Islamabad: The International Monetary Fund (IMF) has requested that Pakistan alter the Sales Tax Act of 1990 to implement the General Anti-Avoidance Rule (GAAR) to combat the large tax frauds that result in trillions of dollars in General Sales Tax (GST) each year.
This could wind up being one of the main requirements of the next bailout package supported by the IMF under the Extended Fund Facility (EFF), for which the teams from Pakistan and the Washington-based lender are anticipated to begin working together in the second week of May 2024.
The International Monetary Fund (IMF) has suggested amending the Sales Tax Act (STA) to prevent companies from deducting input tax from purchases that they knew or should have known were part of a “missing trader fraud arrangement.
” To avoid fines or legal action, it further stated, “This encourages businesses down the supply chain to take reasonable steps to ensure that a supply is not included in this arrangement prior to filing an input tax claim.”
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The yearly amount of fraudulent or flying invoices (tax frauds) in sales tax is estimated by independent tax specialists to be in the trillions of rupees, up to Rs 3 trillion. As a result, the input adjustments claim for refunds needs to be completely redesigned.
Through a Technical Assistance (TA) report, the IMF informed Pakistan that missing trader fraud schemes cheat the government of sales tax. It entails a supplier (missing trader) purposefully neglecting to report the sales tax that the supplier levies on these deliveries, while companies in the supply chain keep submitting claims to the tax authorities for input tax or sales tax refunds.
The STA should be changed to discourage missing trading fraud arrangements, the Fund report revealed, adding, “The IMF understands anecdotally from FBR that missing trader fraud arrangements present a considerable problem in Pakistan, especially in the construction sector and reprocessing of used raw materials.”
“While it is currently illegal to commit, cause to commit, attempt to commit, abet, or connive in the commissioning of tax fraud, as long as one is an active member of a missing trader fraud distribute, this likely only applies to those individuals,” the statement continued.
According to the IMF research, the 2019 report’s proposal was followed in amending the Income Tax Ordinance (ITO) to incorporate an earnings stripping strategy.
In general, new section 106A caps the deduction for interest paid to a non-resident person or associate by a foreign-controlled resident company (apart from insurance or banking companies) at 15% of the total of (a) the taxable income before appreciation and amortization; and (b) the foreign profit on debt claimed as a deduction.
The narrow capitalization rule and the new section 106A cooperate so that any interest that is prohibited is the greater of the amounts that are prohibited under either regulation. Combining the thin capitalization requirement with the earnings stripping rule is a step in the right direction to stop profits from leaving Pakistan for other countries.
A key instrument in the fight against tax evasion would be a well-crafted general anti-avoidance regulation (GAAR). Currently, the STA and other tax laws do not contain a GAAR; however, the ITO does.
A consultant was recruited to undertake the task of developing a unified tax legislation on income tax, sales tax, federal excise duty, and customs duty during the previous PTI-led regime. However, the project was put on hold and never materialized into actual tax regulations.