs.

Methodology for Customs Duty Cost Estimation Data for estimations of Customs is also taken from FBR’s official database, and estimations were Calculated against statutory rates of duties, using revenue forgone approach.

VAT GAP MODEL:

USING SUPPLY-USE TABLES

Definition of the VAT Gap: The VAT Gap refers to the VAT Policy Gap or the VAT

Compliance Gap.

The VAT Policy Gap: The VAT Policy Gap is the difference between the Potential VAT collectible under a benchmark or standard regime’ of the VAT (where there are no exemptions, lower rates or special treatment of any type of consumption or sector/class of taxpayers), and the Potential VAT collectible under the current regime (which includes any special treatment of consumption or sector/class of taxpayers). The VAT Policy Gap estimates the revenue foregone due to the current policy of the government.

The VAT Compliance Gap: The VAT Compliance Gap is the difference between this Potential VAT collectible under the current regime and the Actual VAT collection. The VAT Compliance Gap estimates the gap in VAT due to non-compliance by taxpayers. This study estimates VAT Policy GAP for the year 2021.

Efficient collection of taxes is considered as a cornerstone of a good tax system. However, because of non-compliance and other VAT foregone this efficiency may not be achieved.

Therefore, it creates a Gap between potential VAT and actually collected VAT. Given tax base, if taxes remain unpaid, would cause burden on those who are contributing in this regards. Which is unfair and creates distortions in the economy. Further these unpaid VAT would put burden on the overall public finances resulting in either curtailing the government expenditures or increase the debt burden. Both of which are detrimental for growth and development goals of the government. Despite healthy revenue growth especially by FBR (for the period 2001-2020 average growth is 13.9%), Pakistan’s overall revenue collection has been low when compared to the expenditure outlays.

One of the core reason for these under or low payment in relation to the base is because of Tax Expenditures1. These are normally reported2 and Governments throughout the world use tax expenditures as an alternative policy option to achieve social objectives and promote economic growth. Tax expenditures as a percentage of the total tax collected (income, sales, FED, and customs) have been increasing over time. In Tax

Expenditure Report 2020, based on data pertaining to Financial Year 2018-19, it has increased to an estimated Rs. 1,150 billion in which Tax expenditure for Sales Tax amounted the highest at Rs. 518.8 billion (45% of the total), and in Customs Rs. 253.1 billion (22%). In FY 2018-19, FBR’s tax collection was Rs. 3,828 billion. Overall, tax expenditure to GDP ratio stands at around 3%.

Understanding the scale and the scope of VAT policy gap and evaluating cost and benefit analysis is prerequisite for fiscal governance especially for high deficit countries like Pakistan. One of the suitable approaches to measure the VAT Gap is Top-down approach. In the present analysis only “VAT-GAP” model estimation is done using Supply Use Tables. Sales Tax is currently single largest tax revenue source for FBR. In FY 2019-20 it amounted to 1,597 Billion Rs. which is approximately 40% of the total tax collected by FBR. For Sales Tax (Domestic) the base is considered to be Large Scale Manufacturing (LSM) and for Sales Tax (Imports) the base is imports.

The assessment of VAT gap analysis provides a tool to tax administrators, policy makers and relevant stakeholders, which can be roped through policy choices.

We use a detailed input-output model of Pakistan’s economy to estimate the potential VAT form domestic sales. This supply-use table provide information on the final consumption as well as the production and use of goods and services in the economy.

Not only does the model provide information on total use or gross sales for each of the 40 sectors in the supply-use table but it also provides crucial information on the intermediate and value of primary use, the value of import and exports, and the value of investment expenditures. In other words, the Input-output model provides the necessary information to the model ‘Pakistan’s potential sales tax base’, including the taxable supplies, input credits, and refunds on exports. The most recent Input-output model for Pakistan’s economy is for 20173. We re-benchmark this model to reflect the level of Pakistan’s economy by sectors values for 2020, using national accounts data. The accuracy of our VAT gap estimates suffer significantly because the I-O model does not fully capture the informal sector.

4.1 Consumption Approach

The supply-use table provides information on the final consumption of consumer, government, exporters. The final consumption of commodities includes the VAT in the value. We eliminate the VAT from consumption at commodity level first, then we apply the Commodity VAT rate to calculate the potential VAT Policy Gap using the Supply-Use table.

The VAT Policy Gap is the difference between the Potential VAT collectible under a benchmark of the VAT (where there are no exemptions, lower rates or special treatment of any type of consumption or sector/class of taxpayers), and the Potential VAT collectible under the current regime (which includes any special treatment of consumption or

sector/class of taxpayers).

Potential policy VAT GAP= (Final Consumption - VAT) × - (( - )×

• The estimates suggest VAT policy gap is about $ 3.5 billion which is approximately

4.2 Value Added Approach

To understand the methodology used to estimate the VAT gap, it is necessary to review Some GDP accounting identities. There are three approaches to estimate the GDP, the Income approach, expenditure approach, and the production approach or value added approach. As Input-output table uses both the expenditures approach (horizontally along the row of the model) and the model value added approach (vertically along the columns of the model) to GDP accounting.

The following GDP identities are

GDP = C + I + G + X - M = { ValueAddedc = {(Totaluse - Value_Added)c (1)

Where C is the final consumption expenditures. I is the gross investment expenditures, G is the government purchases of goods and services, X is the value of exports and M is the value of imports The subscripts c stands for the commodities (sectors) We can obtain an expression for the sales tax base by solving the left-hnad-side of (1) for final consumption (C), which yields the following expression

Sales tax base=GDP+M-I-G-X (2)

Substituting (2) into the right-hand-side (1), we obtain an equivalent expression for the

sales tax base.

Sales tax base= ( { Value Adeed i + M i - I i - X i) - G

Multiplying (3) by the sales tax rate ( ) and re-arranging the resulting expression, we

obtain the following definition

Potential VATC ({ tc X (Total Use c + M i - I i - X c - G c ))

Potential VAT Policy Gap =({(Total Use c + M i - I i - X c - G c )) x t

The equation (5) provides operational definitions that are useful for estimating VAT Policy GAP.

• Using the value added approach, the estimates suggest gap is about $ 3.8 billion which is approximately 23 percent of VAT under current regime. This gap close to the VAT policy gap measured by the consumption approach.

Major part of government tax revenues is collected by FBR. A substantial increase in the tax collections has been witnessed during last two decades. FBR tax collection was just around Rs.392 billion in 2000-01 which has jumped to around Rs.4 trillion in 2019-20. The average growth till FY 2017-18 remained 14.1%, however, due to Covid-19 pandemic the yearly growth has plummeted, thus affecting slightly the average annual growth for the period 2001-2020 as well (13.9%).

1.1 Five Years FBR Collection Trend

The last five years’ collection trend is shown in the following table. The 5 years average growth was 9.3%, however, by excluding the last two years, average growth for normal years i.e. FY 2013-14 to FY 2017-18 stands at 14.6% (Table 1).

Table 1: FBR Collection Trend

Tax 2013-14 2014-15 2015-16 2016-17 2017-18 2018-19 2019-20 5 Years

Heads Avg.

DT 877,255 1,033,720 1,217,474 1,344,226 1,536,583 1,445,508 1,523,445 15.7

ST 996382 1087790 1,302,371 1,328,965 1,485,306 1,459,213 1,596,877 12.2

FED 138084 162248 188,055 197,911 213,493 238,186 250,474 12.1

CD 242810 306220 404,572 496,772 608,373 685,575 626,612 21.0

Total 2,254,531 2,589,978 3,112,472 3,367,874 3,843,755 3,828,482 3,997,408 14.6

(*) for the Years 2013-14 to 2017-18

Tax-GDP Ratio

Similarly, in the tax-GDP ratio, similar trend has been noticed and it kept on rising till FY 2017-18 and reached 11.2 (Graph 1), but later on this healthy trend couldn’t continue during FY 2018-19 and FY 2019-20, which is mainly attributed to Covid-19 pandemic related economic challenges.

1.2 CFY Collection: July-March 2020-21

After a slow growth in previous two years now the collection is picking up, which is evident from table 2. This performance is very encouraging as compared to previous couple of years. The nine months target has been achieved to the exte

FBR collects Direct Taxes (DT), Sales Tax (Domestic & Imports), Federal Excise Duty (FED) and Customs Duties (CD). In this study tax-wise buoyancy estimates have been used to forecast the FBR head-wise revenues for FY 2021-22. The tax buoyancy is an indicator to measure efficiency and responsiveness of revenue mobilization in response to growth in the GDP or national income. A buoyant tax means the tax revenues increase more than proportionately in response to a rise in national income/GDP/base.

2.1 Methodology

The SPRS Wing before budget, projects the head-wise revenue estimates based on buoyancy estimates6 from previous years on rolling basis. Tax-wise buoyancy estimates are calculated by using historical collection and respective bases data. The current tax-wise buoyancy estimates are estimated from data for the years 1999-2000 to 2019-20 in respect of economic indicators i.e. GDP, Non-agri GDP, LSM and Imports.

The respective proxy bases of head-wise FBR taxes are as under:

Direct Taxes (DT) Non-agri GDP

Sales Tax Domestic (STD) Large Scale Manufacturing (LSM)

Sales Tax Imports (STM) Import Value

Customs Duties (CD) Dutiable Import Value

Federal Excise Duty (FED) LSM

Buoyancy estimates are derived as = % Change in Actual Revenues

Since these tax bases have a dynamic

relationship with GDP, in the second step % Change in Respective Base

we have calculated the buoyancies of % Change in GDP

these tax bases with GDP =

Finally these two are multiplied to arrive at respective tax to GDP buoyancies=

% Change in Actual Revenues % Change in Respective Base

% Change in Respective Base % Change in GDP

Using these buoyancy estimates autonomous growth for each tax is estimated by using the projections provided by Finance Division for each proxy base.7 It provides for the GDP Growth and inflation forecast for upcoming year. GDP value used for this projection of growth is Gross Value Addition of Sectors at Constant Factor Costs. Using the inflation forecasts these GDP growth estimates are converted into GDP growth estimates at Current Factor Cost. Further, GDP-Gross value addition at Current Factor Cost is used for measuring the Buoyancy estimates to be used for revenue forecasts. In respect of Direct Taxes (DT) Non-Agri GDP has been taken as its proxy base. The buoyancy of direct taxes has been estimated in two steps: in the first step Direct Tax to Non-Agri GDP and in second step Non-Agri-GDP to GDP (Gross Value Addition-Current Factor Cost) is estimated. Then two buoyancy estimates have been multiplied to estimate the Direct Taxes to GDP Buoyancy estimates.

Direct taxes to Non-Agri GDP Buoyancy (B1) = % Change in Direct Taxes

Non-Agri GDP to GDP Buoyancy (B2) = % Change in Non-Agri GDP

Direct taxes to GDP Buoyancy = B1 * B2

Similarly for Customs (CD) the proxy base is dutiable imports, whereas the projections as provided by Finance Division are for the total imports. Therefore, the buoyancy has been estimated in two steps: first Customs to dutiable imports and in second step Dutiable Imports to total Imports and then these two have been multiplied to get the CD buoyancy estimates.

For Federal Excise (FED) and Sales Tax (Domestic) the base is Large Scale Manufacturing (LSM) and for Sales Tax (Imports) the base is imports. Therefore, for these taxes the buoyancy values are directly estimated from proxy bases. Following table reflects the respective buoyancies which are estimated using simple log-log regression method in excel sheet by using log values of actual data for taxes.

Calculating Autonomous Growth

In the second step autonomous growth has been estimated by multiplying buoyancy estimates (Table 3) to projected growths of respective bases (Table 4):

Table 4: Growth Assumptions for FY 2021-22

Table 5 provides an autonomous growth parameters for each tax head. These are based on the buoyancy estimates from the last 20 years actual revenue collection data and the macroeconomic proxy bases provided by Pakistan Bureau of Statistics/Annual Economic Surveys and the growth projections published in Budget Strategy Paper / Economic Adviser’s Wing, Finance Division.

These autonomous growths will be used to project the autonomous growth estimates of respective revenue heads. To be sure of the results robustness a small exercise was also done by using the reduced and increased nominal growths by 10%. The resulting change was insignificant.

2.2 Head-wise Revenue Projections FY 2021-22

The autonomous growth (Table 5) has been applied on base year’s expected collection (i.e. 2020-21) for each respective head to project an increase of Rs. 636 billion. This addition has been added in the expected collection of FY 2020-21 thus, the revenue forecast for FY 2021-22 without additional Policy/Admn measures has been obtained to the tune of Rs. 5,336 billion. The required growth over the expected collection of FY 2020-21 i.e. Rs. 4,700 billion would be 13.5% in FY 2021-22. However, with the addition of Policy/Admn measures the target for FY 2021-22 would be Rs. 5,829 billion, which is near to IMF suggestion i.e. requiring a growth of about 24.0%.

(*) This excludes Policy/Admn Measures and consists of projection due to autonomous growth

Concluding Remarks

It has been found that the overall FBR taxes are buoyant (1.04 overall buoyancy) and there is a potential for increase in tax revenues provided that macroeconomic indicators are doing well. It is evident from last 20 years data that FBR revenues increased substantially with around 14% average growth. The head-wise break-up reveals that the direct taxes are most buoyant with I.13 buoyancy value, followed by sales tax (domestic) with 1.11 buoyancy estimates. On the other hand, sales tax (imports), customs and FED have relatively lesser buoyancies. In this regard, addressing the issues of narrow base, unnecessary exemptions and valuation problems at import stage can be instrumental for making these tax heads more buoyant, thus enabling the revenue organization to fetch more tax revenues.

The revenue forecast for FY 2021-22 by applying the buoyancy estimates and projected respective macroeconomic indicators would be Rs.5,336 billion without Policy/Admn measures. After adding Policy/Admn measures the target would be Rs.5,829 billion. However the revenue collection and achieving of target would largely depend on the performance of the economy against the targets.

Copyright Business Recorder, 2021

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