Sunday, August 3, 2008

The oil pricing formula


By Asad Sayeed and Vikash Ahuja

AFTER yet another price hike in petroleum products, people reeling under the burden of a constant and seemingly endless inflationary spiral are legitimately asking the question whether such sharp increases in petroleum prices are necessary?

An increasingly vigilant media having dissected the different components of the retail price of petroleum products has challenged the government’s decision to keep taxing petroleum products and for allowing the refineries, the oil marketing companies (OMCs) and dealers to rake in huge profits at the cost of the consumer by linking their returns to international oil prices.

A number of these concerns are valid. However a focused analysis of the different components of pricing is necessary to understand who gets what and at whose cost. It is also necessary to understand the compulsions of the government in light of the external and internal imbalances it is confronted with.

There are essentially four elements that constitute the price that the consumer pays on petroleum products. The import parity price is the first element. This comprises the import price, adjusted for government subsidies and duties. To this cost is added the Inland Freight Equalisation Margin (IFEM) that is charged by the OMCs to sell petroleum products at a uniform price across the country. To these two elements is added a 3.5 per cent margin for the OMCs, and four per cent for dealers, of the combined cost of the two elements described above. The sum total of the above three is then subjected to 16 per cent general sales tax by the government.

The frequent lament in the media is that a large chunk of the retail price is the sales tax. The magnitude of taxation in the prevailing price of petroleum and high speed diesel comes to Rs11.95 and Rs8.92 per litre respectively. Moreover, an increase in the international oil price automatically increases the revenue yield of the government.

For the government to forsake revenue through the sales tax in given conditions will be a folly for two reasons. Firstly, once we factor in the subsidy the government provides, the relevant figure to look out for is net taxation (sales tax minus subsidy) rather than sales tax per se. For instance, in the fiscal year 2007-08, the subsidy on petroleum products was Rs175bn, whereas revenue from sales tax was Rs118.2bn. Net taxation in the outgoing fiscal year was, therefore, Rs56.8bn. If the government had reduced or removed the sales tax, the amount of subsidy would have been proportionate to the foregone revenue.

It is important to emphasise that subsidies are not a free lunch. State subsidies are generally financed either through bank borrowing (in other words by printing money) or by borrowing from international or domestic capital markets. If the subsidy is financed through printing money — as the Musharraf government did in the outgoing fiscal year — it creates an inflationary spiral in the economy and wipes out the benefit provided through the subsidy.

Alternatively, if the subsidy is financed through borrowing from capital markets, it creates a future liability on the taxpayer in the form of debt servicing. Now if there are good tidings expected in the future — in the form of a more favourable international environment and high GDP growth domestically — then it may be worthwhile providing a generalised subsidy. But if the future is uncertain, as it certainly is presently, then this becomes a risky proposition.

Second, for a revenue-starved state (remember Pakistan’s tax-GDP ratio at 10 per cent is one of the lowest in the developing world) the petroleum sector is a source of least resistance for tax collection. Until the state broadens its tax base to devise a truly progressive taxation structure and reallocates its expenditure away from territorial to human security, removing the sales tax on petroleum products will only amount to enhancing the fiscal deficit which will have to be paid by present or future taxpayers, perhaps at even more onerous rates. In the present milieu, it only makes sense to provide targeted subsidies to the most vulnerable sections of society rather than subsidise everyone.

The margins of OMCs and dealers, however, have rightly come under fire and in the recent price increase their margins have been frozen. But this is not enough. The formula of linking margins to a proportion of the import parity price and the freight equalisation margin is fundamentally unjust and irrational. It is irrational because distribution or dealership has no link whatsoever with fluctuations in international oil prices.

It is unjust because this formula enables the OMCs and dealerships to rake in profits on the basis of exogenous developments (international oil prices) at the cost of both the state and the consumer. If there was ever an example of blatant profiteering — devised by the Musharraf government, small wonder — as a consequence of collusion between self-appointed policymakers and the corporate sector, this was it. Rather than arbitrarily freezing the margin as has been done now, the formula needs to be altered and margins should be determined on the basis of actual costs and ‘reasonable’ profits to the companies and dealerships.

Rent-seeking by the OMCs, however, is not limited to margins only. The freight equalisation margin is another source of dubious profiteering by these entities. The IFEM is used to equate the prices of POL products across Pakistan and covers primary transport costs incurred by OMCs to transport petroleum products. IFEMs are recommended by the Oil Companies Advisory Committee (OCAC) and are subject to adjustment on the basis of actual monthly freight computations. Since IFEMs are added to IPPs to calculate OMCs’ and dealers’ margins, it creates incentives for OCAC to set IFEMs at higher than actual levels, which not only increases their actual reimbursement but their margins as well.

To illustrate the extent of rent-seeking on the pretext of freight equalisation consider the fact that between Sept 1, 2007 and July 1, 2008 freight margins were increased by 348 per cent for motor spirit, 319.5 per cent for HOBC, 304.2 per cent for kerosene, 81.4 per cent for light diesel and 82 per cent for high speed diesel. This increase in freight charges is nothing short of daylight robbery on the part of the OMCs. Thus, where the government is rightly moving in on curbing the margins on distribution and dealerships, a serious review of the policy on freight equalisation margins is also required.

Another element in the pricing formula that adds to the windfalls of the refineries is the deemed duty benefit that they receive in the import parity price, primarily for diesel but also for other products. In 2001, it was decided to allow the refineries to retain the duty that was charged on local finished products for one year to upgrade their capacity. While some products have been taken off the list, seven years later the refineries are still charging this amount on diesel which constitutes the bulk of the volume consumed in the market. There is no justification, therefore, in allowing this pilferage on the part of refineries to continue.

While the fact remains that the bulk of the price increase in domestic prices is driven by surging world oil prices, some relief can be provided if the pricing formula adopted by the Musharraf-Aziz combine to benefit big business at the expense of the consumer is altered. Lately the OMCs and the refineries have adopted a threatening tone with regard to reduction in their illegitimate profiteering. It is high time their bluff is called and for the sake of the consumer, this relic of the past is undone as soon as possible.

Modern-day slaves


Shifting the burden of its responsibilities on withholding agents, the federal government remains insensitive to their woes

By Huzaima Bukhari and Dr Ikramul Haq

"The only people who do not have to pass the Civil Services exam to work for the government are the withholding agents." (Anon) The federal government retains two percent as collection charges from all the provincial governments on General Sales Tax on Services, which it collects on their behalf (Para 9.6 at page 42 of Explanatory Memorandum on Federal Receipts 2006-2007).

On December 10, 1948, the General Assembly of the United Nations adopted and proclaimed the Universal Declaration of Human Rights, to which Pakistan is also a signatory. Following this historic act, the UN General Assembly called upon all member countries to publicise the text of the Declaration, and "to cause it to be disseminated, displayed, read and expounded principally in schools and other educational institutions, without distinction based on the political status of countries or territories." The failure to implement these instructions by the Pakistani authorities is another ghastly, grisly and hideous story.

Article 7 of the Declaration reads: "All are equal before the law and are entitled without any discrimination to equal protection of the law. All are entitled to equal protection against any discrimination in violation of this Declaration and against any incitement to such discrimination." This principle is also enshrined in Article 4 of the Constitution of Islamic Republic of Pakistan. In civilised societies, laws are supposed to apply equally to all the citizens and legal entities, without even an iota of doubt that one segment of society of class of people is being given preference over another.

Though such an ideal situation appears utopia, yet the responsible and representative governments, wherever possible, try to implement these. One finds no apparent or plausible justification for their non-enforcement. For example, it would be incorrect to accuse a hangman for murder or manslaughter when he pulls the noose around the neck of a convict, because he is merely carrying out the court's instructions; or to file a case against a police officer for assault and battery where he attempts to arrest a criminal, because he too is just performing his duty. No doubt, some laws may have different implications for different people, but generally there is a consensus that they should be non-discriminatory.

The implication of this is that barring a few issues related to essential services, what is good for the federal government should be equally good for the provincial governments and other corporate / non-corporate bodies too. Hence, if the federal government is entitled to retain two percent as collection charges from all the provincial governments on general sales tax on services, which it collects on their behalf, then other bodies should also have the right to retain the same percentage (if not more) on collections they make on behalf of the federal government. After all, cost incurred to carry out such obligations is separate from the expenses that are borne in the course of normal administration or businesses!

When the federal government has entitled itself to compensation (duly endorsed by the Parliament) for work that it does for others, then what prevents the legislation for similar compensation to those who toil relentlessly in collecting massive amounts of taxes for the Centre's treasury? This (mal)practice on the part of federal government constitutes not only forced labour, which is unlawful under Article 11(3) of the 1973 Constitution, but is also tantamount to modern-day slavery that is prohibited under Article 4 of the Universal Declaration of Human Rights: "No one shall be held in slavery or servitude; slavery and the slave trade shall be prohibited in all their forms."

One does not have to be a proclaimed slave for falling in the category of victim of slavery. In fact, it is the substance of the matter (nature of a job) that determines emancipation or otherwise. Therefore, when the federal government obligates withholding agents for collection of taxes on its behalf, it must bear in mind that these agents will have to spend substantial money to fulfill the imposed duty. This involves, in case of the corporate sector, an exclusive department with its own set of employees and other infrastructure that consumes a hefty chunk of their gross profit, which eventually leads to reduction in overall business profits and dividends. Of course, if any laxity or default is committed in the course of this bonded labour, then the withholding agents are subjected to penalties, additional taxes and even prosecution.

Shifting the burden of its responsibilities on withholding agents, the federal government has the audacity to remain insensitive to their woes. Over the last few years, it has been observed that with each passing day not only is this burden increasing but strong coercive methods are also being introduced to supervise their activities.

The Finance Act 2008 has inserted a new authority, the Directorate General of Withholding Taxes, in Section 230A of the Income Tax Ordinance, 2001. This directorate will exercise unbridled, unfettered and unlimited powers in whipping and lashing the 'withholding slaves', forcing them to submit to their masters without as much as raising a meek voice against them, what to talk of demanding some compensation for their labour. How else can a picture of slavery be painted? If this were not bonded labour, then would the government please clarify exactly what is meant by slavery or servitude?

Surprisingly, despite there being a huge department for collection of various taxes and duties, the major portion of revenue target achieved during a fiscal year is dependent upon the efforts of withholding agents. Instead of performing the duty of collecting taxes themselves, the revenue officers are largely engaged in overseeing the work of these agents -- as if they were their employees (or slaves?). Employees of the government earn salaries, but what do slaves get in return? Nothing: only punishment and fear of prosecution even for an inadvertent and small lapse.

It is a pity how an employee of, say the income tax department, can make the life of a withholding agent extremely miserable by his or her arrogance and attitude. There are many instances where withholding agents have been tormented by the presence of such people on their business premises on the pretext of audit and/or examination of accounts related to withholding. All these things could be tolerated if the government was generous enough to compensate these agents by allowing them a cut in the taxes collected by them. This way there would hardly be any grievance.

On the contrary, these agents would perform even better without being threatened of dire consequences. Keeping the corporate psyche in mind, a sensible legislation would greatly enhance revenue collection and reduce the burden of expenses on the withholding agents, guaranteeing a more amiable private-public relationship while upholding the tenets of both the 1973 Constitution and the Universal Declaration of Human Rights.

(The writers, tax advisers, are visiting professors at the Lahore University of

Management Sciences.

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Sindh revenue authority

Source: Daily Dawn

KARACHI, Aug 2: The Sindh Board of Revenue (SBR) has said that the proposal for creation of a Sindh revenue authority is going on since 2001 and the previous government failed to finalise their views on the subject.

Commenting on a news item published in Dawn on July 30, an SBR spokesman said that the present Chief Minister, Syed Qaim Ali Shah, has constituted a committee under the chairmanship of minister of revenue, which has held meetings and will send their recommendations to the chief minister for further action.

The committee members include minister of excise and taxation, representatives of finance department and officials of excise and taxation and board of revenue.