MUSHTAQ AHMAD SUKHERA, FEDERAL TAX OMBUDSMAN:---

This is an own motion investigation of systemic maladministration through exercise of jurisdiction under Section 9(1) of the Federal Tax Ombudsman Ordinance, 2000 (FTO Ordinance). The investigation is based on general Complaints that the Revenue Division/FBR and its field formations aFe not realizing full potential of "Federal Excise Duty" and "Sales Tax" from majority of cigarette manufacturers, operating in the country either by failing to conduct proper audit of these units or ensuring accountal of production of these units in their official record by using monitoring provisions of Sections 45 and 45A of the Federal Excise Act, 2005 read with Sections 40B and 40C of the Sales Tax Act, 1990.

2. The FBR vide its letter C.Nos. 1(2)/STM/2017/3S287-R dated 19.03.2018 and 28.05.2019 furnished following information:-

A CIGARETTE MANUFACTURERS OPERATING IN THE COUNTRY:

(i) Sales Tax is being charged at the standard rate of 17% on import and local sales of cigarettes. Federal Excise Duty (FED) is being charged @ 65% of the retail price on the imports of cigarettes. FED rates applicable to locally produced cigarettes have changed during the last two years and current financial year as tabulated below:--

2015-16
Period Tier Tier Threshold (Retail Prices (RP) per 1000 Cigarettes) FED Per 1000
Cigarettes -
1-7-2015 to 30-11-2015 Tier-I Exceeds Rs.3350.00 Rs.3,030.00
Tier-II Does-not exceeds Rs.3,350.00 Rs. 1,320.00
1-12-2015 to 30-11-2016 Tier-I Exceeds. Rs.3,600.00. RS.3,155.00
Tier-II Does not exceed Rs.3,600.00 RS. 1,420.00

2016-17
Period Tier Tier Threshold (Retail Prices (RP) per 1000 Cigarettes) FED Per 1000
Cigarettes
4-6-2016 to 30-11-2016 Tier-I Exceed Rs.4,000.00 Rs.3,436.00
Tier-II Does not exceeds Rs.4,000.00 Rs.l,534.00
1-12-2017 to 28-5-2017 Tier-I Exceeds Rs.4,000.00 Rs.3,705.00
Tier-II Does not exceeds Rs.4,000.00 Rs.l,649.00

2017-2018 (Effective from 29-05-2017):--
Tier Tier Threshold (Retail Prices (RP) per 1000 Cigarettes) FED Per 1000
Cigarettes
Tier-I Exceeds Rs.4,500.00 Rs.3,740.00
Tier-II Exceeds Rs.2,925.00, but does not exceeds Rs.4,500.00 Rs. 1,670.00
Tier-III Does not exceeds Rs.2,925.00 Rs.800.00

2018-19 (Effective from 1-7-2018):-
Tier Tier Threshold (Retail Prices (RP) per 1000 Cigarettes) FED Per 1000
Cigarettes
Tier-I Exceeds Rs.4,500.00 Rs.3,970.00
Tier-II Exceeds Rs.2,925.00, but does not exceeds Rs.4,500.00 Rs. 1,776.00
Tier-III Does not exceeds Rs.2,925.00 Rs.854.00

2018-19 (Effective from 19-9-2018):-
Tier Tier Threshold (Retail Prices (RP) per 1000 Cigarettes) FED Per 1000
Cigarettes
Tier-I Exceeds Rs.4,500.00 Rs.4,500.00
Tier-II Exceeds Rs.2,925.00, but does not exceeds Rs.4,500.00 Rs. 1,840.00
Tier-III Does not exceeds Rs.2,925.00 Rs. 1,250.00

(ii) It is pertinent to mention that during the Chief Commissioners'- IR conference held on 06.01.2017 in FBR (HQ), it was pointed out that revenue from Cigarette Sector was not showing any improvement due to decrease in the production/sales of the formal sector of Tobacco manufacturing/trade. It was further pointed out that the reduction was mainly due to increase in the illicit manufacturing/trade of this sector. Accordingly, in the Finance Act, 2017 tariff rationalization with reference to FED on Cigarettes was done and tier-III was inserted in the FED Act, 2005 in order to eliminate the illicit trading of tobacco.

(iii) As a result, collection of Sales Tax and FED on local supply of cigarettes increased during F.Y 2017-18 as compared to F.Y 2016-17, as per following details:-

Rs. In Million
PERIOD SALES TAX FED TOTAL
2016-17 17,562.00 66,324.00 83,886.00
2017-18 20,527.00 66,923.00 87,450.00

The rates of duty on cigarettes were increased in the Budget 2018-19 and then in the supplementary budget 2018-19 consequently there is an increase in the revenue collection from cigarettes. During the first ten (10) months of Financial Year 2018-2019 revenue from Sales Tax and FED Was Rs. 15,866.00 million and Rs.65,646.00 million, respectively.

3. FBR also provided information about cigarette manufacturing units which are registered in various Large Taxpayers Units (LTUs)/Regional Tax Office (RTOs) and amounts of FED/Sales Tax paid by these units as indicated in (ANNEX-1).These figures show that overall sales tax revenue from cigarettes sector units had increased from Rs. 14.53 billion in. Financial Year (F.Y) 2012-13 to Rs. 17.668 billion, Rs. 20.988 billion and Rs.23.760 billion in the FYs 2013-14,. 2014-15 and 2015-16 respectively but had dropped to Rs. 17.550 billion in FYs'- 2016-17 and Rs.20.527 billion in F.Y 2017-18.

4. Similar was the position of Federal Excise Duty collection as it increased from Rs.61.670 billion in FY 2012-13 to Rs.70.733, Rs.81.898 billion and Rs.90.437 billion in FYs 2013-14, 2014-15 and 2015-16 respectively but dropped to Rs. 66.131 billion in FY 2016-17 and Rs.66.923 billion in F.Y 2017-18. This shows that the collection from the cigarettes could not touch the level of collection during F.Y 2015-16.

5. FBR also provided details of various units (Annex-D) which were audited by its field formations during last three years or whose production was monitored by posting of FBR staff under Section 40B of the Sales Tax Act, 1990 read with Section 45B of the Federal Excise Act, 2005. It appears to have helped in enhancing sales tax and FED collections from some of the smaller units while revenue from two biggest companies had declined drastically. Thus, snap monitoring of cigarette manufacturing units (along with other high-risk manufactured items) need to be continued at enhanced levels till FBR replaces it with some other better alternate and fool proof monitoring system.

FINDINGS:

6. The information provided by FBR and its field formations was reviewed in order to investigate the effectiveness of monitoring and audit provisions of relevant laws for collection of due government revenue with following observations:

(1) Audits had not resulted in major tax detections, the cases for normal audit of manufacturing units particularly need to be selected by the FBR and its field formations after desk audit of data of these units available with FBR and its field formations in the form of periodic returns and statements prescribed by it (FBR) under various tax laws/rules.

(2) Despite the fact that snap monitoring of production of the cigarette "units under Section 40B of the Sales Tax Act, 1990 read with Section 4SB of Federal Excise Act, 2005 was in place for smaller units, since 2016-17 revenue from cigarette sector had considerably declined. This negative trend appears to be triggered by the following;

a. Departmental action under Section 40B of Sales Tax Act read with 45B of FED had been diluted to mere physical presence of FBR staff at the manufacturing premises of the small cigarette manufacturers without having access to the record of production, sale of goods and stock position.

b. Posting of FBR officials at manufacturing premises without checking their integrity and competence, the exercise goes counter to the interest of revenue. In some cases it practically amounts to certification/stamping the evasion.

c. Even this monitoring regime is confined to the small KPK cigarette manufacturing units. Large units run by multinationals are not covered under this regime.

(3) In order to provide electronic monitoring and tracking in the Sales Tax and Federal Excise Duty regime both Sales Tax Act, 1990 and Federal Excise Act, 200S were amended and new Sections 40C and 45A were inserted respectively vide Finance Act,' 2013. Even after lapse of more than five years, these provisions remained dormant and electronic monitoring system is yet to see the daylight.

Instructions for maintaining record of raw materials, production, sales and invoicing are scattered across rules, SROs, STGOs which renders both compliance and audits, difficult.

RECOMMENDATIONS

7. In view of supra, FBR is directed to:-

i. introduce electronic record keeping and real time data exchange between manufacturers of Cigarettes and FBR formations till electronic monitoring, tracking and tracing system is operationalized;

ii. develop a special, focused and across the board monitoring and enforcement regime for high revenue yielding sectors like cigarette, cement, sugar, beverages and fertilizers. In these major sectors rules for record keeping of raw material, production, storage, compliance and monitoring be re-aligned with classic mode of Central Excise, and implemented in IT based system;

iii. form a dedicated enforcement IT team focused on evasion in tobacco/cigarettes and other evasion prone sectors; entrusted with suitable powers to intervene across the jurisdiction promptly;

iv. extend the procedure prescribed for monitoring Green Leaf Threshing (GLT) units under rules notified vide SRO 1149(I)/2018 dated 18.09.2018 to cigarettes manufacturers as well;

v. license for introducing electronic monitoring, tracking and tracing system in respect of Tobacco products in terms of SRO 250(I)/2019 dated 26-02-2019 has recently been issued to National Radio Telecommunication Corporation (NRTC). Close liaison should be maintained with NRTC for placing the requisite system at all relevant Units expeditiously;

vi. prescribe standard operating procedures should be devised for the staff posted to Manufacturing units under Section 40(b) of the Sales Tax Act, 1990 and Section 45 of the Federal Excise Act, 2005;

vii. assign higher weightage to integrity and competence in defining parameters for selection of staff to be posted to manufacturing units under Section 40(b) of the Sales Tax Act, 1990 and 45 of the Federal Excise Act, 2005 and define performance indicators for monitoring their performance;

viii. consolidate rules, SROs prescribing procedures and general orders to ensure transparency and facilitation of registered persons in compliance;

ix. take effective enforcement measures including: coordinated profiling of smugglers, targeting of routes, warehouses and transport of smuggled cigarettes to check the smuggling of cigarettes from abroad and in the guise of local manufacturing;

x. request the AJK Government to adopt similar electronic system for record keeping and exchange of data as would be developed by FBR;

xi. sign MOU with AJK Government to work out a mutually agreed procedure for cigratees manufactured in AJK including live electronic exchange of clearance data of the consignments destined to the tariff areas of Pakistan so as to ensure that only duty paid cigarettes enter areas of Pakistan; and

xii. submit quarterly implementation report.

Order accordingly.