Input Tax Apportionment for a Mixed-Supply Company
A company registered for sales tax in Lahore supplies both standard-rated goods and exempt goods from the same premises. In the tax period it made standard-rated taxable supplies of PKR 70 million and exempt supplies of PKR 30 million, total PKR 100 million. It incurred input tax of PKR 9 million, of which PKR 5 million relates directly to standard-rated goods, PKR 2 million relates directly to exempt goods, and PKR 2 million is common input tax (rent, utilities, administrative salaries-related services) that cannot be attributed to either category. The company's accountant claimed the entire PKR 9 million as input tax adjustment, arguing that because taxable supplies exceed exempt supplies, the whole input is admissible. The tax office has raised a demand for wrongly claimed input tax and is also questioning whether the company should have apportioned common input tax at all.
1. Determine the admissible input tax for the period, showing the treatment of direct and common input tax.
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Input tax must be matched to the supplies it relates to. The correct treatment is:
- Directly attributable input tax on standard-rated goods: PKR 5 million - fully admissible, because it is consumed in making taxable supplies.
- Directly attributable input tax on exempt goods: PKR 2 million - not admissible, because exempt supplies do not carry input tax credit.
- Common input tax of PKR 2 million - apportioned between taxable and exempt supplies on a reasonable basis, normally the ratio of taxable turnover to total turnover.
Apportionment: taxable supplies PKR 70 million / total PKR 100 million = 70 percent. Admissible common input = 70 percent of PKR 2 million = PKR 1.4 million. Inadmissible common input = PKR 0.6 million.
Total admissible input tax = 5 + 1.4 = PKR 6.4 million. The claimed PKR 9 million is overstated by PKR 2.6 million (2 million direct exempt input plus 0.6 million common input).
Conclusion: the accountant's 'taxable exceeds exempt' argument is not a valid basis for full adjustment; direct attribution plus proportional apportionment of common input is required.
2. The company argues that common input tax such as rent and utilities should be fully admissible because those costs support the taxable business. Evaluate this argument and state what documentation supports the apportionment.
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The argument fails because common input tax by definition supports both taxable and exempt activities. The sales tax law does not permit full credit for input tax that is not wholly attributable to taxable supplies; it requires apportionment where a registered person makes both taxable and exempt supplies. Accepting the company's view would give a credit for tax embedded in exempt-supply costs, which is contrary to the design of the tax.
Supporting documentation the company should retain:
- Sales tax returns and invoices for the period showing taxable and exempt turnover separately.
- Purchase invoices and input tax register identifying which inputs relate to which supplies.
- A documented apportionment formula (turnover ratio), consistently applied and approved in the accounting records.
- Rent agreements, utility bills, and service invoices supporting the common input amount.
- Working papers showing the computation of admissible and inadmissible input tax.
A reasonable and consistently applied basis is acceptable, but it must be documented. If the turnover ratio fluctuates, the company may use a provisional monthly apportionment with an annual adjustment.
Conclusion: the common input is only partly admissible; the company should reverse PKR 0.6 million and maintain records supporting the 70 percent apportionment.