Income Tax Policy Options and Enforcement Measures

INCOME TAX POLICY OPTIONS AND ENFORCEMENT MEASURES <!--[if gte mso 10]> INCOME TAX POLICY OPTIONS AND ENFORCEMENT MEASURES By M. Iqbal Patel, F.C.A., Karachi The Government of Pakistan has adopted a comprehensive program of microeconomic stabilization and sustainable development as set out in the Memorandum of Economic and Financial Policies for November, 2008-June, 2010, to be supported by the International Monetary Fund (IMF) under a 23 month Stand-By-Arrangement (SBA). The Federal Board of Revenue (FBR) is required to submit legislative amendments on number of tax policy and administration measures envisaged during the program period with objective of substantially increase in tax revenue to parliament by end June, 2009. The IMF's first review program will focus on the progress in developing the government's tax reform agenda. Tax policy.---The taxation policy of Pakistan is complex, inequitable, suffers from distortions, exemptions, inconsistent, tax burden is unevenly distributed, subject to frequent change. Over 80% tax revenue is generated through indirect taxes that are universally believed to be regressive. Above all the tax policy is victim of politics, resultant the nation is poor and the few class of persons are wealthy. The government has enhanced the taxation target for the current fiscal year from Rs.1.25 to Rs.1.36 trillion under IMF directives whereas there no corresponding measures are planned how to generate this additional Rs. 110 billion. The Government is to explore indigenous revenue sources to achieve target with accelerating efforts to expand tax base. Though the government has many options to widen the tax net by encompassing more potential sectors of the economy for revenue generation and rounding up all exempted money generating sectors into the tax net but it lacks political will to do so and strong leadership. Tax base.---The present tax policy suffers from narrow tax base, widening of the tax based is talked about since age-old by the tax officials and experts. The IMF has also realization of this fact and therefore, has conditioned in approving its rescue package for its expansion. Surely the global lender would surprise to know that the FBR received total 1:7 min returns in the tax year 2008 which is mere 1% of total population of 170 min of the country. Further astonishing fact is that out of these returns filed, half that is 800,000 tax returns were of salaried persons. It also matters to consider that how many out of 900,000 returns filed by the business entities and others, have declared taxable income and tax was actually paid by them. The finance Advisor of Prime Minister, Shaukat Tarin conceded the fact at the recent conference on Tax Policy Options held by the FBR in compliance with the term of a Letter of Intent (LoI), to review tax policy and administration. But successive governments have failed to broaden the tax net as they lacked political will to take measures which could bring all categories of taxable income into the ambit of tax laws. It is the main reason that tax-GDP-ratio of Pakistan is low at 9.6% in the region. Though it is not acceptable level of tax efforts but it will remain at this dismal level as long as the number of tax payers remains low. The question is that why the level of taxpayers is so low despite the fact that there has been a conspicuous growth and prosperity in particular segment of the society. The corporate sector contributes 24% of GDP but it contributes 66% in tax collection whereas agriculture and services contribute 22% and 54% to GDP respectively but their contribution to tax collection is negligible. This scenario calls for radical changes in the tax policy in which tax burden is evenly distributed on all the revenue generating potential sectors. There is need to bring them into tax-net so as to each of them should contribute according to their ability to the national exchequer. Drive to widen tax base.---There is need to enhance the co-ordination of the FBR among the utility agencies such as electricity, gas and telecommunication and others requiring them to collect NIC numbers from their consumers at the time of payment of their bills and communicate this information to the FBR who should register the consumer on their record and issue NTN to them and issue notice to provide prescribed information on simple Form submitted to them along with the notice. Thereby gathering of information in this way from the millions of the consumers will go long way to dig out some of them who are eligible to file the return but failed to do so. Similarly there is big gap between the companies registered with the Securities. Exchange Commission of Pakistan (SEC) and number of companies who file returns, co-ordination of the FBR with SEC to collect the information of the companies registered with it and the detail of their sponsors/directors will help to bring the non-filers into tax-net. In this regard the World Bank's advise to the FBR to use information from external sources to bring new companies into tax net, needs to be followed by the FBR in letter and spirit. Similar efforts in other area will certainly enhance the tax-net such as there are millions who derive income from dividend who are subject to withholding tax there from but are missing from record of the tax-authorities. Scrutiny of the withholding statements filed by the companies paying dividend, allotting them NTN and issue of notices along with a Form requiring them to submit the same duly filled in will bring many new taxpayers on the tax record. In fact accelerating efforts are required on the part of the tax officials which will go long way to expand the tax-net. There is considerable room to realize actual tax potential on stock exchange transactions under section 233A, passenger transport under section 234, CNG Stations under section 234A, electricity consumed by commercial/industrial consumers under section 235 and telephone subscribers under section 236 to broaden the sphere of collection of taxes provided withholding tax on them is closely monitored. Further withholding tax is being deducted from cash withdrawals from banks under section 231A, on prize bonds and other prizes under section 156 and on profit on debt paid by the banks under section 151,has tremendous potential to enhance the tax-net. The FBR in this connection will have to co-ordinate with the State Bank of Pakistan, and Pakistan Banks Association to access the bank records to ascertain whether tax under the above said provisions have duly been withheld and deposited into national exchequer by the banks/financial institutions. The other most neglected area from the withholding tax is rental income, which needed to be targeted for improving direct taxes collection and ultimately expand tax-net. The FBR requires to compile a database on properties by collecting information from provincial governments, concerned local authorities, development agencies, cantonment boards and other authorities including co-operative societies. The data so collected should be utilized for effective monitoring of deduction of tax under section 155 at the time of making payment of rent of immovable properties. There a large scale survey is required to check whether foreign missions in Pakistan, who have hired hundreds of houses in the federal capital, hospitals, schools, associations of persons, trusts and non-profit organizations, who frequently hire buildings are duly deducting withholding tax on rental income and have deposited the same into government treasury as required under law. Similarly in case of big development authorities like CDA, defense and co-operative societies where large number of houses are let out to company's, trusts and the provincial authorities requires immediate attention of FBR. The collection of tax from rental income is an area of huge revenue potential but has been excessively neglected. There other area to expand tax-net is withholding tax collection from commission paid on sale of petroleum products to petrol pumps. The section 156A provides for every company selling POL products to the owners of the petrol pumps is required to deduct withholding tax @ 10% of the commission paid on these sales. There hundreds of petrol pumps are operating countrywide and they have different distributors. However, there is no mechanism in place to regularly monitor withholding tax collection from the amount of commission allowed to petrol pump operators. The importers of oil included a large number of public and private companies taking advantage of deregulated petroleum sector. All such companies are engaged making purchases through agents and brokers. In view of huge turnover of POL products involved, there is revenue leakage, which needs to be checked through collection of withholding tax at source. Income tax is chargeable under section 156 on the winners of prize bonds, lottery, a raffle, lottery, quiz or crossword puzzle. The winners of lotteries, raffles and prizes on sales promotion of various products by telecom, petroleum companies have massively evaded taxes, committing serious violations of the Ordinance. Most of the winners are paying no income tax on prizes won through lucrative promotional schemes announced by the telecommunication and petroleum companies. It seems that FBR is not taking interest for collection of tax on lotteries, prizes for promotional sales and puzzles etc. It relies only on the State Bank of Pakistan who deducts tax from the prizes on the bonds issued by the government. The telecom and petroleum retailers etc. are paying a lot of prizes on purchase of their products by consumers. If this source is religiously pursued, the government can generate a lot of money. There requires strict enforcement of the provisions of the Ordinance to ascertain the tax due to be withheld and tax actually withheld under the provisions of this section. The most important aspect of tax deducted at source is to ascertain whether the tax deducted by the withholding agent is deposited into the government treasury as required under the Ordinance. For instance the Collectors of Customs are withholding agents under section 148, but it is observed within tax department that they do not comply with the provisions of the Ordinance. The evasion opportunities are abundant in case tax withholding at import stage being existence of system of exemption from tax deduction in the Ordinance. The monitoring of this source and reconciliation of withholding tax collected at the import stage and subsequently it is credited to the exchequer would check discrepancy, if any , in the figure. The FBR should implement the World Bank's advice to chalk out an enforcement strategy with specific actions to deal with non-compliant taxpayers particularly withholding tax agents and non-filers of income tax returns for broadening the tax base. FBR taxation plan.---Although the FBR already has prepared a 10-year Taxation plan, "Vision 2016" to raise tax-GDP-ratio to 14.5-15% in the next ten years, starting from 2007-08 to '2016-17, increasing the collection of tax revenue to Rs.4.3 trillion in 2016-17. The main thrust of the plan is to, bring each and every .potential sector into the tax net including agriculture. Since the plan has been approved by the former President General Pervez Musharraf, the FBR should implement this home grown plan instead of taking the exercise again under the directives of IMF, as it has as much sanctity as 17th amendment of the Constitution which is enforced by the democratic government. The analysis of present Income Tax Ordinance 2001 (Ordinance) reveals many potential sectors have been exempted from tax. The government should adopt prudent tax policies that would contribute to gradually enlarge the number of taxpayers, enhance income tax revenue and increase the tax-GDP-ratio to an acceptable level at 15% within the next five years and also expanding the static tax base which is possible only when all exempted money generating sectors provided in the Ordinance are rounded up into tax-net. Agriculture Income.---The section 41 of the Ordinance exempts any income derived by a person from land the largest sector of the economy. But it is kept out of tax net which is a major hurdle in widening the tax base and is ensuring equity, as almost the entire income tax collection is shared by trade, industry and salaried class. The tax base could be broadened without much hassle if there is commitment to do so by the government. It is alleged that the strong lobby of landed gentry has been impeding levying of tax on agriculture thus driving the nation to widen the tax base. The arguments offered by the opponents of levy a tax on agriculture paint a dark picture to show that they are overburdened with indirect taxation, incidence of poverty in the rural areas coupled with ever-increasing input cost all have made their life miserable. Their arguments do not hold good. Because all sectors or taxpayers pay indirect taxes and subject to high cost of doing business, but they all pay direct income tax too. It is also argued that Constitutional amendment is necessary to bring the agricultural income into tax net. This is one of the misconceptions and misrepresentation on the agriculture taxation. The former Prime Minister, Mr. Z.A. Bhutto, who was leading a party of landed gentry, had introduced tax on agricultural income through Finance Act, 1977 without making any Constitutional amendment. The present government may follow the suit provided it has political will to do so. The mechanism provided in the aforesaid Act was judicious as the agricultural tax collected was required to be deposited in the provinces wherefrom it was collected. Thus revenue generated would be utilized for alleviation of property of rural areas and in creating other infrastructure of the area wherefrom the revenue is raised. Although presently the so-called agricultural tax is collected by the provinces but it is ineffective being collection by all the four provinces is hardly amounted Rs.300 min. The FBR's study revealed that if the collection of farm tax is transferred to Federal Government, it can collect Rs.60-70 bin from agricultural tax. The agriculture is contributing 22% to the GDP but its contribution in taxes is negligible. It is indeed shocking that the lawmakers keep themselves out of tax net who in fact are the main beneficiaries of tax revenue. It is need of the hour that the sector should be taxed in the same manner as other sectors are contributing to achieve revenue target. It is necessary to remove controversy on agriculture tax, the basis of tax on agriculture income needs to be changed. As a matter of fact presently the farm tax is collection on the basis of the size of the land holding which is not correct basis as it would be just like to levy tax on the size of premises of an industry. In order to remove controversy on agriculture tax it is necessary to change the basis of such taxation. The tax on agriculture income should be computed on actual income earned from the sale of agricultural produce in a manner as provided in case of business under section 18, that any income derived by any trade, professional or similar association from the sale of goods is chargeable to tax under the head Income from Business. Thus income earned through sale of agriculture produce may be determined under the provisions of the Ordinance applicable in determining the taxable income under the head Income from Business. This concept treating the agriculture activity as business activity gets further support from exemption allowed from deduction of tax at source in the S.R.O.586(I)/91, dated 30-6-1991, to the recipients. of payments from a company exclusively for the supply of agricultural produce. Moreover, the FBR has also worked on proposal to collect tax from agriculture sector on income basis against existing provincial practice of collection it on land holding basis as disclosed by former Chairman, M. Abdullah Yusuf in a press conference. However, the section 41 has extended the agriculture income to rental income derived by a person from land or building used for agricultural purposes, is not correct in view of decision of Indian Supreme Court who has held that extension of the term agriculture to any activity which has some connection with or is in some way dependent on land is not sufficient to bring it within the scope of the term of agriculture is unwarranted. This concept has been recognized by FBR in their circular 6/1958, dated 28-4-1958. The section 41 may accordingly be considered for omission in the light of the above discussion and the section 18 may accordingly be amended to extend the taxation on sale of agriculture products, Capital Gain on Real Estate.---The section 37 of the Ordinance taxes a gain arising on the disposal of capital asset by a person in a tax year but it exempts a gain arising on disposal of an immovable property. Thereby gain on real estate is beyond scope of taxation under the Ordinance which encourages speculation and non-productive investment. This sector may also be considered for levy of capital gain tax on real estate which is necessary to discourage investment in non-productive and speculative activities. In this regard a healthy fiscal measure was initiated through Finance Bill 2008 which had imposed a minimum direct tax on the developers/builders engaged in the business of construction and sale of residential and commercial plots/houses. But the Finance Act 2008 converted it into indirect tax and shifted the tax burden from the developers/builders to the general public engaged in buying of residential and commercial houses for collection of excise duty from them instead of directly collecting income tax from the influential real estate builders and developers. The government's this policy change did not only defeat the objective to bring the real estate into tax net but also encourages undocumented developers and promoters in the real sector. This tax policy change needs reconsideration to reverse it as it was originated. The section 37, may be considered to amend it by bringing an immovable property in the definition of capital asset for the purpose of application of provision of this section. Capital Gain Tax on Redeemable Capital.---The section 53 of the Ordinance exempts the income or persons specified in the second Schedule from tax. Accordingly Clause (110) exempts any income from the sale of modaraba certificates or any instrument of redeemable capital, listed on any stock exchange in Pakistan or shares of a public company up to tax year ending on June 30, 2010. The exemption of capital gain on sale of shares was introduced in the Income Tax Ordinance, 1979 (repealed) which was expiring on 30-6-1983, but with a view to encouraging investment on the stock market was extended up to 30-6-1988; since then over a quarter century has passed, it has always been extended in annual budgets on the same repeated ground. Though it is admitted fact that the stock markets have grown and reached to maturity to the extent that the main players/members have become the big capitalists and owns industries, banks, financial institutions in addition to big brokerage houses. Despite this fact continuation of exemption of capital gain income on stocks, therefore, is not justified in view of rise in capitalization and exceptionally high volume of stock transactions in the stock exchange markets which is evident that the stock business has been very well established. Further sound principle of taxations demands that income derived from whatever source ought to be taxed. Exemption on CGT is a classical example to demonstrate that the principle of taxation applicable in our country is inequitable and unfair because a small genuine investor is liable to pay income tax @ 10% and also zakat @ 2.50% on his dividend income; whereas huge amount of CG is not chargeable to tax. Moreover, the exemption on CGT is allowed without prescribing any condition of holding period of shares etc. it makes the exemption more vulnerable. The imposition of capital gain tax on stocks transactions has become necessary to discourage speculative and non-productive investment as witnessed the stock markets were crushed. The Planning Commission has recommended in 2007 for imposition of CGT on stock and real estate transactions. The Securities Exchange Commission of Pakistan though believes that the economy is losing sizable revenue by not levying CGT on trading in the share market, but is in favour of continuity of exemption of CGT, subject to provision is made in the law for a holding period of securities for minimum three months, the gain may be taxed as per the tax laws to discourage speculative trading for short term gain in the stock markets. In India and UK, CGT exemption is allowed only subject to the condition of minimum holding period of securities while investors in Pakistan have no such condition. The Clause (110) may be omitted and gain arising on sale of securities may be made chargeable to tax under section 37 in order to levy of CGT on stock transactions which would generate sizable revenue and discourage speculation. Other exemption under 2nd Schedule.---The Second Schedule specifies exemptions/concessions from various incomes, reduction of tax rates and tax liability The Schedule creates a privilege class of persons, such as legislatures, judiciaries and arm forces, who have been given special treatment in respect of their income and perquisites free from tax. An ordinary citizen who earns a small amount exceeding Rs.100,000 per annum is made liable to pay income tax under the Ordinance irrespective of size of his family, expenses on education, health and maintenance expenses; whereas the privileged class mentioned above enjoys exemption not only of their income but on all their unlimited perquisites. The perks and packages of the ministers and the legislatures on luxury cars, posh houses and foreign tours etc. runs in millions and ultimately have to bear the load, by the taxpayers. The lawmakers have exempted themselves from taxation as much as possible. The tax policy is, thus non-judicious it should eliminate these distortions and anomalies by bringing their perks into tax net. Furthermore it provides for exemption to class of persons without assessing their benefits and objectives set for their exemptions are achieved. For instance under Clause (132) lifetime exemption from income tax is allowed to the power projects, but the country failed to achieve its objective to be self-sufficient in power sector as evident from chronic power crisis facing the country. There is need to scrutinize the Schedule with a view to introduce the measures that would lead to introduction of an equitable system of tax wherein relief is provided to the poor classes and remove distortions in the economy. Withholding taxes (WHT).---The government's major reliance for collection of income is on withholding tax system. It contributes over 60% of total collection of income tax. There are approximately 20 categories of withholding tax agents, who have to deduct tax from under various provisions of the Ordinance and deposit it into national exchequer. They are also required to file monthly and annual withholding tax statements. The system of WHT is inconvenient and cumbersome for the withholding agents who are strictly monitored by the tax officials of respective jurisdiction. However, the system is not properly followed by the public sector development projects, foreign missions in Pakistan, Collector of Customs and banks, do not comply with the respective provisions of WHT of the Ordinance. If the tax authorities make them to comply with the provisions of WHT And monitor strictly the withholding statements filed by the withholding agents, massive tax evasion can be checked by them and tax net can be expanded considerably. Moreover, WHT system creates distortions in the taxation system being many taxes deducted at source are considered full and final payment of tax liability of a taxpayer. Thus the taxpayers falling under presumptive tax regime (PTR) neither undergoes under exercise of assessment of their income as provided in the Ordinance nor are probed by the tax officials in respect of the income or tax liability declared by them. This aspect of PTR makes a parallel tax system which needs to be reviewed to abolish the PTR system of WHT. Tax rates.---The tax rates are higher and needs downward revision. It is learnt that the government as usual this time also intends to enhance the rate of some of the withholding tax rates in order to meet the enhanced tax target. If the government will resort to this practice, it would be a source of inequity and will promote non-compliance or incentive for tax evasion. It would also defeat the ongoing Tax Administration Reform Programme (TARP) sponsored by World Bank and TFID which mainly focus on promotion voluntary tax compliance. The common man is already overburdened by ever-increasing cost of basic needs such as escalation in electricity, gas and other food stuff prices, in case tax rate are increased further, it will further make their life miserable. In fact our serious problem is not tax revenue but very serious problem with our fiscal policy is that the government doesn't give enough consideration to containment of expenditures which is more important than revenue generation. It gives priority to party agenda over national interest on one hand and the influence of powerful lobbies that always have a vested interest in keeping themselves out of tax net on the other hand. The government should realize that we find ourselves in a pretty dire situation, the rulers class should adhere to a path of fiscal discipline.