Taxation

Definition and explanation

Miss Rabia Asad
Iqra University Islamabad
 Taxation
• Taxation, imposition of compulsory levies on individuals or entities by
governments. Taxes are levied in almost every country of the world,
primarily to raise revenue for government expenditures, although
they serve other purposes as well.
• In modern economies taxes are the most important source of
governmental revenue. Taxes differ from other sources of revenue in
that they are compulsory levies and are unrequited—i.e., they are
generally not paid in exchange for some specific thing, such as a
particular public service, the sale of public property, or the issuance of
public debt.
 Purposes Of Taxation

1. is to distinguish between objectives of resource allocation, income

redistribution, and economic stability.
2. The second objective, income redistribution, is meant to lessen
inequalities in the distribution of income and wealth.
3. The objective of stabilization—implemented through tax policy,
government expenditure policy, monetary policy, and debt
management—is that of maintaining high employment and price
stability.
 Purpose of taxation
• There are likely to be conflicts among these three objectives. For
example, resource allocation might require changes in the level or
composition (or both) of taxes, but those changes might bear heavily
on low-income families—thus upsetting redistributive goals. As
another example, taxes that are highly redistributive may conflict with
the efficient allocation of resources required to achieve the goal of
economic neutrality.
 Classes Of Taxes

• Direct Taxes and indirect taxes

• In the literature of public finance, taxes have been classified in various
ways according to who pays for them, who bears the ultimate burden
of them, the extent to which the burden can be shifted, and various
other criteria. Taxes are most commonly classified as either direct or
indirect, an example of the former type being the income tax and of
the latter the sales tax.
 Direct taxes

• Direct taxes are primarily taxes on natural persons (e.g., individuals),

and they are typically based on the taxpayer’s ability to pay as
measured by income, consumption, or net wealth.
• It is usually said that a direct tax is one that cannot be shifted by the
taxpayer to someone else.
 The main types of direct taxes
• Individual income taxes: these are commonly levied on total personal
net income of the taxpayer.
• In order to make it more equitable, they are commonly adjusted to
take into account the circumstances influencing the ability to pay,
such as family status, number and age of children, and financial
burdens resulting from illness. 
• Taxes on net worth: these are levied on the total net worth of a
person—that is, the value of his assets minus his liabilities.
• Net worth: the value of his assets minus ha person’s liabilities.
 Types of taxes
• Personal or direct taxes on consumption :(also known as expenditure
taxes or spending taxes) are essentially levied on all income that is not
channeled into savings.
• this form of tax has been used in only two countries, India and Sri
Lanka; both instances were brief and unsuccessful.
 Taxes at death
• It has two forms: the inheritance tax, where the taxable object is the
bequest received by the person inheriting, and the estate tax, where the
object is the total estate left by the deceased.
• Inheritance taxes sometimes take into account the personal circumstances
of the taxpayer, such as the taxpayer’s relationship to the donor and his
net worth before receiving the bequest. Estate taxes, however, are
generally graduated according to the size of the estate, and in some
countries they provide tax-exempt transfers to the spouse and make an
allowance for the number of heirs involved.
• Taxes on transfers do not ordinarily yield much revenue, if only because
large tax payments can be easily avoided through estate planning.
 Indirect taxes
• Indirect taxes are levied on the production or consumption of goods
and services or on transactions, including imports and exports.
Examples include general and selective sales taxes, value-added taxes
(VAT), taxes on any aspect of manufacturing or production, taxes on
legal transactions, and customs or import duties.
 SALES TAX

• A sales tax is a consumption tax imposed by the government on the

sale of goods and services. A conventional sales tax is levied at the
point of sale, collected by the retailer, and passed on to the
government.
• Conventional or retail sales taxes are only charged to the end user of
a good or service.
• Because the majority of goods in modern economies pass through a
number of stages of manufacturing, often handled by different
entities, a significant amount of documentation is necessary to prove
who is ultimately liable for sales tax.
 Example
• For example, say a sheep farmer sells wool to a company that
manufactures yarn. To avoid paying the sales tax, the yarn maker
must obtain a resale certificate from the government saying that it is
not the end user. The yarn maker then sells its product on to a
garment maker, which must also obtain a resale certificate. Finally, the
garment maker sells fuzzy socks to a retail store, which will charge the
customer sales tax along with the price of said socks.
 Sales tax
• Different jurisdictions charge different sales taxes, which often
overlap, as when states, counties, and municipalities each levy their
own sales taxes. Sales taxes are closely related to use taxes, which
applies to residents who have purchased items from outside their
jurisdiction. These are generally set at the same rate as sales taxes but
are difficult to enforce, meaning they are in practice only applied to
large purchases of tangible goods. An example would be a Peshawar
resident who purchases a car in Islamabad; she would be required to
pay the local sales tax, as though she had bought it at home.
 Sales tax history
• Sales tax was declared a federal subject in 1948 through the
enactment of General Sales Tax Act, 1948 and in 1952, this levy was
transferred permanently to the Central Government. Sales tax was
levied at the standard rate of 6 pies per rupee at every stage
whenever a sale was effected. The trading community protested
against this system, and this resulted in the enactment of Sales Tax
Act 1951.
 Sales tax history
• A system of licensed manufacturers & wholesalers was instituted whereby
they were allowed to purchase goods free of sales tax from each other
and pay tax on sales to unlicensed traders. Imports were chargeable to
Sales Tax but the licensed manufacturers & wholesalers were allowed to
import goods without the payment of Sales Tax. Later on Sales Tax became
chargeable on locally produced & imported goods at the time of their
sales & import, respectively. The sales tax, was collected under the
Finance Ordinance, 1956, on goods which were chargeable to Central
Excise Duty, as if it were a duty of Central Excise. In April 1981, by virtue of
an amendment in the Sales Tax act, 1951, the collection of Sales Tax on
non-excisable goods was also entrusted to the Central Excise Department.
 Sales tax replaced
• In the late eighties the government decided to replace Sales Tax with
the Value Added Tax in the country as a part of its structural
adjustment program which was undertaken to correct anomalies &
distortions both in our tax & non-tax regimes. Accordingly new
enactment titled Sales Tax Act 1990 replaced Sales Tax Act 1951 with
effect from 1-11-1990.
 LIABILITY TO SALES TAX

• Following sectors are required to get registration for sales tax and charge sales tax
on their supplies/ services:
• Manufacturing
• Import
• Services
• Distribution, Wholesale & Retail stage.
• Previously it was being charged at the manufacturing & import stage, and its scope
has been extended now to remaining sectors.
• Sales Tax is chargeable on all locally produced and imported goods except
computer software, poultry feeds, medicines and unprocessed agricultural produce
of Pakistan and other goods specified in Sixth Schedule to The Sales Tax Act, 1990.
 REGISTRATION

• Requirements: Every person in sectors mentioned above, who makes

a taxable supply in Pakistan is required to be registered under the
Sales Tax Act. However, manufacturers having taxable turnover below
five million rupees and also utility bill below Rs. Seven lac during the
last twelve months are exempted from registration and payment of
sales tax. Similar exemption is also available to retailers having total
turnover below Rs. five million in the last twelve months.