Summary of Tax Expenditure 2021

SUMMARY OF TAX EXPENDITURE 2021

Tax Expenditure Report 2021 for federal taxes, based on data pertaining to FY 2019-20, 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.

Any amount paid as donation to the following institution, foundations, societies, boards, trusts and funds

Any income derived by following entities: Specific Entities by name

The tax payable on profits and gains derived 9 by a person from low cost housing projects shall be reduced by fifty percent.

Taxpayers deriving income from low cost housing projects

n.a.

2,838.55 Total

SALES TAX ESTIMATES

the machinery specified in clause (i);

6(A)(i) Plant and machinery, operated by power of any Section 4 Manufacturing (Industrial 39 (Zero Rated) description, as is used for the Inputs) 0 manufacture or production of goods by that manufacturer; Sub Total 17,562 Less Adjustments 4,675 Total 12,887

• Note-I (adjustment in estimation): In case of zero-rated items, the adjustment includes leaving out tax expenditure estimation on some items, which if were not zero-rated, the full input tax would have been claimed, such as crude oil, machinery for E&P sector, and material related to exports. The tax expenditure to the extent of these items is thus deducted from the total estimation of Part 1 (zero rated items). Item-wise cost is below:

to the conditions, restrictions and procedure given below, namely:-

General Masses

federal government

Masses

Table-1

General Masses

Inputs) General Masses

control, transmission gear and transmission tower, power transmission and distribution cables and conductors, insulators, damper spacer and hardware and parts thereof adapted to be used in conjunction with the machinery and equipment as specified in clause (a)

Section 3

General Masses

Section 3

General Masses

Section 3

General Masses

Sub Total

Clause (aa) of Energy Sector 133 sub-Section 2 of 51 LNG/RLNG 17,480 12 General Masses Section 3 Sub Total 19,321

Explanatory notes on Sales Tax Estimates

A. Types of Concessions

In sales tax act, concessions are granted broadly by three ways

• I. Zero rating,

• II. Exemptions,

• III. Reduced rates.

1. Zero rating

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.

2. Exemptions

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.

3. Reduced rates

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.

1. Product-based Concessions

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.

2. Use-based Concessions 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.

3. Buyer-based Concessions

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.

4. Economic activity-based concessions

Certain tax concessions under the act are granted for a specific economic activity. Like export promotions or certain activities in export processing zones. A unique case in Pakistan is the case of exemptions in erstwhile Federally Administered Tribal Areas (FATA), where exemptions are granted for mainstreaming of the geographic areas.

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.

Summary of Customs Duty Estimates

Rs. in million

Benchmark for Customs Duty Cost Estimation

• 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), 5^th 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

1. FRAMEWORK OF VAT GAP

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.

2. BACKGROUND ON VAT-GAP

Efficient collection of taxes is considered as a cornerstone of a good tax system. However, because of noncompliance 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

1 A tax expenditure is a deviation from a defined “benchmark” tax structure. A benchmark is a reference tax system that defines what ought to be taxed in the normal course, when there are no deviations.

2 Amongst the G20 countries, 17 provide public estimates of tax expenditures (Hutton Eric, 2017). In Pakistan also under the PFM Act-2019 a detailed report was published for FY2019-20 by FBR and presented along with budget FY2020-21 in parliament. Whereas overall estimates have been published in Economic Survey, Ministry of Finance since 2008.

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.

3. METHODOLOGY

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. ANALYSIS

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

-VATc) × τc = (Final Consumption-VAT) × τ-∑((Final Consumptionc c

3 Constructed by Asian Development Bank (ADB)

4 Average exchange rate in 2020=150

Table 2: Supply-Use Tables: Potential VAT GAP calculated using Consumption Approach

• The estimates suggest VAT policy gap is about $ 3.5 billion which is approximately 21 percent of Actual VAT collected upto 2020.

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= ∑Value_Addedc = ∑(Total_use-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

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

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

Potential VATc = (∑τc × (Total Usec + Mi -Ii -Xc -Gc)) (4)