The International Monetary Fund (IMF) has strongly recommended Pakistan to withdraw sales tax exemption on fertilizers, pesticides, and tractors, continue with the general sales tax (GST) harmonization, introduce Personal income tax (PIT) reforms in the budget (2022-23) including a reduction in the number of rates and income tax brackets; cut in tax credits and allowances and special tax procedures for very small taxpayers.
This has been mentioned in the IMF staff report 2021 on Article IV Consultation and Sixth Review which was released on Saturday.
The report revealed that the Pakistani authorities are in the process of drafting PIT legislation by end-February 2022 to ensure it will be ready to come into effect on July 1, 2022, with the FY 2023 budget. These PIT reforms will yield an estimated 0.3 percent of GDP in revenue gains in FY 2024. Aiming at simplifying the system, increasing progressivity, and supporting labor formalization, it will:
i. reduce both the number of rates and income tax
brackets;
ii. reduce tax credits and allowances (except those for disabled and senior citizens, and Zakat receipts);
iii. introduce special tax procedures for very small taxpayers; and
iv. bring additional taxpayers into the tax net. Low-income households will remain protected as the reform preserves the current PIT threshold (almost 3 times income per capita).
The IMF has further recommended the tax authorities introduce high-quality revenue measures to make the tax system simpler. The report stated that the implementation risks are considerable, particularly if tax buoyancy declines in a scenario of slowing imports. In this situation, staff would recommend considering bringing forward plans to expand the number of removed exemptions to include fertilizers and tractors, which constitute 23 percent of current GST tax expenditures and whose removal is under consideration as a 2023 budget measure.
The additional tax policy reforms that remain key in the period ahead will help Pakistan address its perennial challenge of a low revenue base, which weighs on debt sustainability and severely constrains much-needed fiscal space for growth-enhancing spending on infrastructure, education, healthcare, and social support. Against this backdrop, staff urged the authorities to continue broadening the tax base, reducing informality, and simplifying and modernizing the tax system.
The GST base harmonization will be critical to improving competitiveness and the business environment. Under the current system, the sales tax base is fragmented, with services subject to provincial taxation and goods under federal government taxation. The fragmentation of the tax base has severely compromised tax policy design and administration, generated disagreements over tax base definition and crediting, caused cascading and double taxation for businesses, and significantly increased compliance costs. Indeed, the system is cumbersome and harms competitiveness by increasing the cost of doing business.
The authorities recognize that tax administration reforms and enforcement efforts need to complement their tax policy measures. Leveraging including from the IMF and World Bank, the authorities plan over the medium term to:
i. introduce a centralized, risk-based compliance function;
ii. update IT and automation;
iii. use third-party data, cross-checks, and analysis;
iv. simplify registration and filing processes;
v. modernize and target audit practices, and
vi. bolster the large taxpayer office (LTO).
In line with standing IMF technical assistance advice, staff discouraged the use of third-party audits in favor of developing an adequate compliance risk management framework. Efforts will also be made to establish a single filing, taxpayer, and return portal, and redress high outstanding tax arrears.
To contain smuggling, the authorities are in the process of reintroducing the track-and-trace system for tobacco products but a full roll-out remains delayed on account of capacity constraints. The report further highlighted that the tax revenues are expected to increase by 1.2 percentage points of GDP from FY 2021, boosted by
i. revenue measures;
ii. reinforced tax administration efforts; and
iii. automatic stabilizers.
The main additional tax measures are implementing the reform of General Sales Taxes (GST). Parliament will adopt the GST reforms part of the supplementary budget, in line with staff recommendations (PA), to broaden the GST tax base and eliminate about 2/3 of the tax expenditures on GST.
This is achieved by undoing policy reversals that extended preferential treatment to numerous goods in the FY 2022 Finance Act; by moving most goods from zero-rating (Fifth Schedule) or reduced rates (Eighth Schedule) to the standard sales tax rate; by eliminating exemptions (Sixth Schedule) for most goods excluding basic food, live animals for human consumption, and health- and education-related goods; and by applying the standard rate to higher-end cellphone devices (previously under the Ninth Schedule).
The Pakistani authorities have informed the IMF that the General sales tax (GST) reform is estimated to yield 0.5 percent of GDP in FY 2022 (0.8 percent of GDP in annualized terms). Notably, it undoes numerous policy reversals included in the FY 2022 Finance Act and also:
i. eliminates most zero-rated goods (Fifth Schedule) and moves them to the standard sales tax rate;
ii. removes reduced rates under the Eighth Schedule and brings most of those goods to the standard sales tax rate;
iii. eliminates exemptions (Sixth Schedule) excluding a small subset of goods (i.e., basic food, medicines, live animals for human consumption, education, and health-related goods) and brings all others to the standard rate;
iv. removes the Ninth Schedule to replace a specific tax rate for cell phones with the standard rate, which is imported in the completely built unit (CBU) condition having a price of US$200 or more; and
v. raises the point of sale (POS) GST to the standard rate.
Low-income households are protected from most of the impact of the reform as several key items will remain tax-exempt, notably:
i. essential food products;
ii. sales by informal markets and small retailers; and
iii. food consumption from home production. In all, about 60 percent of tax expenditures were removed. However, we require additional time to design a more equitable subsidy scheme to replace tax expenditures on fertilizers, pesticides, and tractors—currently accounting for 23 percent of total tax expenditures—which we will implement in the FY 2023 budget after deliberations in the Fertilizer Commission constituted by the Government.
iv. Lastly, the process of harmonizing the service sales tax across provincial jurisdictions, with support from the World Bank, was launched in September 2021 with a decision to create common definitions for goods and services between the provinces and FBR as a first step towards reducing the current fragmentation in the sales tax system and broadening the tax base.
Source: Pro Pakistani