CONSTITUTIONAL ANOMOLIES & EXEMPTIONS IN TAXATION CAUSE LOSSES

CONSTITUTIONAL ANOMOLIES & <!--[if gte mso 10]> CONSTITUTIONAL ANOMOLIES & EXEMPTIONS IN TAXATION CAUSE LOSSES By Ibqal Patel, Chartered Accountant, Karachi The income tax had been the principal source of Revenue for the Federal Government now it stands next to sales tax. Its contribution to tax revenue stood at 31 % in 2005 and its share in GDP has increased to around 9 % of GDP. Despite these reassuring statistics, there is widespread disaffection with tax policy of the Government. There is a consensus among a broad spectrum of the stakeholders 'that the present taxation system breeds mistrust and feel that with-out a fundamental redesign of the tax policy, the Government may find difficulty to meet its ever increasing- demands for revenue generation. There are several factors that have resulted in this state of affairs. Some of them are rooted in the income tax legislation, others are an outcome of the Constitutional structure of the country, and others are the result of a complex web of lobbying and political compromises. The exemptions are allowed to various types of incomes in the Second Schedule of the Income Tax Ordinance, 2001 (Ordinance) are examples of tax policies and of political compromises with implications for tax administration which are not within the ambit of the tax authorities. Similarly, exemption allowed to agricultural incomes from federal income taxes is the most glaring example which has its basis in the Constitution of the country, that in turn limits the taxpayer base and increases the burden of tax on the non -agriculture and non-corporate sector. The section 41 of the Ordinance, in line with Constitutional provision, exempts agricultural income derived by a person from tax under the Ordinance. Although the tax to GDP ratio has increased to 9% in 2005 but still it is the lowest in the region. The reason being that the sector creating the great distortion is the agriculture sector by not paying tax proportionately to its share to GDP. It has been felt that agriculture having 21.5% of GDP but has lowest contribution of only 1.2% in taxes which is main reason of lowest tax to GDP ratio. This lowest contribution of agricultural sector highlights the need to bring this untapped income into tax net for broadening tax base. The late Z.A.Bhutto had introduced for the first time the tax on agricultural income. But the late General Ziaul Haq after takeover of the Government, among others, repealed this reform without making any formal announcement and won his side all the feudal that have powerful patrons and they continue to be the best of democracy, military rule and mix of the two till this day. It is now argued that agricultural income is provincial subject matter and it is being taxed by them. The agricultural related taxes were introduced in Sindh in 1994 since then agricultural tax is on declining in the last four years. Its collection was Rs 201 min in 2003-04 compared to Rs. 444.77 min in 2000-01. Although fact is that the rural elite gets 33 % subsidy on electricity bill of their tube wells, agricultural loans disbursed during July-March 2004-05 amounted to Rs.73.8 bn against Rs.47.9 bn during the corresponding period last year, in addition the loans given by commercial banks surpassed Zarai Taraqiati Bank for the third consecutive year at concessional rate of interest, allowed free of duty import of tractors, supply of fertilizers at cheaper rate, despite all these incentives allowed to them at a substantial cost to the tax years, but hardly they pay farm tax on their income. The second category as a result of political lobbying and Constitutional anomalies is the exclusion of the immovable property from the ambit of capital gain. The section 37 of the Ordinance excludes any immovable property from the definition of capital asset, in line with item 50 of the Federal Legislative List Part-I, Fourth Schedule of the Constitution. Thus the imposition of tax on the capital gains arising from transfer/sale of immovable property is beyond the taxing power of the Federation. Addressing a seminar, the CBR Chairman said to the business community that black economy has no future in the country whereas gain on sale-purchase of immovable property/open plots is exempted from tax constitutionally which fuel black economy and raise the prices of the properties beyond the reach of the genuine buyers. It also encourages the speculative business in the stock market. The Economic Survey Report 2004-05 indicated that as compared to the last few years, in the year 2004-05 the cost of exemptions in taxes had registered a massive growth. By 25.5% to Rs.24.85 billion from Rs. 19.80 billion in the year 2003-04 as sector wise break up is given the in table below: 2004-05 2003-04 (Rupees in Bln) Customs 12.38 4.40 Sales tax 7.85 9.25 Income tax 4.60 6.15 Central Excise Duty 0.02 - Total Rs. 24.85 19.80 It will be observed from the above table that revenue loss due to exemptions available under customs increased by 181.4% dining the year 2004-05 compared to such losses under other statutes. The total number of exemptions available to taxpayers under the Second Schedule Part I to the Ordinance stands around 100. And total cost of these exemptions under income tax head stood at Rs. 4.60 bn during the 2004-05. It may be noted that this exemption amount did not include of total exempt income under agricultural sector nor capital gain. Further that break up of the said 100 exemptions shows that around 20 % of them are related to the salaries, allowances and perquisites derived by the members of Armed/Air Forces of Pakistan and Pakistan Navy and about 10 % of them relates to the legislatures, the Government officers and judiciary. Further analysis of revenue collection and exemptions allowed in 2004-05 shows that revenue collection from customs was third in rank at Rs. 113.9 on equal to 19% of total collection made in 2004-05 whereas the loss of revenue occurred to the national kitty owing to duty exemptions was at the top of it at Rs. 12.78 on. Further collection from GST was at the top than other sources of revenue at Rs.239.53 on equal to 41 % of total revenue generated in 2004-05. Further break up of it shows that 40% revenue from GST was from domestic consumers and 60% was attributed at import stage. Revenue from direct taxes contributed of Rs. 182.7 on in 2004-05 which was 44% of total indirect tax revenue collected. This trend shows that revenue target surpassed the original target of Rs.580 on for 2004-05 was attributable to the import activities increased and it did not reflect impressive performance of the tax authorities. Moreover the significance of sales tax has grown over the years, presently contributing 58.7% of indirect taxes or 40.5% of tax revenue. Thereby the common man is burdened with the tax burden more and more which negates the claim of the Government of poverty reduction goal is achieved. However, the import activities increased during the year but revenue on this score did not match with its increase; The share of custom duty collection to total indirect taxes has been reduced to 28% because the import tariff under the donor's pressure has been reduced considerably. The revenue collection from the customs has resultantly decreased. The Government's present policy to reduce the import tariff to the minimum has rendered the imported goods, cheaper than locally manufactured goods available in the markets. The markets are flooded with Chinese goods in particular and of others European countries in general. Consequently local industries are facing closure and unemployment is increasing. The Governments under pressure of the donors who have subjected it to brutal plunder under neo-liberal reforms. The history is the lesson that under the pressure of the donors IMF and WB who forced Zambia to adopt economic reforms under the cover of sweeping trade liberalization, dismantling of public sectors and massive privatization, it was forced to lower tariff on textile imports, especially used clothes, which cause a surge in import of cheap second hand clothing from industrialized countries. Resultant textile sector of the country collapsed but vanished and around 30,000 people lost their job. Similar situation is being created in our country under the beautiful slogan of economic reforms and trade liberalization by the IMF and WB supported by US and their allied countries. Our import bill has surpassed the export earning 32%, local industries are adversely affected and revenue collection from Customs has also decreased. These factors are warning bells for the Government to review its policy on import tariff. It may be understood that increase in aid from the donors gives greater lever to them to impose more conditions on our economy. In the circumstances that the Chairman of C.B.R. has made appeal to the business community to join hands to achieves the ambitious target of Rs.690 bn set for the year 2005-06. In order to expand the tax base, overhauling of the exemptions provided in the Second Schedule is necessary to determine whether the objective set by providing these incentives, the growth of investment or the welfare of the general public is achieved. For instance the income of the Mutual Funds, Modarabas or capital gain income from the sale of shares etc are exempted under different clauses of the Schedule from tax chargeable under the Ordinance needs to be reviewed in the present scenario of growth achieved in these sectors, since these exemptions were allowed to them at a time when these sectors needed incentives in the year 1981 or onward. But presently these Funds have matured enough that they have surplus funds which are utilized for investment in acquiring banks and industrial projects by their operators. These factors are pointers that they no more need exemptions from tax but they may be made to contribute to the national exchequer. It will facilitate the C.B.R. to expand the tax base. It would be interesting to mention the glaring example that recently inserted clause (106A) in the Finance Act, 2005, has exempted from income tax to the corporate entities of WAPDA who were granted exemption from income tax for the assessment years 1998-99 to 2000-01 as per ECCs decision in January 13, 1998. That is after the exemption period has expired for over four years, it has now been exempted with retrospective effect for unlimited period. The agony is that the powers conferred to the Federal Government under section 53 of the Ordinance are being mis-used through its applicability retros pectively. The C.B.R. has double standard policy in respect levying or exempting any income from tax. It also discriminates among the sectors. For instance it is squeezing the manufacturing sector, which contribute 61% taxes, while its share in GDP is only 15.9% whereas it has left the agriculture sector having 21.5% of GDP but its yield in taxes is only 1.2%. The increase in the income tax collection during last few years is mostly due to withdrawal of around 90 income tax exemptions from the Second Schedule of the Ordinance as part of IMFs conditionatlities under the Poverty Reduction and Growth Facility programmed rather than expanding the income tax base. However, it is pointer the scope of expanding of tax base if the exemptions in the Second Schedule be curtailed further. In order to enhance the growth rate there is need to expand tax base but the Government also take into account seriously the losses occurs in the public sector and subsidized Government corporations/ authorities on account of irregularities and mismanagement of the funds. Such as WAPDA who sustained loss of Rs.10.39 bn. Moreover, the Accountant General has pointed out that National Highway Authority sustained loss of Rs.74 bn on account of irregularities in 2002-03. The waste of taxpayer's money in such a manner is a source of discouragement for them to pay taxes. The situation suggests to conduct study on vital tax policy issues for broadening the incidence of tax to all sectors of the economy and giving relief to those sectors which appeared to be over-taxed While the Government claims that the economy has attained high growth but it continue to face several challenges and the Social indicators presents the different picture; poverty continues to affect millions households. The economic governance has to be improved so that the benefits of growth reach to the masses. ***