MUSHTAQ AHMAD SUKHERA, FEDERAL TAX OMBUDSMAN:---

This is an own motion investigation of systemic maladministration through exercise of jurisdiction, conferred under Section 9(1) of the Federal Tax Ombudsman Ordinance, 2000 (FTO Ordinance), based on a news item published in the Daily Dawn dated 4th March 2018, regarding ghost entities registered as manufacturers with fictitious addresses, being setup only for tax evasion by claiming benefit of SRO 1125(I)/2011 dated 31.12.2011. These fraudulent entities not only evaded sales tax in respect of imported fabrics but were involved in issuance of fake invoices for claiming sales tax refund as the FBR had failed to build robust system whereby such fake registration could had been avoided. Once these fraudsters are registered as 'manufacturers' by the Local Registration Office of the RTO concerned, the benefit of SRO 1125(I)/2011 dated 31.12.2011 is extended by the Customs Department at the time of import on the basis of profile available on FBR's website. The Risk associated in the registration of 'manufacturer' by the Inland Revenue (IR) appeared to be flawed, which needed investigation.

2. In response to the notice issued to the Secretary, Revenue Division in terms of Section 10(4) of the FTO Ordinance read with Section 9(1) of the Federal Ombudsmen Institutional Reforms Act, 2013, the Chief-IR (Operations-II), FBR submitted interim reply vide letter dated 12.04.2018. It was contended that sales tax registration system had been automated with checks including physical verification of premises, evidence of installed machinery and cross verification through utility bills. However, these checks were not available in compulsory registration module. In August 2017, the field formations reported misuse of the provision, by the units registered without due process and were accordingly de-registered/suspended or their manufacturing status was deleted. Out of 155 units, 142 were suspended/blacklisted or de-registered, while remaining units were re-processed under the law. It was informed that the registration system was decentralized in July 2015 and the field formations were authorized to process registration applications filed through Inland Revenue Integrated System (IRIS) registration module.

3. FBR furnished additional information vide letter dated 09.07.2018. It was contended that Sales Tax Registration Rules were revised vide SRO 494(I)/2015 dated 30.06.2015 whereby certain checks were put in place for manufacturers including GPS-tagged photographs of factory premises, machinery, industrial electricity or gas meter installed. Rule 5 of the Sales Tax Rules (the Rules) specifies the procedure and process of registration application. In order to protect the legitimate revenue, FBR added the requirement of biometric verification of applicant of sales tax registration as well as physical verification of business/ manufacturing premises. The registration application is processed by the computer system and if found complete in all respect, risk scores are assigned. In case the application is found low risk, registration is issued by the computer system. The high risk cases are sent to the Zonal Commissioner-IR (CIR) of RTO concerned for further inquiry and scrutiny of documents. The registration procedure incorporated in IRIS was not in conformity with the Registration Rules and accordingly necessary modification in the IRIS-Sales Tax Registration System (STRS) was carried out in March 2016 by integrating risk based parameters in the sales tax registration module. The risk scores were assigned on the basis of utility bills, premises and other miscellaneous checks. The sales tax registration system was risk based and in case of low risk the registration was automatically granted whereas high risk cases were selected for detailed scrutiny and physical verification.

4. The FBR vide letter dated 03.09.2018 informed that in order to control issuance of fake and flying invoices by ghost manufacturers and other registered persons, Sales Tax Real Time Invoice Verification (STRIV) system had been introduced with effect from 01.07.2016. The system required all registered persons to submit the details of supplies in Annex-C of monthly return then the registered persons were allowed to select the invoices declared by their suppliers after which input and output tax was accounted for in the system.

5. During the investigation of misuse of SRO 1125(I)2011 dated 31.12.2011, following two cases cited in the above news item as 'manufacturers' were scrutinized to ascertain the flaws and loopholes in the sales tax registration system:

i) M/S ARAN MART INTERNATIONAL

STR NO:1700429226517

The above person was initially registered with the Sales Tax Department as importer/exporter/service provider on 12.11.2014. Later on, the registered person added 'manufacturer' activity in the registration profile through application dated 06.11.2015 which was allowed without any physical verification. Though, the Rules provided for physical verification of manufacturing premises, installed machinery and biometric verification, the IRIS Registration Module did not incorporate modification as per revised rules and the registered person took advantage and misused the system. On the basis of sales tax return filed by the registered person, it was observed that after obtaining the status of `manufacturer', fabrics including shirting and suiting fabrics, polyester printed fabric, viscose shirting fabric and woven dyed printed cotton premium lawn fabric worth Rs.1.272 billion was imported during the period December 2015 to February 2017 under SRO 1125(I)/2011 dated 31.12.2011. The FBR vide letter dated 30.09.2018 provided list of units registered as 'manufacturers' without physical verification and before incorporation of risk engine in IRIS with directions to field formations to conduct physical verification of manufacturing status and premises in all such cases. The RTO-II, Karachi carried out physical verification but the said registered person was not found available at the registered address. The Registered Person (RP) was actually a commercial importer but registered as 'manufacturer' for the purposes of misuse of SRO 1125(I)/2011. After due scrutiny and following legal procedure, the Commissioner-IR, Zone-II, RTO-II, Karachi suspended the Sales Tax Registration (STR) of Messrs Aran Mart International vide order dated 26.01.2017 and SCN dated 26.01.2017 was issued. The suspension order was uploaded on 26.01.2017 on the system as per screen shot of Commissioner-IR status management portal of FBR. After uploading of suspension order on FBR system i.e. from 26.10.2017, goods imported should not have been cleared by customs authorities. The customs authorities allowed imports valuing Rs.119.46 million after suspension of STR.

ii) M/S VENUS & CO., STR NO:0216630500337

The above person was initially registered as manufacturer, importer and exporter of textile goods on 20.10.1994. He was subsequently suspended on 20.10.2017 on the charge of tax fraud and misuse of benefit allowed by SRO 1125(I)/2011. The unit was however, restored by the Commissioner-IR, Zone-I, RTO-III, Karachi vide order dated 13.12.2017 in compliance of Hon'ble High Court of Sindh Order dated 07.12.2017 in C.P. No.D-8007/2017.

During the period from July 2015 to June 2016, the RP imported fabrics of Rs.738.458 million whereas sales/ supplies were shown at Rs.623.637 million out of which supplies of Rs.577.649 million (i.e. 92.62% of total supplies) were made to blacklisted units. After amendment in SRO 1125(I)/2011 vide SRO 584(I)/2011 dated 01.07.2017, the RP imported finished fabrics including shirting and suiting fabric and polyester printed fabric worth of Rs.409.988 million as 'manufacturer' at zero percent sales tax but no manufacturing process of finished fabrics was carried out and the same was declared to be sold to other registered manufacturers. The Deptt carried out inquiry of the buyers and found that no payment was made by the said buyers on subsequent stage despite the fact that the RP was required to charge and pay sales tax on supply of finished fabric. A show-cause notice dated 18.05.2018 was issued and an amount of Rs.32.799 million on account of sales tax and Rs.8.700 million as further tax was adjudged to be payable vide Order No.195/2018 dated 06.08.2018.

FINDINGS:-

6(i) The review of Sales Tax Registration Rules and risk score weightage assigned to the risk parameters employed in the registration process which lead to misuse of 'manufacturer' status by registered persons for the purpose of tax evasion. FBR vide SRO 494 (I)/2015 dated 30th June, 2015 showed that the IRIS based Sales Tax Registration module failed to timely incorporate the provisions of revised registration rules. The requisite changes in IRIS were incorporated after nine months vide SRO 227(I)/2016 dated 21st March, 2016. The FBR had failed to take timely action in integrating the registration module in IRIS system thereby providing opportunity to the unscrupulous elements to take advantage of the weaknesses in the registration procedure of the sales tax department. Moreover, modification in the registration module was carried out after nine months of the revision of Sales Tax Registration Rules, but evidently no exercise was carried out by the field formations to verify that the existing manufacturers were registered in conformity with the provisions of revised rules.

(ii) Scrutiny of the registration profile of M/s. Aran Mart International reveals that the registered person added 'manufacture' activity through application dated 06.11.2015 i.e., after Sales Tax Registration Rules were revised on 30th June, 2015. The filed formation had thus failed to exercise due vigil, physical verification of premises and biometric verification. For this laxity, the RP after enjoying unlawful benefit is not traceable. Similarly, M/s. Venus and Co. availed benefit of SRO 1125(I)/2011.The concerned field formation failed to monitor their transactions and took belated action to recover short levied government dues.

RECOMMENDATIONS:

7. (A) Case Specific Recommendations:

(i) FBR to direct the Directorate General (I&I)-IR to:

(a) conduct detailed investigation to find out real owners of Messrs Aran Mart International by inter alia utilizing information available in customs clearance documents and instruments used for payment of import duties and taxes; and

(b) recover the amount of illegal concessions availed by Messrs Aran Mart International under the law/rules; and

(c) ascertain IR staff responsible for approving "manufacturer status" of Messrs Aran Mart International either through collusion or failure to take precautionary measures for protection of government revenue for taking disciplinary action under E&D Rules and for recovery under the law/rules; and

(d) initiate criminal proceedings against the owners of Messrs Aran Mart International along with those delinquent tax functionaries who deliberately and with ulterior motive connived to approve the 'manufacturer' status of M/s. Aran Mart International;

(ii) direct the Chief Commissioner IR, Corporate RTO Karachi to recover from Messrs Venus and Co. sales tax amounting to Rs.32.799 million and further tax of Rs.8.700 million assessed by the Deptt vide order No.195/2018 dated 06.08.2018.

(iii) direct the Directorate of I&I (Customs) to investigate and fix responsibility of clearance of imports after suspension of STR of the M/s. Aran Mart International;

(B) Institutional and Systemic Reforms

FBR to -

(i) develop a comprehensive risk management framework in the working of IRIS based Sales Tax Registration Rules and revisit the approved risk engine and scores to mitigate the possibility of any misuse of "manufacturer status" by the registered persons;

(ii) arrange audit of all 'manufacturers' who availed the benefit of SRO 1125(I)/2011 to find out whether "manufacturer status" was granted after fulfillment of requisite conditions and in cases of irregular approvals of "manufacturer status" fix responsibility on the dealing staff for proceedings under E&D Rules and take necessary measures under law/rules for recovery of losses caused to government revenues;

(iii) direct PRAL and Directorate of Reforms and Automation (Customs) to develop and implement system/software for live data synchronization with WeBOC regarding sales tax registration to ensure blacklisted and suspended RPs are not able to import and get undue benefit of SRO 1125(I)/2011; and

(iv) to direct all Commissioners to conduct half yearly physical verification of all units registered in their jurisdiction as 'manufacturer' to verify existence of manufacturing facility of all such units;

(v) submit quarterly implementation report.

SD/-
MUSHTAQ AHMAD SUKHERA
FEDERAL TAX OMBUDSMAN