Malik Zohaib Nawaz
In Pakistan, where tax-to-GDP has been a matter of debate among economist and policy managers. Whenever any new tax policy is formulated, a resistance is witnessed from a particular sector. Every time similar types of statements / arguments are pleaded for seeking relaxation or concessions. Due to the pressure groups and stakeholders, tax policies / laws are amended to accommodate them addressing their concerns and grievances. Historically, certain business sectors have been enjoying concessions under tax laws. The advocates of tax concessions for specified sectors provide various reasons and rationales,some of which apparently seem justifiable.
Export sector is one of the privileged sectors which has enjoyed concessions under multiple policies of government. However,historically, exports of Pakistan have remained very depressed. The reasons for low performance are lack of technological& innovative skills, non-diversification, non-adaptation of modern techniques, low value addition etc. Therefore, government played its role and supported the export sector on various fronts. One of the incentives was provided under the Sales Tax Act, 1990 (ST Act). Under ST Act, registered person suffers sales tax on purchases of raw material and other goods (termed as input sales tax) and charges sales tax on its sale (termed as output tax). The difference between output tax and input tax becomes sales tax liability of a registered person which is paid to the government. Through such mechanism, the sales tax is paid on value addition which is an effective tool to tax the value addition in economy. Exporters were also subject to similar mechanism of sales tax with the difference that,in case of exports, sales tax (output tax) is chargeable at the rate of 0%. Resultantly, input tax suffered on procurement of goods / raw material etc becomes refundable to exporters. The mechanism is perfectly correct and applicable in most of the countries in similar pattern. However, in Pakistan, the mechanism miserably failed as Federal Board of Revenue (FBR) could not implement a transparent mechanism for release of sales tax refunds. The exporters had genuine concerns which required corrective measures.
In order to remove the impediments in sales tax refund process, special regimes were introduced for the exporters as per which their purchase side was also allowed to be zero-rated. Resultantly, exporters’ working capital efficiency increased as very meager refundclaim arose. The scheme was genuinely used by the exporters but various scams of exploiting the scheme were also identified. Therefore, such scheme was withdrawn vide Finance Act, 2019 as a result of which issue of sales tax refunds arose again. However, this time, a special module was devised for processing of sales tax refunds for exporters of specified sectors which was based on technological checks and controls. The module was named as Fully Automated Sales Tax E-Refund system (FASTER). Although FBR claimed that sales tax refund under FASTER would be processed within 72 hours but practically there were various procedural issues within this system. Gradually, various adjustments and modifications were made which improved the transparency and efficiency of refund processing.
Through Finance (Supplementary) Act, 2022[FSA 2022], a major amendment has been made for pharmaceutical sector. Previously, raw material, Active Pharmaceutical Ingredients, substances used in manufacturing of pharma goods and finished goods wereexempt from sales tax. Such exemption has been withdrawn vide FSA 2022 whereas finished goods of pharmaceutical goods falling under Chapter 30 of Drug Act, 1976 have been allowed 0% sales tax under Fifth Schedule to ST Act. Now, manufacturers of pharma sector would suffer sales tax on purchases of raw material and related substance whereas they would charge sales tax at the rate of 0% while making sales to distributors, wholesalers and retailers. If no sales tax is charged or it is charged at 0%, there would be no difference in the value of sales but there is a huge difference in computation of sales tax liability / refund. After zero-rating on local sale of pharma products, manufacturers would be entitled to claim input sales tax suffered on their purchases which would become refund owing to zero output tax. One can argue that if raw material and ingredients were exempt previously then what would be the difference of this amendment on the pharma sector. The answer is that there were various other input taxes suffered by the manufacturers which were becoming cost for the manufacturers as they could not claim such input taxes owing to exempt sales. For example, packing material and utility are the major components on which sales tax is suffered by the pharmaceutical manufacturers which were ultimately becoming cost of the product and passed in the supply chain. After allowing zero rating on local sales of pharma products, input sales tax suffered on packing material, utilities and other goods is now claimable as input sales tax. As a result of such claim, the cost of production would be reduced and can be passed through the supply chain.
The Chairman FBR has also stated that due to this amendment in the ST Act, the prices of pharmaceutical goods would be reduced by 15% to 20%. The statement sounds lucrative in an inflationary economy, but reality is bitter. First of all, manufacturers have some genuine concerns over the mechanism of refund process through FASTER which in itself has various procedural issues. Secondly, the working capital cost of manufacturers would also increase significantly as most of the raw materials of pharma sector are imported for which substantial financing is required. Rupee depreciation and surging policy rate would aggravate the issue of working capital management. If refunds are processed faster, the concerns of manufacturers can be addressed to some extent as the adverse impact of financing cost would be mitigatedand in that case the statement of Chairman FBR about price reduction can become a reality. However, like other sectors, if refunds could not be processed as promised then situation can be exacerbated because it would result in shortage of pharmaceutical products from market. Blockage / delay in refunds would be a very sensitive issue and may result in serious crisis. Therefore, a comprehensive procedure of new FASTER system should be devised taking the manufacturers on board as any delay or impediments would have serious consequences.
Therefore, new FASTER system should in fact be more FASTER. If refunds are processed through speedy track and financing cost remain under control, then the prices of pharma products would actually come down and consumers would fetch the benefit of zero rating on pharma sector. However, the government should be vigilant from the middle chain which has all the secret tools to reverse any economic theory in this country. There is an apprehension that instead of price reduction from manufacturers, the middle chain may absorb such benefit and consumer would still be suffering.