Federal encroachments on provincial taxes


According to a Business Recorder report, the first meeting of the working group constituted by the ninth National Finance Commission (NFC) award discussed the draft report assigned to Sindh on devolved versus integrated tax structure – evaluation of the tax collection framework in Pakistan. It has been circulated to the federal and other provincial governments for comments.

There is no doubt that the federal government has suffered a considerable loss of revenue after the last NFC award that envisages a higher percentage allocation to provinces from the divisible pool – a long standing provincial demand. In addition, while previously the federal government was collecting sales tax on services on behalf of the provinces upon payment of a fee the provinces post-eighth NFC award decided to collect this tax themselves through establishing and strengthening their own tax collecting machinery.

The Sindh government clearly took the lead in this matter, and Punjab followed suit though Khyber Pakhtunkhwa has also established its own revenue authority to collect sales tax on services. The reason for the provinces opting to collect sales tax on services themselves was premised not on the fact that the money collected would not go into the divisible pool to be distributed according to the agreed NFC award formula but be credited directly into the coffers of the province.

The report highlights what are clearly flawed definitions that are being supported by the federal government, in a calculated and deliberate attempt to encroach on provincial right to collect sales tax on services – a right that is enshrined in the constitution.

Examples include sales tax on retail, wholesale and distribution services, as well as sales tax on insurance and freight of imported goods. But this is not the extent of the federal government’s attempts at undermining the capacity of the provinces to generate higher revenue for themselves and thereby gain greater financial autonomy.

The report prepared by the Sindh government also indicates that the federal government has begun to impose withholding tax on services, for example, on banking transactions, vehicle registration tax as well as on telecommunication services.

There is little doubt that Sindh and Punjab have made tremendous strides in generating revenue from sales tax on services with other provinces expected to catch up within a year or two.

The report also suggests that the federal government allows the provinces to collect tax on goods, within the federal domain as per the constitution, on payment of a fee that would, the report claims, lead to greater revenue collection for the federal government.

This, the report argued credibly, would mean that sales tax collection would come under one authority and lead to an increase in revenue.

The report also notes that the federal government has begun to impose federal excise duty on service items that are already taxed by the provinces and urged FBR to delete Table II of the First Schedule to the Federal Excise Tax 2005 as all such services are already subject to provincial sales tax.

The federal government has unfortunately failed to reform its tax structure and continues to rely on enhancing revenue collections through raising taxes on existing taxpayers, imposing withholding tax which, as per a definition, is not a direct tax as it can be passed onto consumers/clients and encroaching on provinces’ domain.

One can only hope that the federal government focuses on enhancing FBR collections under direct taxes and instead of encroaching on provincial financial autonomy tries to compel provinces to increasingly take over greater financial responsibilities especially with respect to devolved ministries thereby reducing its own need for revenue.