Issues in provincialisation of sales tax on services
The issue was underlined by the consensus evolved last week by the provincial finance ministers at their informal meeting in Lahore to push Islamabad to restore the provincial right to levy and collect the consumption tax on services.
The call has also brought into focus the objection to the provincial demand from the centre to allow the provinces to expand the tax’s scope to cover virtually hundreds of services that still remain outside of its ambit or are being taxed by federal government - especially higher revenue generating but cross-provincial services like financial and telecom services. Nevertheless, the provincial demands regarding sales tax on services are being interpreted as an expression of their urge for greater autonomy and some space to enhance their own tax revenue and reduce their heavy dependence on federal transfers.
“The disparate noises for greater fiscal powers for provinces found a single voice when finance ministers decided to jointly press Islamabad to transfer the collection of the provincial tax to them. Also provinces agreed to follow up on their longstanding demand for the expansion of the scope of provincial sales tax for raising their revenue generation for development,” a senior Punjab government official tells Dawn.
“The provinces’ demands also reflect their frustration over resource constraints they have to face at the time of budget-making and allocating funds for development,” the official said.
The issue of expanding the provincial own tax revenue base has always been of critical importance for the provinces, which are heavily dependent upon federal transfers under the National Finance Commission (NFC) Award for meeting their revenue and development needs.
The federal transfers in case of Punjab, for example, have historically comprised almost 70 to 80 per cent of its total revenue budget. It compares with only nine to 12 per cent of its provincial tax revenue.
“Under the constitution, sales tax on services falls within the domain of the provinces. But the provinces cannot tax a service without the concurrence of the federal government,” a senior Islamabad-based official, who was part of the last NFC negotiations between provinces and the centre, told Dawn.
“Consumption tax on services has a huge potential to generate revenues - according to some estimates Rs300 billion can be collected if all services are brought into its net, and also become a major resource base for provinces as the rapidly growing service sector forms 56 per cent of the economy,” he said.
It is in this backdrop that Punjab and Sindh - whose respective service sectors forms well over 52 per cent of their gross domestic products, have long been calling for federal permission to extend the net of the provincial tax on all services falling within their territories.
It, says a Punjab finance department official, is “the tax of future” with immense potential for growth as the share of services sector in the provincial economies is increasing rapidly.
“It is the most robust tax, and is critical for enhancing the provincial own tax resource. If the provinces are allowed to levy this tax, it could push their own tax revenues dramatically and help reduce their dependence on federal transfers. But the problem is that the federal government is not letting us tax more services, and wants to keep major revenue generating services with itself,” he said.
In 2001-02, provinces were allowed to levy provincial sales tax on 14 or so services. Later, the number was cut down to just six, low revenue generating services - like hotels, caterers, clubs, TV/newspaper advertisements, courier services, customs agents, etc, because the remaining were already under the central excise duty or federal general sales tax.
“The higher revenue generating services like financial and telecom services and carriage of goods by rail or air are still kept by the centre to itself,” the provincial finance department official said.
As the provinces did not have arrangements and capacity to collect the tax, its collection was left for federal government to perform.
The centre deducts two per cent of the total proceeds as collection charges and distributes the remaining among the provinces according to the NFC formula.
This year Punjab expects to receive Rs2.7 billion from the proceeds of the tax on services.
The Islamabad based official said “When you levy a tax, you need to put in place efficient and well functioning paraphernalia for its collection.
“Provinces don’t have that kind of tax collection system. It is easier to levy and collect sales tax on goods but not on services.
“I think that provinces should reach out to the centre for expanding the scope of tax on services - maybe in the excise mode, on more services and determine the rates on each service according to its potential, but best leave its collection to the central tax collection machinery. Even in India, this particular tax has been taken over by the central government from the states because of the issues involved in its collection. The centre could deduct collection charges and even a share of 10 to 20 per cent from the proceeds, and distribute the rest among provinces,” he argued.
But the collection of consumption tax by provinces is not the only issue. Many feel that provinces, which have legal right to tax services, could not be allowed to do so in case of a cross-provincial service.
Former caretaker finance minister Dr Salman Shah - who supports the concept of devolution of taxation on services to the lowest rung of government if it possesses the capacity to collect taxes and if the service being taxed falls within the entity - argued that provinces could not handle sales tax on cross-provincial services like financial and telecom services because it required very sophisticated, scientific knowledge and data to determine as to which province should get powers to collect tax on which service. The banking services might be used in Punjab but the service providers with their headquarters in Karachi would be paying tax to the Sindh government, he said.
He said provinces still had numerous services - like retail and wholesale markets, accounting firms, lawyers, health and education services, etc - to tax without hampering trade and economic activities as these are offered within their respective areas of jurisdiction. “Taxing such services wouldn’t cause inter-provincial bickering. Nor would it disturb economic activities,” he maintained.
Further, he said, “the devolution of taxation on cross-provincial, higher revenue generating services to the provinces would benefit only Punjab and Sindh, which have a well developed service sector. What about the NWFP and Balochistan? They don’t have a robust service sector. They will lose heavily and it would impoverish them further, enhancing regional disparity just like India where the richer states are getting richer and the poorer ones getting poorer because of smaller number of federal taxes. Therefore, it is always desirable that such services are taxed by the federal government and the proceeds distributed among the provinces under the NFC formula, which is a big equaliser,” insisted Dr Shah.
A finance division official admitted that distribution of provincial sales tax proceeds – collected by the federal government – between the provinces could be a problem. “If the proceeds are distributed on the basis of population, Punjab benefits. If it is done on the basis of collection, Sindh stands to get a larger share. In both cases the NWFP and Balochistan would be the net losers. So it is better that half of the sales tax on services proceeds are distributed among the provinces on the basis of collection and the other half on the basis of the NFC award. True, both Punjab and Sindh would lose some part of their revenue but it is necessary in the interest of protecting the populations of the NWFP and Balochistan,” he argued.