Value-added Tax (VAT)/General Sales Tax (GST) frauds are rife in developing as well as advanced economies using VAT/GST system for raising indirect tax revenues. Perhaps, susceptibility of VAT/GST to frequent frauds as a weakness has emerged as the most-debated issue in the recent past. In Pakistan, GST fraud is no less than a daunting challenge for the Inland Revenue tax administration as it occurs in more than one form.
A person, most commonly, commits sales tax fraud when he gets taxable supplies from persons or business concerns who are not registered under the Sales Tax Act, 1990, (hereinafter Act) and/or from those involved in falsification of the sales tax invoices for the purpose of either understating the tax liability or overstating the entitlement of tax credit or refunds. Loss of sales tax revenues also occurs where businesses remit to the government less tax than they have charged to their customers or where they claim deductible input tax on the basis of fake invoices.
A ‘taxable supply’ takes place when an importer, manufacturer, wholesaler (including dealer), distributor or retailer supplies goods other than those exempt under Section 13 of the Act. It is important to mention here that supply of goods chargeable at the rate of zero percent is considered taxable supply under Section 4 of the Act.
All persons engaged in making taxable supplies in Pakistan are required to get registered under the Act. Manufacturers are required to get registered if the value of their supplies in the last twelve months exceeds Rs 5 million — the threshold is now Rs 10 million from 1st July 2016 — or if their annual utility (electricity, gas and telephone) expenses exceed Rs 700,000 in the said period. Retailers must get registered if the value of their supplies in the last twelve months reaches Rs 5 million. There is no registration threshold for importers, wholesalers (including dealers) and distributors.
Since a considerable part of Pakistan’s economy is informal, therefore, taxable supplies are usually made by people or businesses which are not registered under the Act. Discovery of unregistered businesses gives rise to a windfall for the tax authorities. For example, the tax authorities visited the business premises of non-registered manufacturer ‘A’ that was engaged in manufacturing and supplying wooden furniture. They found that A’s unremitted sales tax liability for the last five years was Rs 176 million and assessed A for that amount, without allowing A to deduct any input tax. A argufied the assessment on the ground that it could not have manufactured the furniture without the purchase of wood. Consequently, even though A could not produce any purchase invoices, the assessment should be reduced by the VAT on A’s inputs. Besides, even if A would liquidate the entire business, the proceeds would not be sufficient to pay the tax debt. Where A produces and supplies furniture for a value of over Rs 1,000 million, it must logically be assumed that A must have purchased a considerable amount of wood, even if A is not registered and cannot produce any purchase invoices. So, it would be fair if the tax authorities would limit the assessment to, say, 70pc of A’s turnover. Is it likely that the High Court will grant A such a flat-rate deduction? The answer is NO, because such a flat-rate deduction would put a bomb under the entire sales tax system that is solely based on invoices, and not on an estimated value added. Sales tax is based on actual turnover minus the sales tax actually paid on inputs. It is clear that A will never be able to pay the assessment unless his profit margin is much higher than 17pc. It is very common that non-registered businesses go bankrupt after the tax authorities discover their unlawful activities and assess them for unremitted VAT.
In another case, the department conducted action under Section 38 of the Sales Tax Act, 1990, on the manufacturing premises of ‘B’ who manufactured and supplied wheat threshers and other agricultural machinery. On the basis of record resumed, its sales tax liability was worked out at Rs 38 million as output tax without giving the benefit of input tax adjustment. ‘B’ agitated that it is beyond his capacity to pay such a hefty amount. Furthermore, ‘B’ produced record of inputs. About 70 percent of inputs used in manufacturing of taxable supplies were imported items subject to sales tax at import stage as the same were not produced /available in Pakistan. But ‘B’ failed to produce ‘invoices’ as per relevant provisions of the Act. [If B had actually produced the evidence (customs documents) on the imported goods, including the amount of sales tax remitted to the customs authorities on importation, the tax authorities would have reduced the assessment accordingly]. Holding an invoice, normally, is only an administrative requirement, which should not have the effect that the importer loses the right to deduct input tax, if there is alternative evidence.
The most common form of sales tax fraud on the part of registered businesses is understating the value of supplies or overstating the value of purchases, or both. The objective is to reduce the tax liability of the business or to claim even a refund of sales tax as flying invoices only make it more difficult for the authorities to trace the real supplier and assess the supplier for unremitted sales tax. Many dummy firms register themselves only for the purpose of issuing sales tax invoices in order to enable other businesses to reduce their tax liabilities or to claim refunds. These firms register on the basis of fake documents and in the names of employees or persons having no connection with any business activity. The magnitude of the problem is illustrated by the number of bogus companies that were busted by the Intelligence and Investigation department. A company misused SRO 1125 and out of demand of Rs 439 million, an amount of Rs150 million was recovered from that. Another gang of fraudsters misused SRO 1125 and committed tax fraud to the tune of Rs 796 million.
In Pakistan’s informal economy, which predominantly consists of small- and medium-sized enterprises, legitimate businesses face difficulties in purchasing inputs from registered suppliers because they are difficult to find. Purchases from legitimate suppliers do include sales tax but that sales tax can be deducted by the customer, which means that the sales tax is not an actual burden on the purchaser, unless the purchaser is not registered. Non-registered suppliers commonly offer inputs of similar quality for lower tax-exclusive prices. The prices are lower, not because non-registered suppliers evade sales tax, but because they evade other taxes, such as income tax and social security contributions.
However, even registered businesses do not always operate within the limits of the sales tax legislation because, in order to boost deductible input tax, they frequently purchase fake purchase invoices. Analysis of data of some registered businesses indicated that they claimed input tax in relation to purchases that were not even related to their business activity. For example, a manufacturer in the tea sector claimed input tax on the invoices issued by other registered persons engaged in supply of tyres and aerated water.
There are registered dormant businesses that file ‘nil’ returns for many years but, in reality, they issue fake invoices enabling other registered businesses to deduct large amounts of input tax. Like many economies in the world, it is a daunting challenge to tackle the issue of fake and flying invoices in Pakistan as well.
There are also cases in which registered businesses have claimed sales tax in relation to invoices which were connected with fake/non-verifiable customs import declarations.
These loopholes must be plugged in to stop such kinds of frauds and the squandering of the national exchequer.