KARACHI: State Bank of Pakistan (SBP) on Friday said revenue collection by the Federal Board of Revenue (FBR) during the remaining months of current fiscal year may be challenging due to incentives announced under export package and exemptions to CPEC-related projects.
The central bank in its second quarterly review on State of Pakistan’s Economy stated that the slowdown in tax revenue collection is partly due to several tax incentives announced to promote investment and boost economic activity in the country; this includes the reduction in the corporate tax rate.
“Besides, in the wake of recently announced incentives – especially the export package and the tax exemptions for some CPEC-related projects – accelerating revenue collection during the remaining part of FY17 may also be challenging,” the SBP said.
Under Prime Minister Package of Incentives for Exporters, the government: (i) allowed duty draw back up to 7 percent on the export of garments, home textiles, processed fabric, Greige fabric and yarn manufacturing cum exporters units (vide ministry of textile SRO No. 1(42) TID/17-RDA); (ii) exempted custom duty on import of raw material for textile (vide FBR S.R.O. No. 39(I)/2017); and, (iii) exempted sales tax on import of textile machinery (vide. FBR S.R.O. No.36 (I)/2017). Similarly, vide FBR S.R.O. No.735 (I)/2016, Chinese construction companies were allowed income tax exemption under some CPEC projects.
The central bank said that the growth in FBR’s tax collection remained subdued at 7.0 percent during July – December FY17, against a robust 17 percent increase recorded in the corresponding period last year. The recovery in direct taxes in Q2-FY17 was partially offset by a slowdown in indirect tax collection.
On the surface, the broad-based deceleration in both direct and indirect tax collection can be interpreted as an unintended consequence of fiscal measures to support investment and economic activity in the country. It also highlights the continuing structural weaknesses in the tax system, which currently is narrowly based and skewed towards indirect taxes. However, the government has taken a number of measures to improve the taxation structure, as a part of the continuous reforms agenda, encompassing both policy and administrative dimensions. Such efforts will go a long way in improving the country’s tax system in years to come.
Enabled by a sharp recovery in Q2-FY17, direct tax collection grew by 8.4 percent during H1-FY17; however, it still remained lower than the 17.8 percent increase recorded in H1-FY16.
The SBP said that some slowdown in direct taxes was expected on account of reduction in the corporate tax rate. The other main factor was a decline in commercial banks’ profits, and a moderate pace of increase in corporate profitability.
Within the direct taxes, the growth in withholding tax (WHT), which accounts for 67 percent of direct taxes, decelerated to 10 percent in H1-FY17 from 20 percent in the last year. Similarly, growth in voluntary tax payments (with a 28 percent share) fell to 6.6 percent in H1-FY17 from 21.0 percent increase in the last year. Collection on demand was the only component that rebounded sharply, growing by 32.2 percent during H1-FY17 after declining 27.7 percent last year.8 However, its share in direct taxes is only 5 percent.
The growth in indirect tax collection in Q2-FY17 (at 1.6 percent) could not maintain the pace observed in the first quarter (12.2 percent). As a result, the half-yearly growth fell to 6.1 percent from 16.4 percent last year. The major drag came from a decline in sales tax collection, which was partially offset by a steady growth in customs duty and federal excise duty.
Sales tax collection, which accounts for 66 percent of indirect taxes, declined marginally by 0.2 percent during H1-FY17. The disaggregated analysis shows that drag was due to sharp decline in domestic sales tax collection by 4.7 percent.
However, most of this was offset by a 3.7 percent increase in sales tax collection on imports. Major revenue spinners, including POL, fertilizer, and natural gas contributed to decline in domestic sales tax collection. These more than offset higher sales tax collection from electrical energy and cement sectors. Improved electricity generation and steady growth in cement sales – reflecting ongoing work on several CPEC projects – led to higher collection from these segments.
The decline in collection from fertilizer was due to reduction in sales tax under the package announced for farmers last year under the agriculture package. Related to this, the decline in collection from natural gas was due to reduction in prices of the natural gas for feedstock. In addition, an increase in FED on cigarettes resulted in loss of revenue from sales tax through lower sales of locally manufactured cigarettes.
Collection from customs duty grew by 22.6 percent during H1-FY17 compared to the 31.5 percent growth realized during the previous year. This sustained increase in customs duty was a natural outcome of the substantial increase in imports: both due to higher demand for machinery and raw materials and the increase in global commodity prices, mainly oil and cotton. Although the government announced some tax exemptions on CPEC-related machinery imports, its impact was not significant given the overall import volume.
Therefore, customs duty continues to remain a dependable source of revenue generation. Further, changes in tariff structure (especially for higher slabs) and an increase in rates for iron and steel also resulted in higher custom duty collection.
FED collection grew by 15.9 percent during H1-FY17 compared to 15.2 percent growth in the last year. This steady increase was mainly contributed by higher production of cement and beverages.
As mentioned earlier, the increase in the FED rate on cigarettes reduced the demand for locally manufactured sticks and simultaneously boosted that for non-taxed/smuggled brands; ultimately collection from cigarettes (which constitutes around one third of overall FED collection), declined by 13.3 percent during H1-FY17. In response, FBR started a crackdown against illicit cigarettes to harness the true revenue potential from this source.