Presentation Anomalies In Salestax&federalexcise

SHEKHA & MUFTI

CHARTERED ACCOUNTANTS

ANOMALIES IN SALES TAX & FEDERAL EXCISE Adnan Mufti FCA Partner, Shekha & Mufti

The Institute of Chartered Accountants of Pakistan 24 February 2009

An independent member firm of

MOORE STEPHENS INTRNATIONAL LIMITED

members in principles cities across the world

SHEKHA & MUFTI CHARTERED ACCOUNTANTS

OVERVIEW SALES TAX  POLICY & INTERPRETATION OF ISSUES          

Audit by Directorate of Revenue Receipt Audit (DRRA) Export Refunds Refund on Building Materials, Steel, etc Refunds under Section 66 Multiple Audits Record Keeping & Audit Toll Manufacturing Work Back Assessment Consumption of Procured Goods vs. Taxable Activity Accounting for Refunds

SHEKHA & MUFTI CHARTERED ACCOUNTANTS

OVERVIEW SALES TAX (cont…)  LEGAL ISSUES  Value of Supply not inclusive of Special Excise Duty  Market Values  Taxation of Retailers  Award of Stay by Collector (Appeals)  Sales Return beyond 180 days  Recovery of Adjudged Tax  Revised Return  Wastage  Input tax Credit on Fixed Assets  Input Tax on Goods Destroyed  Mismatching of Penal Interest

SHEKHA & MUFTI CHARTERED ACCOUNTANTS

OVERVIEW SALES TAX (cont…)  PROCEDURAL MATTERS  Apportionment of Input Tax on Exports  Audit Report  Verification of Transactions  Alternative Dispute Resolution

SHEKHA & MUFTI CHARTERED ACCOUNTANTS

OVERVIEW FEDERAL EXCISE  LEGAL ISSUES     

Duty Adjustment Basis of Duty Adjustment Credit & Debit Note SED Drawback Mandatory Payment Before Filing Appeals

 PROCEDURAL MATTERS  Duty on Franchise Fee / Royalty

SHEKHA & MUFTI CHARTERED ACCOUNTANTS

SALES TAX

SHEKHA & MUFTI CHARTERED ACCOUNTANTS

Policy & Interpretation of Issues

SHEKHA & MUFTI CHARTERED ACCOUNTANTS

AUDIT BY DIRECTORATE OF REVENUE RECEIPT AUDIT (DRRA) The Sales Tax Appellate Tribunals and Peshawar High Court have held that DRRA has no powers of audit of taxpayers’ records. Despite this, the department continues to issue DRRA audit notices to the taxpayers.

Suggested Action Article 201 of the Constitution prescribes that any decision of a High Court shall, to the extent that it decides a question of law or is based upon or enunciates a principle of law, be binding on all courts subordinate to it. Accordingly, the Federal Board of Revenue should clarify that henceforth DRRA shall not undertake any audit of taxpayers’ sales tax and excise records.

SHEKHA & MUFTI CHARTERED ACCOUNTANTS

EXPORT REFUNDS Apart from the list of supportive documents prescribed in Rule 38 of Sales Tax Rules 2006, the department requires the refund claimant to furnish records, returns, accounts, statements, summaries pertaining to his suppliers to cross match the payment of output tax. This has created the following problems:  The desired documents are not prescribed under the law or the rules  Under the law, the supplier is not bound to furnish his returns, summaries and other statutory declarations to his buyer  In certain cases, the department directly contacts the respective supplier to verify the genuineness of the disputed transaction; however in other cases, the onus of verification is transferred upon the refund claimant himself. Recently, the Large Taxpayers’ Unit Karachi has discontinued the above refund verification mechanism which has resulted in 2 sets of practices prevailing in Regional Tax Office and Large Taxpayers Unit (LTU). The LTU now requires the refund claimants to get the invoice summary statements, sales tax returns, etc. of their suppliers verified / authenticated from their respective Collectorates, otherwise Bank Guarantees furnished by refund claimants may be encashed. Suggested Action To streamline the entire refund verification and sanctioning process, the FBR should device necessary mechanism for the whole country in the light of the Section 10 and Sales Tax Rules 2006 thus ending practical hassles, liquidity problems for refund claimants and frivolous litigation pertaining to refunds.

SHEKHA & MUFTI CHARTERED ACCOUNTANTS

REFUND ON BUILDING MATERIALS, STEEL, ETC After the suppression of SRO 578(I)/98 dated 12 June 1998 through SRO 490(I)/2004 dated 12 June 2004, sales tax paid on building materials has become eligible for refund / adjustment purposes. However, the RTO has placed certain other conditions attached to the refund claim such as filing of Approved Building Plan, BOQ, Counter Confirmation from respective Trade Association, etc. Such requirements are not spelled out either in the statute or the rules. Besides, they are against the superior courts’ decisions. The LTU, like before, does not require such additional documents. Suggested Action In line with the statute and the related judgments of the superior courts, the said Standing Order may be withdrawn forthwith and refunds may be allowed on building materials without any exception.

SHEKHA & MUFTI CHARTERED ACCOUNTANTS

REFUNDS UNDER SECTION 66 Legal Position: “ No refund of tax claimed to have been paid or over paid through inadvertence, error or misconception …………shall be allowed, unless the claim is made within one year of the date of payment…” Departmental Interpretation “ No refund of tax claimed ……..…………shall be allowed, unless the claim is made within one year of the date of payment…”

Suggested Action In line with an identical pronouncement by the High Court, the FBR should clarify that where the tax claimed as refund was not paid due to inadvertence, error or misconception, the time limit of 1 year will not be applicable. Accordingly, all claims not falling under the above, should be admissible and entertained without any time limit as already held by High Court. The Supreme Court has already held that no limitation of time can be placed upon filing and sanctioning refunds.

SHEKHA & MUFTI CHARTERED ACCOUNTANTS

MULTIPLE AUDITS The tax authorities conduct multiple audits of same tax period under different names, i.e., investigative audit, desk audit, audit for abnormal profile, etc. Under section 25, the tax department may conduct audit of registered person only once a year. Also, the terms ‘Desk Audit’, ‘Investigative Audit’ ‘Abnormal Tax Profile’ have not been defined in the statute. Recently the Federal Tax Ombudsman (FTO) has also held that ‘abnormal tax profile’ is not defined in the Law and thus no scrutiny may be made by the department on this account.

Suggested Action All audits or scrutiny other than the usual audit prescribed under section 25 may be withdrawn.

SHEKHA & MUFTI CHARTERED ACCOUNTANTS

RECORD KEEPING & AUDIT During the audit exercise, sometimes the tax authorities call for documents like Audited Accounts, Cost Audit Report, Minutes of BOD, Income Tax Records, etc which are not prescribed records in section 22 of the Act. In certain cases, cases have been established out of the information so sought and show cause notices issued to the taxpayers.

Suggested Action The FBR and Federation of Pakistan Chamber of Commerce & Industry (FPCCI) have already agreed upon records which may be sought by the tax administration during tax audit. This agreement was also made public vide FBR’s letter dated 17 November 2001. It is suggested that the suitable amendments made be made in section 22 of the Act by incorporating the above FBR letter as part of the statute.

SHEKHA & MUFTI CHARTERED ACCOUNTANTS

TOLL MANUFACTURING The amended definition of the term ‘supply’ does not include “Other Disposition” as part of supply. “Other Disposition” was discussed in Para 1(E) of Sales Tax General Order (STGO) No. 3/2004 dated 12 June 2004 wherein the FBR had opined that return of goods by the vendor back to the principal tantamount to “Other Disposition” and accordingly liable to sales tax. Hence, it appears that Toll Manufacturing is out of the tax ambit.

Suggested Action Since now toll manufacturing is out of ‘supply’, it is suggested that Part I(E) of above STGO may also be withdrawn to avoid potential problems for the taxpayers during audit.

SHEKHA & MUFTI CHARTERED ACCOUNTANTS

WORK BACK ASSESSMENT In many cases, the department creates tax demands based on work back method. Under the law, except in cases where the taxpayer fails to file the return, no officer can make a worked back assessment and create liabilities.

Suggested Action The superior courts have held in numerous judgments that unless supply of taxable goods is established, no tax can be levied. The Supreme Court has also held that work back assessment under Rule 226 of (repealed) Central Excise Act 1944 is illegal. It is, therefore, suggested FBR should clarify that except in case of section 11(5) read with Para D of STGO 3/2004, no assessment may be made on presumptive basis.

SHEKHA & MUFTI CHARTERED ACCOUNTANTS

CONSUMPTION OF PROCURED GOODS VS. TAXABLE ACTIVITY Prior to Finance Act 2008, the act of putting to private, business or non business use of goods acquired or manufactured in the course of business was treated as “supply”. Vide Finance Act 2008, ‘goods acquired’ is out of the definition meaning thereby no sales tax is leviable on non business consumption of purchased goods. However, the present definition is in conflict with the term “taxable activity” which also includes anything done during commencement or termination of economic activity.

Suggested Action Clause 2(33)(a) should be brought in harmony with section 2(35) to avoid unnecessary litigation on this account.

SHEKHA & MUFTI CHARTERED ACCOUNTANTS

ACCOUNTING FOR REFUNDS In recent cases, the tax authorities have started rejecting refund claims where such claims were not booked as receivable in the taxpayers’ audited accounts. In support of such contention, the tax authorities contend that non recording of refund as receivable from government tantamount that the sum of claimed was charged off in cost of sales; thus becoming part of selling price which was ultimately recovered from the customers. Therefore, such claims were rejected under Section 3B of the Act.

Suggested Action The above appears to be an attempt to override the explicit provisions of the Act which makes no distinction between corporate and non corporate taxpayers. In quite a few cases, because of the contingent nature of refunds due to interpretational / legal issues, the taxpayer could not book it as receivable in the accounts. This is the internationally accepted and practiced accounting convention. It is, therefore, suggested that refund cases may be examined only in the light of books required under section 22 of the Act and agreement reached between FBR and FPCCI.

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Legal Issues

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VALUE OF SUPPLY In terms of Federal Excise Notification 655(I)/2007 dated 29 June 2007, Special Excise Duty (SED) is not taken into account for the purpose of computing “value of supply” under Sales Tax Act 1990. This exemption is incorrectly placed in Federal Excise Law instead of Sales Tax and thus lacks due intended legal support

Suggested Action It is suggested that section 2(46)(a) of Sales Tax Act 1990 should be modified as follows: “value of supply” means;- in respect of taxable supply, the consideration in money including all Federal and Provincial duties except special excise duty levied under section 3A of Federal Excise Act 2005 and taxes, if any, which the supplier receives from the recipient for that supply excluding the amount of tax”.

SHEKHA & MUFTI CHARTERED ACCOUNTANTS

MARKET VALUES In case where there is sufficient reason to believe that value of supply has not been declared correctly, the dispute is resolved by forming valuation committee comprising representative of business community and the tax department. Nevertheless, in most of the cases, the department continues to dispute valuation on the basis of available market price with adjudication orders passed without forming valuation committees.

Suggested Action Identical to ADRC, a panel comprising of business community may be formed by FBR and all disputes regarding the value of supply may be referred to such committees under 2(46)(e).

SHEKHA & MUFTI CHARTERED ACCOUNTANTS

TAXATION OF RETAILERS A registered retailer is required to pay turnover tax on value of supplies specified in 3rd Schedule of the Act on which the respective manufacturer had already discharged the entire tax liability. Further, 5(3) of Sales Tax Rules 2006 allows corporate buyer / income tax withholding agents to claim sales tax paid to retailers. This Sub Rule is in conflict with Section 2(28) and Rule 3 whereby retailers are the persons supplying goods to general public for consumption purposes. Thus, according to the statute, no input tax becomes admissible to the buyer / end consumer.

Suggested Action Double taxation on 3rd schedule items should be removed at retail stage. Further, Rule 5(3) should be amended keeping in view the ancillary specific provisions and the spirit of Retail Taxation.

SHEKHA & MUFTI CHARTERED ACCOUNTANTS

AWARD OF STAY BY COLLECTOR (APPEALS) With the removal of sub section 4 of section 45B, the law now appears to be silent with respect to powers of Collector (Appeals) to grant stay against a departmental demand, subjoined at appeal stage.

Suggested Action It is suggested that the power of Collector (Appeals) for grant of stay in sub judice cases may be restored. This suggestion is notwithstanding the dictim of superior courts whereby the authority empowered to grant ultimate relief is always empowered to grant interim relief as well.

SHEKHA & MUFTI CHARTERED ACCOUNTANTS

SALES RETURN BEYOND 180 DAYS Section 9 of the Act read with rules thereof restricts self adjustment through credit & debit note beyond 180 days, which is extendable to another 180 days only with prior approval from the Collector. The law does not cater return of goods, particularly food items, which carry expiry of a longer period than 1 years.

Suggested Action In the present era where technology checks can be placed, as long as the registered person is able to prove the genuineness of original and revised transaction, no time limits may be imposed upon him under the rules for issuing credit and debit note or enjoying related tax credit / adjustment.

SHEKHA & MUFTI CHARTERED ACCOUNTANTS

RECOVERY OF ADJUDGED TAX Section 48 read with Rule 71 empower initiation of recovery proceedings at the end of 30 days from the date of order in which government dues are adjudged against the taxpayer. On the other hand, section 45B allows the taxpayer to file an appeal with the Office of Collector (Appeals) within 30 days from the date of receipt of order. Thus, Rule 71 is in conflict with section 45B of the Act.

Suggested Action Due to secretarial formalities, adjudicating orders are served to the taxpayer long after their pronouncements. It is, therefore, suggested that Recovery Rules may be amended and recovery proceedings may only be enforced after 30 days of service of order to the taxpayer. This amendment is also required in the best interest of natural justice.

SHEKHA & MUFTI CHARTERED ACCOUNTANTS

REVISED RETURN Section 26(3) allows the registered person to file a revised return with the permission of the Collector to rectify any omission or wrong declaration made in his monthly tax return. However, there is no mechanism for revising the monthly special return, which is filed by 42 sectors of the economy.

Suggested Action It is suggested that necessary amendments may be made and reference of section 27 may also be incorporated in section 26(3) of the Act.

SHEKHA & MUFTI CHARTERED ACCOUNTANTS

WASTAGE There is no provision in the statute governing both visible and non visible wastage that occurs during manufacturing process. The audited accounts also do not separately disclose wastages; rather the same is reported as part of stock consumed. Quite often, cases are established against the taxpayers on account of difference in stock figures which usually is due to the element of wastage.

Suggested Action To address this critical issue, it is suggested that Industrial Notes may be drawn by the FBR in consultation with trade, industry and tax consultants encompassing business processes of significant sectors and standard ratios of wastage occurring during such processes.

SHEKHA & MUFTI CHARTERED ACCOUNTANTS

INPUT TAX CREDIT ON FIXED ASSETS Under Section 8B, input tax attributed on fixed assets is adjustable in 12 equal monthly installments. However, the term ‘fixed assets’ has not been defined in the statute. Capitalisation policy of businesses differs from each other. Especially in case of non corporate taxpayers, due to non availability of audited accounts, disputes may arise as to what constitutes fixed assets. Consequently, cases could be established where the taxpayer had claimed the entire sales tax in a single return instead of prorating it over 12 months time. Suggested Action The term ‘fixed assets’ may be defined in the same fashion as plant and machinery is defined in the Customs Act 1969.

SHEKHA & MUFTI CHARTERED ACCOUNTANTS

INPUT TAX ON GOODS DESTROYED Rule 23 of Sales Tax Rules 2006, disallows input tax credit in respect of goods destroyed being unfit for human consumption..

Suggested Action Except for above change brought in vide Finance Act 2008, the legal position has been consistent for destruction of goods since 1990. Further, we understand input tax has been declared as vested right of the taxpayer under the main statute and the same cannot be taken away by subordinate legislation. It is suggested that the disallowance, being ultra vires of section 8 of the Act, may be withdrawn.

SHEKHA & MUFTI CHARTERED ACCOUNTANTS

MISMATCHING OF PENAL INTEREST A registered person can be penalized with default surcharge @18% p.a if he fails to pay off the tax liability by due date. On the other hand, failure of the department to pay off the due tax refunds in time only costs it 6% p.a

Suggested Action Keeping in view the rate of inflation, cost of funds and above all – natural justice, the interest on delayed refund may be enhanced to atleast 12% p.a thus compensating the taxpayers for the departmental delays / non compliances.

SHEKHA & MUFTI CHARTERED ACCOUNTANTS

Procedural Matters

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APPORTIONMENT OF INPUT TAX ON EXPORTS Tax attributed to exports and zero rated supplies is refundable to the registered person. However, the law does not prescribe any formula / method of proration of input tax between exports and local supplies.

Suggested Action A formula / mechanism identical to the ‘Apportionment of Input Tax Rules’ should be introduced in the statute. Else the exporter may be allowed to carry forward entire excess input tax to the next tax period without any exception.

SHEKHA & MUFTI CHARTERED ACCOUNTANTS

AUDIT REPORT Upon completion of departmental audit, the audit report prepared by the auditors and reviewed and approved by the Additional Collector, is required to be sent to the registered person followed by an Audit Completion Certificate in the prescribed format. However, in practice, no such audit report is discussed or shared with the taxpayers. The department also does not issue Audit Completion Certificate and huge demands are created without proper compliance of the law.

Suggested Action The taxpayer should be aware of the results of department audit. This would be not only in compliance with the legal framework but might also facilitate quick payment(s) of unpaid tax by the taxpayer alongwith reduced penalty under section 33.

SHEKHA & MUFTI CHARTERED ACCOUNTANTS

VERIFICATION OF TRANSACTIONS  Section 73 fails to address cases where payments are knocked off through contra book entries between buyer and sellers.  The provision does not cater situations where payments become doubtful or eventually turns irrecoverable for the supplier  The law does not take into account transactions where payments are made by creditors / guarantors / 3rd parties on behalf of the buyer.

Suggested Action We understand that the basic intent of section 73 has been to document the economic and business transactions. This objective may well be achieved within sophisticated accounting and corporate environment and the growing business realities. Thus, section 73 may be amended to cater the inter company (book) transactions and the issue of bad debts.

SHEKHA & MUFTI CHARTERED ACCOUNTANTS

ALTERNATIVE DISPUTE RESOLUTION The law does not provide a comprehensive framework for ADRCs. Resultantly, no concrete solution is available to the following problems confronting the mechanics of ADR: • Too centralized mechanism • CBR holds powers to accept or reject the recommendations of ADRC without assigning any reason thereby wiping of the entire process of deliberations and efforts • Powers of ADR have not been specified; for instance, legally ADRC cannot order inspection of books of accounts of a 3rd party • No provision exists requiring appellate forums to put the judicial proceedings in abeyance till the outcome of ADR • Can documents exchanged / agreement reached at the ADR stage be put as evidence at any judicial proceedings ?

Suggested Action A comprehensive ADR framework should be developed encompassing the extent and scope of both the Committees and FBR respectively. For this purpose, liaison may be made with Karachi Centre for Dispute Resolution, constituted with the assistance of International Finance Corporation (IFC) and Sindh High Court.

SHEKHA & MUFTI CHARTERED ACCOUNTANTS

FEDERAL EXCISE

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Legal Issues

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DUTY ADJUSTMENT Under section 6, FED is adjustable only if the registered person holds a valid proof to the effect that he has paid the price of goods purchased by him including FED and received the price of goods sold by him including FED through banking channels. The condition of payment and receipt is creating lot of problems for the taxpayers. On the other hand, SED is adjustable on payment basis.

Suggested Action There is a need to bring harmony among the two duties. It is suggested that both FED and SED should be made adjustable on accrual / paid basis as per section 7 of Sales Tax Act 1990. Further the duty adjustment should not be made subject to receipt of sale proceeds and related duty.

SHEKHA & MUFTI CHARTERED ACCOUNTANTS

BASIS OF DUTY ADJUSTMENT FED paid on excisable goods, which are used directly as input goods for the manufacture of dutiable goods, is adjustable against the final liability. On the other hand, SED paid on industrial inputs is adjustable against the SED chargeable on the goods manufactured therefrom. The term ‘industrial input’ has not been specified under the law.

Suggested Action In the absence of any definition of ‘industrial inputs’, it could be construed to include everything consumed for the manufacturing / allied activity like spares, printing, stores, equipment, etc. In order to avoid litigation on this account, it is suggested the term ‘industrial inputs’ may be defined in the law.

SHEKHA & MUFTI CHARTERED ACCOUNTANTS

CREDIT & DEBIT NOTE Identical to section 9 of Sales Tax Act 1990, Rule 14A also allows adjustment(s) in tax invoice or return for dutiable goods. However, the benefit of such Rule has not been extended to dutiable services.

Suggested Action To bring harmony in application of duty provisions to both and services, it is suggested necessary amendments may be made in Rule 14A to include reference of dutiable goods and dutiable services.

SHEKHA & MUFTI CHARTERED ACCOUNTANTS

SED DRAWBACK Under SRO 655(I)/2007 read with Federal Excise General Order (FEGO) 1 of 2008, in case of exports, the SED paid on purchases / import shall be paid to the exporter as drawback. However, since July 2007, no such drawback is paid to the exporters.

Suggested Action It is suggested that necessary instructions may be passed onto field formations to process outstanding SED drawbacks. To expedite around 2 years pending claims, it is also proposed that SED Drawback may be sanctioned to the large taxpayers upon submission of revolving bank guarantee..

SHEKHA & MUFTI CHARTERED ACCOUNTANTS

MANDOTORY PAYMENT BEFORE FILING APPEAL Under Section 37, before preferring appeal before Office of Collector (Appeals) or Appellate Tribunal, a taxpayer is required to deposit the impugned duty demanded or penalty imposed in the appealable order. This mandatory compulsion is considered as a hindrance in the dispensation of justice.

Suggested Action The identical provisions in Income Tax and Sales Tax have already been repealed. Therefore, it is suggested the same is also removed from the excise law.

SHEKHA & MUFTI CHARTERED ACCOUNTANTS

Procedural Matters

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DUTY ON FRANCHISE FEE / ROYALTY In terms of Rule 43A(7), the franchisee is entitled to take credit of the duty on franchise fee, technical service or royalty so deducted by bank making remittance on his behalf. However, the tax return does not contain any column for such credit.

Suggested Action Annexure E of the return may be amended and a column should be incorporated so that due credit may be availed by the franchisee for duty so deducted by banks.

SHEKHA & MUFTI CHARTERED ACCOUNTANTS

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