Sales Tax on Services under Provincial Laws By: Mazhar Saleem Shah 29 July 2015

Contents: Mandate of taxation under the Constitution Regulatory framework of FED & Sales Tax on Services Taxable, Non-taxable and Exempt Services Modes of Taxation Core Concepts & Cardinal Provisions of Provincial ST Laws Taxation of Services under Omnibus Tariff Headings Cross-border Transactions Input Tax on Goods & Services Withholding Sales Tax Regimes under SRB & PRA Disputed / Contentious Issues among Federal & Provincial Authorities

Mandate of Taxation under the Constitution: Under the Constitution of Pakistan sales tax on services is a Provincial subject. Entry No.49 of Fourth Schedule (Federal Legislative List) of the COP reads as under: “Taxes on sales and purchases of goods imported, exported, produced, manufactured or consumed except sales tax on services.” Federation is still vested with right to impose ‘duties of excise’ under Entry No.44 (whether goods or services), as such FED is applicable all over Pakistan on certain specified services e.g. air travel, chartered flights & carriage of goods by air. PRA has challenged this position vide its budgetary measures 2015-16. SRB, PRA and KPKRA imposed taxes on certain services, which are beyond the taxing rights of the Provinces, thus challenging authority of the Federation. Effective 01 July 2015, FBR will be authorized for administration and collection of sales tax on services under the ICT Sales Tax Ordinance, 2001 (scope of taxation broadened extensively vide Finance Act, 2015).

Regulatory Framework of FED & Sales Tax on Services Territory Levy on Services Legislation Regulator All over Pakistan FED (Services not Provincial subject) Federal Excise Act, 2005 FBR Islamabad FED (Services covered under Table-II of First Schedule) Sales Tax Islamabad Capital Territory Sales Tax Ordinance, 2001 Sindh Sindh Sales Tax Sindh Sales Tax on Services Act, 2011 SRB Punjab Punjab Sales Tax Punjab Sales Tax on Services Act, 2012 PRA KPK KPK Sales Tax Khyber Pukhtunkhwa Finance Act, 2013 KPKRA Baluchistan Baluchistan Sales Tax on Services Act, 2015 to be formed GO HEADER & FOOTER TO EDIT THIS TEXT 11/12/2018

Taxable, Non-Taxable and Exempt Services Difference between the terms ‘Non-Taxable’ and ‘Exempt’ Under all 04 Provincial Legislations – First Schedule provides list of services which can be taxed, whereas Second Schedule provides the list of services, which are taxable. Under PRA & KPK legislations exemptions are embedded in Second Schedule SRB provides exemptions through separate notification No.SRB-3-4/7/2013, dated 18 June 2013, as amended vide notification No.SRB-3-4/2/2015, dated 01 July 2015. Baluchistan has not yet provided any exemption notification, which is expected to be notified, hopefully with retrospective effect. As of to-date., only few services mostly within the social sectors still out of tax ambit. Certain new services brought under tax-net vide Provincial Budgets of 2015-16 would open the doors of litigation i.e. rent of immoveable properties, ready-mix concrete, commission agents, air-travelling, carriage of goods by air, etc. KTBA

Modes of Taxation – Normal regime Section 3(1) of Sindh, Punjab and Baluchistan Acts and Section 19(1) of KPK Act deal with normal tax regime, where service provider is resident of the Province having jurisdiction to collect sales tax. Under this provision, a Taxable Service is a service listed in the Second Schedule to the Act, Provided by a registered person From his registered office or place of business in the Province In the course of an economic activity, including in the commencement or termination of the activity. Explanation: This sub-Section deals with services provided by registered persons regardless of whether those services are provided to resident persons or non-resident persons. GO HEADER & FOOTER TO EDIT THIS TEXT 11/12/2018

Economic Activity - Defined “Economic activity” means any activity carried on by a person that involves or is intended to involve in provision of services to another person, and includes – an activity carried on in the form of a business, including a profession, calling, trade, or undertaking of any kind, whether or not the activity is undertaken for profit; the supply of movable property by way of lease, license or such similar arrangement; and a one-off adventure or concern in the nature of a business or trade. Exclusions: An economic activity does not include “employment” or “a private recreational pursuit or hobby of an individual”.

Modes of Taxation - Reverse Charge Section 3(2) of Sindh, Punjab & Baluchistan Acts and 19(2) of KPK Act deals with taxation under reverse charge mode, where the recipient of service is liable to discharge the tax liability. Under the relevant provisions of law, a service that is not provided by a registered person shall be treated as taxable service, if Listed in the Second Schedule to the Act, Provided to a resident person By a non-resident person In course of an economic activity, including in the commencement or termination of the activity. Explanation: This sub-Section deals with services provided by non-resident persons to resident persons whether or not resident person is an end consumer of such services

Modes of Taxation - Reverse Charge Punjab’s Act extended the scope of reverse charge taxation by enacting a new provision (Section-4), which requires deposit of sales tax with PRA adopting ‘consumption’ or ‘termination’ basis. This provision still remains a bone of contention for disputes with SRB. Subsequently, KPK and Baluchistan also adopted this provision to aggravate the problem. Till date, no MOU is in place to develop principles on ownership of taxes where a particular taxable service originates in on tax jurisdiction but terminates in another tax jurisdiction. Best recourse for the taxpayer is to follow law of the land.

Cardinal Provisions – Definition of “Service” “Service” or “Services” means anything which is not goods or providing of which is not a supply of goods and shall include but not limited to the services listed in First Schedule; Explanation: A service shall remain and continue to be treated as service regardless whether or not rendering thereof involves any use, supply or consumption of any goods either as an essential or as an incidental aspect of such rendering

Value of Taxable Services - Defined The value of a taxable service is – The consideration in money received including all taxes, except sales tax. Trade discounts mentioned on tax invoice allowed Whether have been provided on payment of charge or free of charge or on any concessional basis  Value of services should be open market price if – consideration received in kind Transaction between Associate Persons Any special nature of transaction, it is difficult to ascertain value. Collection Authority is empowered to fix the value of taxable service. “Open Market Price” means – the price, the services or similar services would fetch in open market between persons not associated, or determined on the basis of prevailing market conditions

Time of Services Provided or Rendered A taxable service shall be considered to have been provided in the tax period during which The service is provided to the recipient an invoice for the value of the taxable service whichever is earlier is issued consideration for the same stands received; When a service is provided over a period of time and where payment for the same is made on a periodic basis, the service shall be treated as comprising two or more separate and distinct services, for each separate part of the related consideration.

Excess Tax Any amount of sales tax collected under a misapprehension of law or otherwise Not payable as tax or which is in excess of the tax payable, and Incidence has been passed on to the consumer, Shall be payable to the Government. Such excess collected amount of tax shall be recovered accordingly and no claim for refund in respect of such amount shall be admissible. Default surcharge and penalties applicable. The burden of proof that the incidence of tax has been or has not been passed on to the consumer shall be on the person collecting the tax.

Taxation of Services under Omnibus Tariff Headings Franchise services [9823.0000] Persons engaged in contractual execution of work or furnishing supplies [9809.0000] Contractor of building including multi-discipline works, etc. [9814.2000] Business Support Services [9805.9200] Management consultants [9815.4000 & 9819.9300] Technical, scientific & engineering consultants [9815.5000] Technical testing and analysis service [9819.9400] Maintenance or cleaning services [9822.2000] Management Services including Fund & Asset Management Services Commission Agents

Rules of Play Essential character of the service should be checked first. Substance should prevail over form – It is highly important to examine the nature of transaction to identify the service. Concept of incidental or ancillary service is equally important. Similarly, incidental supply of goods in the course of provision of service is to be examined. Point of taxation and place of taxation be examined on principles in line with international practices, if not described in Federal/Provincial laws. Clarity and Presentation of financial statements matters a lot to avoid confrontation with SRB & PRA authorities.

Cross-border Transactions Where a service originates within the Province, but terminates outside Pakistan, such person shall be required to pay tax on such service to that Provincial tax regulator. Chapter IV of the Punjab Sales Tax on Services (Adjustment of Tax) Rules, 2012 provides that providing of a taxable service by a registered person shall be treated as export of service, and no tax is payable thereon, if such service is delivered and used outside Pakistan and payment for such service is received in convertible foreign exchange through declared banking channels; and There is no concept of “export of services” in other Provincial Acts.

Cross-border Transactions A person being a resident, who received taxable services from an unregistered, non resident person, shall be deemed to be a registered person and is liable to be registered for the purposes of Provincial Acts. Thus, sales tax is payable in reverse charge mode on import of services from non- resident persons.

Input Tax on Goods and Services Section 2(14) of the ST Act defines the expression “input tax” as- “Input tax", in relation to a registered person, means- Tax levied under the ST Act on supply of goods; Tax levied under ST Act on the import of goods; FED paid on goods or services under FE Act in sales tax mode. Provincial sales tax levied on services rendered or provided Tax levied under the ST Act, as adapted in the Azad Kashmir, on the supply of goods received by the person; Definition of the “Provincial sales tax” under ST Act has been amended through Finance Act 2013, as below – “Tax levied under the provincial laws, which are declared by the Federal Government, through notification, to be provincial sales tax for the purposes of input tax”.

Input Tax on Goods and Services FBR did not issue notification until 26 March 2014, as referred under the definition of ‘Provincial sales tax’, which deprived FBR registered persons to claim input tax paid with Provincial tax regulators on acquisition of taxable services. The matter was challenged before the High Courts, allowing the adjustment of input tax through manual filing of sales tax returns with FBR. Finally, through Notification SRO 212(I)/2014 dated 26 March 2014, FBR notified whereby sales tax levied through the Provincial Acts has been declared as provincial sales tax for the purposes of input tax. Input tax on purchases of goods as applicable under Sales Tax Act, 1990 can be off-set by registered service providers against output tax on services as applicable under respective Provincial laws. It is important to develop nexus of input tax with the services rendered or provided, apart from other conditions.

Input tax on Goods and Services An online transfer of payment from the declared business account of the buyer / service recipient to the declared business account of the supplier / service provider or payments through the credit card shall be treated as transactions through the banking channel, Transactions are verifiable from the bank statements of the respective supplier / service recipient and the buyer / service provider. Payment in case of a transaction on credit is so transferred within 180 days of issuance of tax invoice Supplier / Service recipient shall not be entitled to claim input tax credit, adjustment or deduction or refund, repayment or drawback or zero rating of tax, if amount so transferred shall not be deposited in the declared business bank account of the supplier. Negative lists of goods and services maintained by SRB and PRA, wherein input tax is inadmissible, if the goods & services not acquired as stock-in-trade.

Apportionment of Input Tax Rule of Apportionment also applies for input tax claims on services: Input tax paid on goods and services used/relating wholly to taxable supplies / services shall be admissible under the law. Input tax paid on goods and services used/ relating wholly to exempt supplies / services shall not be admissible. Input tax incurred / used in making taxable supplies or providing of taxable services and also for non taxable or exempt services, shall be apportioned according to the following formula for availing input tax adjustment- Adjustable Input Tax Value of taxable supplies on taxable supplies = ----------------------------------- x Residual Input Tax (value of taxable + exempt supplies)

Withholding Sales Tax Regimes Sales Tax Special Procedure (Withholding) Rules, 2007 Sindh Sales Tax Special Procedure (Withholding) Rules, 2014 Punjab Sales Tax on Services (Withholding) Rules, 2015 Issued by FBR Issued by SRB Issued by PRA

Mechanism under WST schemes A withholding agent registered for sales tax is required to Deposit withheld amount by declaring purchases in monthly sales tax return (either input tax is required to be claimed or not) FBR amended its Withholding Rules to require monthly deposit of WHST on accrual basis. Prior to 01 July 2015, it applied on payment basis. A withholding agent not registered for sales tax is required to Be e-enrolled on e-portal of respective authorities File monthly withholding e-statement Deposit the withheld amount of sales tax.

Services not subject to WHT Following taxable services are exempt from sales tax withholding Federal WHT Telecom Sindh WHT Banking Company Financial Institution Port Operator Airport Operator Terminal Operator Airport Ground Service Provider Insurance Co. (except re-insurance company) Punjab WHT Services provided by companies being active taxpayers (other than advertisement services). Courier Insurance Banks

Withholding Agents – SRB SRB’s WHT Rules shall apply on providing of Taxable Services Persons specified as withholding Agents Federal, Provincial Government, including local and district government, departments and offices; Autonomous bodies; Public sector organizations including public corporations, SOE, etc. Organizations which are funded, fully or partially, out of the budget grants of the federal or provincial government; Companies as defined in Section 2(28) of Sindh Act; Recipients of service of advertisement, who are registered under FBR or SRB and SRB registered persons receiving taxable services from unregistered persons.

WHST Regime under SRB Sindh Sales Tax Special Procedure (Withholding) Rules, 2014 All Withholding Agents except Clause (f) W/H Agent in under Clause (f) i.e. FBR or SRB registered persons Registered Service Providers Unregistered Service Providers Persons providing advertisement, auctioneers, renting of immoveable property and inter-city road transport Deduct 1/5TH of the Sindh Sales Tax Amount Deduct at applicable rate of SST on gross value of Services Deduct at applicable rate of SST on value of Services

Withholding Agents – PRA Persons specified as withholding Agents Federal, Provincial Government, including local and district government, departments and offices; Autonomous bodies; special institution, government owned enterprise, regulatory or statutory body Public sector organizations / program / project Organizations which are funded, fully or partially, out of the budget grants of the federal or provincial government; Recipients of service of advertisement, who are registered for sales tax on goods with FBR or for sales tax on services with PRA. A company which is resident or has a place of business in the Punjab. Registered persons receiving taxable services from other than registered persons; and Accounting office responsible for making payment against invoices for the taxable services received by an office or department of the government, Federal Government, Provincial Government or local governments.

WHST Regime PRA Punjab Sales Tax on Services (Withholding) Rules, 2015 All categories of Withholding Agents acquiring taxable services On payments to Unregistered persons and Registered Persons (Not being Companies under ATL Advertisement service providers All registered Companies appearing in Active Taxpayers’ List Companies if flagged as Non-Active Taxpayer No Withholding Deduct whole amount of sales tax at applicable rate on gross value of services

Disputed / Contentious issues: Disputed / Contentious Issues among Federal and Provincial Authorities

Franchise Services Scope of franchise service lacks clarity based on the definition of the term ‘franchise’ as provided under Federal and Provincial laws. Numerous cases are pending for decision before the superior courts. SRB demands payment of Sindh sales tax on the franchise services, if the royalty or franchise agreement is executed through the registered office based in Province of Sindh. . PRA however clarified that reasonable basis / methodology be adopted when franchise service can be attributed to activity performed in multiple tax jurisdictions. SRB also imposed sales tax under ‘franchise services’ when there is no consideration involved between the franchisee and franchiser. In this case, the tax is computed at the rate of 10% of the gross turnover. Varied rates on franchise services in Punjab and Sindh/Islamabad

Contractual execution of work (9809.0000) Persons engaged in contractual execution of work or furnishing of supplies are subject to sales tax under all Provincial as well as ICT Sales Tax Ordinance. Only those services fall under the head of “contractual execution of work or furnishing of supplies” which involve both supply of goods and rendering of taxable services under a contract. In effect, only a composite contract involving an element of goods as well as of taxable services would be taxable under the above heading. Under SRB’s exemption notification, a sub-threshold for service component i.e. Rs.10 million is additionally provided, which strengthen the position that the tax is applicable only for composite contracts. Sales tax on component of goods is payable with FBR. No sub-threshold of exemption on service component under PRA, ICT, KPK and Baluchistan Acts.

Status of SST on Transportation Services Sindh Government kept the enforcement of levy of SST on transport services suspended since it is brought to tax statute vide Sindh Finance Act, 2014 till further orders. On 24 July 2015, SRB issued a Circular No.1/2015 to keep the levy in abeyance until further orders or till 31 December 2015, whichever is earlier. Amnesty offered by SRB vide exemption notification to transport contractors will not be availed due to above suspension. PRA already enforced PST on specified transport services. Levy-in-abeyance may not require the Withholding Agents to deduct and pay WHST with SRB, though risk of confrontation may not be mitigated.

Wisdom begins in wonder (Socrates) Thank You

© 2015 KPMG Taseer Hadi & Co., a Partnership firm registered in Pakistan and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and "cutting through complexity" are registered trademarks of KPMG International Cooperative ("KPMG International").