Demystifying the Input Tax Disallowance Notice: Documentation to Support Your Claim

In Pakistan's dynamic business environment, navigating the intricacies of indirect taxation, particularly Sales Tax, is a constant challenge. One of the most formidable hurdles taxpayers can face is the issuance of an Input Tax Disallowance Notice by the Federal Board of Revenue (FBR). This notice, if not addressed effectively, can lead to significant financial penalties and increased tax liabilities. Understanding the underlying reasons for such disallowances and, more importantly, knowing what documentation is crucial to defend your input tax claims is paramount for every business owner, tax professional, and corporate decision-maker. This guide will equip you with the knowledge to proactively prepare and robustly support your claims when faced with this critical compliance scenario.

Understanding the Input Tax Disallowance Notice

An Input Tax Disallowance Notice typically arises when the FBR, during an audit or scrutiny of tax returns, identifies discrepancies or perceived non-compliance related to the input tax credit claimed by a registered person. Input tax refers to the sales tax paid by a registered person on the supply of goods or services made to them, which they can otherwise claim as a credit against their output tax liability. The FBR's objective is to ensure that only legitimate and verifiable input tax claims are allowed, preventing revenue leakage.

Common Grounds for Disallowance

Several factors can trigger an input tax disallowance. Recognizing these common pitfalls is the first step in effective prevention:

• Non-issuance of Valid Tax Invoices: The cornerstone of claiming input tax is the possession of a valid Sales Tax Invoice (STI) issued by a registered supplier. Missing or invalid STIs are a primary cause for disallowance. A valid STI must contain specific prescribed information as per the Sales Tax Act, 1990.
• Suppliers Not Registered or De-registered: Claiming input tax from suppliers who are not registered under the Sales Tax Act, 1990, or who have been de-registered by the FBR, is a direct contravention and will lead to disallowance.
• Discrepancies in Supplier's Returns: If the sales tax reported by your supplier in their Sales Tax Return does not match the amount on the invoice you hold, the FBR may disallow your claim. This highlights the importance of your suppliers' compliance.
• Goods/Services Not Used for Taxable Supplies: Input tax can generally only be claimed on goods and services used or intended to be used in the course or furtherance of your taxable supplies. If the FBR believes the input was for exempt supplies or personal use, they may disallow the claim.
• Late Filing of Returns: There are specific timelines for claiming input tax. Failing to claim input tax within the prescribed period (generally within six months of the end of the tax period in which the tax was paid) can lead to its disallowance.
• Discrepancies with FBR Databases: The FBR increasingly relies on integrated data. Discrepancies between your declared input tax and information available on FBR's systems (e.g., supplier's reported sales) can lead to notices.

Essential Documentation to Support Your Input Tax Claims

The adage 'the burden of proof is on the taxpayer' is particularly relevant when defending input tax claims. Proactive and meticulous documentation is your strongest defense. Here's a comprehensive list of what you need:

1. Valid Sales Tax Invoices (STIs)

This is non-negotiable. Ensure every STI you rely on is:

• Issued by a Registered Supplier: Verify the supplier's registration status at the time of the transaction.
• Contains All Prescribed Particulars: As per Section 23 of the Sales Tax Act, 1990, and related rules, a valid STI must include:
  • Name, address, and Sales Tax Registration Number (STRN) of the supplier.
  • Name, address, and STRN of the recipient.
  • Date of supply.
  • Description, quantity, and value of goods or services.
  • Sales tax amount charged.
  • A unique sequential invoice number.
• Original and Legible: Ensure the invoice is not a photocopy that is illegible or damaged.

Action Item: Implement a robust system for receiving, verifying, and archiving all STIs. Consider a digital archiving system for easy retrieval.

2. Proof of Payment

While the STI establishes the tax liability, proof of payment demonstrates that you have actually paid the sales tax to your supplier. This is crucial for substantiating your claim.

• Bank Statements: Showing the debit entry for the payment made to the supplier.
• Payment Vouchers: Supported by bank transfers or cheque copies.
• Remittance Advice: For electronic fund transfers.

Note: For cash payments exceeding the prescribed limit (currently PKR 50,000, as per Section 22A of the Income Tax Ordinance, 2001, which often influences indirect tax considerations), FBR may question the deductibility/claimability if proper banking channels are not used. While not directly a Sales Tax Act provision, it's an indicator of FBR's preference for documented transactions.

Example: If you paid your supplier PKR 1,000,000 for goods, and PKR 150,000 was Sales Tax, your bank statement must clearly show the entire PKR 1,000,000 payment to the supplier. Partial payments or payments not directly traceable to the supplier can be problematic.

3. Goods Transport Documents

For goods-based businesses, transportation documents are vital to prove the movement of goods and their intended use for your taxable supplies.

• Delivery Challans: Especially if goods are delivered directly to your premises.
• Inland Transportation Bills: If you hired third-party logistics.
• Loading/Unloading Receipts.

These documents, when cross-referenced with STIs and delivery notes, help establish the physical receipt of goods for your business operations.

4. Contracts and Agreements

For services, or for goods supplied under specific arrangements, contracts provide context and evidence of the nature of the transaction and its relation to your taxable supplies.

• Service Agreements.
• Purchase Orders: Detailing the goods/services ordered.
• Memoranda of Understanding (MOUs).

These documents can help demonstrate that the input was genuinely for your business activities, particularly if the FBR questions the nature or purpose of the expenditure.

5. FBR Verification of Supplier's STRN

Proactively verifying your suppliers' Sales Tax Registration Numbers (STRNs) is a best practice. While not always mandatory for the claim itself, it significantly strengthens your position if a disallowance notice is issued.

• FBR's Online Verification Portal: Regularly check the validity of your suppliers' STRNs on the FBR website.
• Record of Verification: Maintain a log of when you verified each supplier's STRN.

Pro Tip: If a supplier's STRN becomes invalid after you've transacted with them, your claim may still be valid provided you can demonstrate that you reasonably believed they were registered at the time of the transaction and that they have accounted for the sales tax. However, relying on outdated information is risky.

6. Records of Business Operations and Usage of Goods/Services

This is where you demonstrate that the goods or services for which you claimed input tax were indeed used in the course or furtherance of your taxable supplies.

• Production Records: Showing raw materials used.
• Inventory Records: Tracking goods purchased and sold.
• Service Delivery Records: If the input was for services used to provide your taxable services.
• Fixed Asset Register: For capital goods.

These internal records provide the operational context that validates your input tax claims.

7. Reconciliation Statements

Regular reconciliation between your purchase records, STIs, payment records, and your filed Sales Tax Returns is crucial. This helps identify and rectify discrepancies before they attract FBR attention.

• Supplier-wise reconciliation.
• Period-wise reconciliation.

Example: You have STIs worth PKR 1,000,000 from Supplier A for a quarter. Your bank statements show payments totaling PKR 950,000 to Supplier A for that quarter. This discrepancy needs investigation and explanation. Furthermore, comparing the total input tax claimed in your return against the sum of tax on all valid STIs is essential.

Responding to an Input Tax Disallowance Notice

Receiving a notice can be stressful, but a structured and evidence-based response can significantly improve your chances of success.

Step-by-Step Response Process:

1. Acknowledge Receipt and Understand the Notice: Carefully read the notice. Identify the specific period, the value of input tax being disallowed, and the stated reasons for disallowance. Note the deadline for response.
2. Gather Supporting Documentation: Collect all the relevant documents as outlined above for the specific transactions or periods in question.
3. Conduct Internal Review: Analyze the reasons provided by the FBR. Does the notice reflect a genuine misunderstanding, an error in your records, or a flaw in your supplier's compliance?
4. Prepare a Detailed Written Response: Address each point raised by the FBR systematically.
5. Submit Documentation: Attach copies of all supporting documents to your written response. Ensure you keep originals safe.
6. File within the Deadline: Timely submission is critical. Missing the deadline can forfeit your right to object.
7. Follow Up: Track the status of your response and be prepared for further queries or a personal hearing.

Common Mistakes to Avoid:

• Delaying the Response: The longer you wait, the harder it becomes to retrieve information and the more likely it is that deadlines will be missed.
• Providing Incomplete Documentation: A response without proper evidence is unlikely to succeed.
• Making Assumptions: Don't assume the FBR's understanding is correct. Clearly present your case with facts and evidence.
• Not Verifying Supplier Compliance: Failing to check if your suppliers are compliant can have downstream consequences for you.

Legal Basis and FBR Guidelines

The FBR's authority to disallow input tax stems from various sections of the Sales Tax Act, 1990, particularly those relating to the conditions for claiming input tax credit (e.g., Section 8) and the powers of audit and assessment (e.g., Section 25). FBR Circulars and General Orders often provide further clarification on the interpretation and application of these laws. While specific SROs are dynamic, any SRO that modifies the conditions for input tax claims or reporting requirements would be directly relevant. It is advisable to consult the latest FBR guidelines and amendments to the Sales Tax Act, 1990.

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Key Takeaways:

• Meticulous record-keeping of Sales Tax Invoices and proof of payment is fundamental.
• Proactive verification of supplier registration status is a critical risk mitigation strategy.
• Operational records demonstrating the use of goods/services in taxable supplies are essential.
• A timely, structured, and evidence-based response to FBR notices is paramount.

Frequently Asked Questions (FAQs)

Q1: What is the time limit for claiming input tax credit in Pakistan?
Generally, input tax credit must be claimed within six months of the end of the tax period in which the tax was paid. However, it is always best to refer to the latest provisions of the Sales Tax Act, 1990, as this can be subject to amendments.

Q2: Can I claim input tax if my supplier fails to file their sales tax return?
While the Sales Tax Act, 1990, primarily links input tax claim to the possession of a valid tax invoice, FBR's practical approach often considers the supplier's compliance. If your supplier has not declared the sale and paid the tax, the FBR might disallow your claim. This underscores the importance of maintaining good relations with compliant suppliers.

Q3: What happens if I cannot provide proof of payment for an input tax claim?
Without proof of payment, the FBR is likely to disallow the input tax claim, as it demonstrates that you have not, in fact, borne the cost of the sales tax. Bank statements and payment vouchers are crucial here.