T-axing the golden goose

Shahid Sattar
September 02,2019

With the imposition of general sales tax (GST) at 17 percent on the previously zero-rated textile sector, Federal Board of Revenue (FBR) is looking to collect Rs600 billion from the sector and giving a refund of approximately Rs480 billion on exports.

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INDUSTRY

This misguided and ill-planned thrust for taxation and documentation has driven the economy to the ground and economic activity is now gasping for air. Surely the government does not intend to induce a forced closure of the sector. Taxing transactions beyond a simple GST is inefficient and counter-productive


With the imposition of general sales tax (GST) at 17 percent on the previously zero-rated textile sector, Federal Board of Revenue (FBR) is looking to collect Rs600 billion from the sector and giving a refund of approximately Rs480 billion on exports.

This is only part of the story as there are many other ways in which the tax authority is planning to increase revenue collection as a figure to symbolically meet the target of Rs5.5 trillion in 2019-20. Withdrawal of zero-rating has impacted the system extremely negatively but there are equally, if not more, additional measures that are surely going to induce a complete shutdown of industry. Let’s see how.

At the time of withdrawal of zero-rating the government’s rationale was that domestic commerce does not pay tax and the GST was designed to bring the domestic commerce into the GST net.

The industry provided the government with data that proved beyond doubt that out of all domestic production 70 percent was exported and only 30 percent was sold in the domestic market and that to burden the exports with additional cost of borrowing for the GST and awaiting refund would render Pakistani products uncompetitive in the international markets.

The industry represented to the government that Sales Tax should be collected at the point of sale which would not only capture sales emanating from domestic production but also the true value of under-declared imports, smuggled goods, and used clothing.

When it was apparent that the government was adamant on its plans, it was agreed that initially a lower rate of GST (7.5 percent) would be imposed and increased over time so that the market could adjust to the additional liquidity requirements. Despite this agreement the government went ahead and imposed the 17 percent GST, which is the primary cause of the huge liquidity problems now.

Furthermore, at the time of withdrawal of zero-rating the government repeatedly assured the industry that Sales Tax refunds would be made within 72 hours of shipping of goods.

Under the best case scenario this would have meant that for exporters the refunds would involve 180 days before the refund is received. Contrary to what was agreed the government has now added the condition that funds have to be received on account of the exports prior to refund. This adds a further 6 months to the process.

Fundamentally this means that the entire GST collected within the first year will remain with the government in perpetuity or until the system is changed again.

It must be noted that the additional cost of borrowing Rs600 billion for the sales tax prior to refund is likely to be Rs72 billion. This is an unnecessary increase in the cost of production on which we already score dismally.

This is directly the consequence of the fact that approximately 70 percent of all the textile production of Pakistan is exported directly or indirectly. This is further complicated by the structure of the industry, which is fragmented with very few vertically integrated companies, which leads to ‘multiple taxation’ of the same goods. The bulk of the textile output is from indirect exporters such as spinners, weavers, finishers, etc, whose products after finishing are finally exported.

A 4 percent withholding tax on every transaction within the sector will result in Rs115 billion being transferred to the government from industry for at least 180 days.

Should the collection of 4 percent withholding tax continue, despite the clear interpretation in law that it should not, in commercial terms this would mean a reduction of liquidity/working capital of the sector by further Rs115 billion. These are the funds that sector does not have.

Being more than the profitability of the great majority of the units in the textile chain this would directly cause these units closure leading to unemployment, lower GDP, and substantial reduction in exports. In this connection the FBR is invited to check and ascertain the average profitability in this sector which under no circumstances can be 14 percent of turnover as a 4 percent withholding tax translates to approximately a 14 percent profit on turnover.

Only 90 percent of input tax will be allowed to be set off against the output and the 10 percent to be refunded 14 months later. This will also permanently transfer Rs60 billion from industry to the government.

In commercial terms this means that 10 percent of all GST collected (1.7 percent of sale value) would remain permanently blocked with FBR as the refund provision kicks in only after a period of 1 year and two months. This translates to a permanent transfer of a float of Rs60 billion from Industry to the government’s coffers.

This would directly cause further pressure on these units leading to closure, unemployment, lower GDP, and substantial reduction in exports. Coupled with the 4 percent withholding tax and the additional funds required to pay the 17 percent GST in the first place, there appears to be no chance of the industry surviving the additional working capital requirement or the wiping out of the slim margins and the already low profitability.

This will necessarily turn into a loss for the great majority of the registered and compliant units in the sector leading to their imminent closure.

There are now over 60 withholding taxes and about 70 percent of revenue comes from them. These are extremely regressive in nature as they do not rely on the margins or profitability of the company and act as accelerators to hasten the demise of companies that could have survived a downturn in the market but were unable do so because of regressive taxes such as turnover.

Just the fiscal measures taken are likely to hit the industry with an additional cash requirement of approximately over Rs800 billion. These are the funds that the FBR is looking to collect additionally from the textile sector as part of their requirement to collect an additional Rs1.5 trillion this financial year to fulfill their completely unrealistic target of Rs 5.5 trillion.

The very interesting conclusion that can be derived from these measures is that the government must surely think that the industry is operating on net profitability of at least 20 percent plus. This surely is not the case.

Given that neither such liquidity nor profitability exists in the sector, the current FBR strategy is a sure-shot recipe for a monumental disaster. We are heading towards massive de-industrialisation, a precipitous fall in exports and extremely unmanageable levels of unemployment.

To further complicate matters the governments well-intentioned but mis-guided documentation drive of seeking CNICs (computerised national identity cards) for all sales through registered, law-abiding, taxpaying industries has not been accepted by the unregistered dealers and as a consequence all sales in the domestic sector have come to a standstill since August 1, 2019.

As a result there is no cash flow to pay wages, salaries, utility bills, taxes, etc, and according to all estimates it will lead to a shutdown of a substantial number of mills that are currently operating (supplying to the domestic sector) by the second week of September with the rest following soon.

This misguided and ill-planned thrust for taxation and documentation has driven the economy to the ground and economic activity is now gasping for air.

Surely the government does not intend to induce a forced closure of the sector. Taxing transactions beyond a simple GST is inefficient and counter-productive.

The above measures are designed to kill transactions. There is a clear need to review and assess the lacunae in these measures and weed out those that are impeding transactions.

The industry fails to gauge the economic direction of the government whether they want to promote industry, exports and employment or discourage it all. The 17 percent sales tax + 4 percent withholding tax + 5 percent on utilities, 1.5 percent turnover tax, and 15 percent markup on the Rs600 billion sales tax is far too great a liquidity drain and way beyond the sustainability or profitability of the sector.

Beyond the fiscal measures the government has still not formulated a long-term textile policy without which there can be no long-term investment, modernization, or upgradation. In a much-appreciated initiative regionally competitive energy tariffs were approved by the government; however, their implementation still remains irregular and subject to court orders and industry as a result is unsure of their costing, which is hurting exports.

Expecting any sustainable increase in exports under these circumstances will remain a dream unfulfilled. To sum it all up the government with its policy formulation flaws and unfair dealing with the textile industry is for sure trying to kill the goose that lays the golden eggs.

The writer is an industry official


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