Undocumented Economy Corporate View

UNDOCUMENTED ECONOMY UNDOCUMENTED ECONOMY CORPORATE VIEW By M. Iqbal Patel, Chartered Accountant, M. Iqbal Patel & Co., Karachi Undocumented and informal economy is the central problem of the economic and taxation systems of the country. But it surprises when the issue is commented by a regulator. The Securities and Exchange Commission of Pakistan (SECP)'s Chairman has expressed his concern over the state that the size of undocumented economy is expanding, the reason quoted by him is that because the people are not voluntarily paying taxes, which is a disputable assertion. However, he skipped to suggest any answer of the problem to resolve it which as a regulator he was expected. The State Bank of Pakistan has estimated the size of informal economy in Pakistan was around $34 bln in 2011. The problem of documentation of economy is related to corporate laws as much as it is related to tax laws. There are number of - provisions under sections 230-247 and in the Fourth and Fifth Schedules etc. of the Companies Ordinance, 1984 (CO) which provides for documentation of business transactions making the Board of Directors of the companies responsible to keep proper books of accounts recording therein the transactions concerning all money received, expanded in respect of which the receipt and expenditure take place, all purchases of goods and assets, the liabilities etc. of the company which are open for inspection by the SECP. Thereby the financial activities of the corporate sector are fully documented. Furthermore the directors and the principal officers of a company are made accountable they will be guilty of an offence if they or any of them failed to comply with, intentionally or otherwise, the statutory requirement of maintaining records. In that case they shall be penalized for the offence awarding punishment of imprisonment or a fine or both. The objectives of the aforesaid statutory requirements and the strict measures are to ensure that the accounts should present true and fair view of the state of the affairs of the company, safeguard the interest of the minority shareholders and the exchequer too. Moreover, in order to strengthen the documentation system more reliable and accountability of the directors and the principal officers of the company in managing the affairs of the company and to enhance the confidence of the minority shareholders, the CO requires the directors of a company to get the accounts audited by an external auditors who inter alias others certify in their report that the company has maintained proper accounts in compliance with the CO and the accounts reflects true and fair view of the state of the affairs of the company. Moreover, to ensure the compliance a well monitoring system is in place whereby a company is required to submit copies of the audited accounts to the SECP besides to the shareholders. Incidentally it is worth to mention that the Institute of Chrartered Accountants of Pakistan and The Institute of Cost and Management Accountants jointly award Corporate Excellent award every year to those listed companies whose presentation of annual accounts found to be excellent in respect of sharing information etc, with their members but interestingly the list of such Companies includes normally repeatedly almost the same companies. Similar is the case with the Karachi Stock Exchange who award annually Top Companies Award to the Companies who distribute handsome return to their shareholders, however, it is observed from the list of such companies include repeatedly almost same companies. It reflects that over 95% listed companies do not share information with the shareholders or do not pay them adequate return on their investment. This aspect also needs to be looked into by the regulators concerned. The purpose of high lightening the detail of the measures provided in the CO for documentation in corporate sector and their enforcement through the SECP, is to emphasize the fact that even though the corporate sector is well documented but whether this sector fulfils its obligation paying due income tax, if the answer is negative, then it needs to fix the responsibility for failure to bring the sector into tax net fully. The SECP has registered the total corporate portfolio of 63,226 as on November 30, 2012. It includes over 80% private companies besides listed or unlisted public companies and others. Though comparing of registration of companies on monthly basis evidenced growth of corporate sector which is a healthy sign and reflects expansion of documented formal sector, but comparing registration of companies on yearly basis, it indicates graph has fallen from 6000 companies were registered in 2005-2006 to 3000 in 2009-2010. When compared the companies registered with the SECP with the number of income tax returns filed With the tax authorities, it presents very dismal picture. The tax departments received 21,000 corporate returns in 2010 when there 56000+ companies were registered with the SECP. In defense for low filers one may argue that the companies registered with the SECP included dormant and defunct companies that did not carry out any business activity. Even though if 12,000 such companies as were on the record of the SECP on June 30, 2010, is excluded even then non-filers from corporate sector constitutes over 50% indicates very large size of the tax evaders were from documented sector. There are also dormant companies over one-third of around 700 listed companies of Karachi Stock Exchange. The question bothered is whether the issue has been probed by the regulators concerned, the reason and that whether the sponsors or directors of such companies are holding same position in other companies. Further analysis of corporate returns by the tax authorities in respect of declaration of income, revealed that majority of the companies either have declared loss or nil income. In fact corporate profitability recorded an impressive growth of 20% on year-to-year basis to Rs.86.2 bln. Nevertheless the question is that how a company is surviving over the years by continually if it is sustaining losses. Further the section 231 of the CO provides full proof of monitoring process to ensure the compliance with the statutory requirements to document the business activities of a company. It provides that the books of accounts of every company are open to inspection by the SECP. The CO provides for monitoring of the affairs of the companies by the SECP through their annual accounts besides other measures. It empowers the SECP to take action against a company even whose liquidity or debt-equity ratio has deteriorated below the specified level or non-declaration of dividend or sustaining losses etc. The SECP .under any such situation is required to investigate the affairs of a company, it may appoint administration to take over the management of such company or even change the directors of the company. The KESC is listed company on all the three Exchanges is a classical example. It has been in losses for years with negative margins and is subject to mismanagement too yet it is doing its business without interruption and questioning by the regulators. Similar is the case with textile companies where the sponsors are getting richer despite declaring losses. It is the biggest sector but contribute little tax revenue to the exchequer. Further the non-performing loans are piling up, the major borrowers are from corporate sector that are getting the NPL written off or waiver of the loans by the banks. The investigation as to where this money was expanded by the companies or what were the causes for their failure to repay it etc requires answers and needs probed by the regulators, the SECP or the SBP who collects the audited annual accounts and other returns regularly from the companies/banks. Further more out of the 63,000+ companies registered with the SECP around 51,000 i.e. 80% are private companies. This mushroom growth of the private companies is in fact by-product of the listed companies who siphoned off their fund to their associated private companies. Thereby their associate companies prosper at the cost of minority shareholders of the listed companies which discloses losses all the time, depriving the shareholders of their due return on their investment besides evasion of due income tax. Though the CO has legalized the financing to associated companies but it requires revision keeping in view the ground reality of its misuse and adverse impact on the interest of the minority shareholders. The case of Pakistan is very unique in the world. Though it feels constrain of resources on one hand and runs State affairs through bank borrowing, both internal and external. The country's debt servicing alone has crossed $1 billon mark during the first quarter or FY 2012-13 mainly because a high burden of foreign debt and IMF loan repayment but the tax policy of the country spares milky cows and the weak goats are forced to pay taxes for those who have managed lawfully to remain out of tax net. The extent of lavish expenditures by the rulers can be judged that the Prime Minister exhausted the fund of Rs.22 bln budgeted for the year 2012-2013 within five months in November 30, 2012, he was approved further Rs. 10 bln without accountability of the fund expended. Although the country is in need of the resources, it is striving to improve its Tax-GDP-ratio which is the lowest in the region, but the elite class is enjoying tax exemptions. There is no political will to introduce tax reforms replacing the existing discriminatory tax policy with equity based tax policy to expand tax base. The world leaders and the international donors have realized this weakness of tax policy of the country, have, therefore, asked the government to collect tax from the wealthy class as they showed reluctant for financial assistance to Pakistan out of their tax payers' money. This is a black spot on our creditability as a nation. Take the example of President Barrack Obama who is striving for legislation of fiscal cliff to extend tax cuts for middle-class Americans in order to try to preserve them for the wealthy raising tax rates on the wealthiest Americans that will lead to faster economic growth. Whereas the wealthiests in Pakistan are protected through Presidential Ordinance allowing them tax free earning through capital gains irrespective of their sources of investment in share business. Thereby informal economy has been recognized by the government formally. The efforts for documentation of economy require forming a strategy jointly by the regulators FBR, SBP and SECP firstly to strengthen their compliance process instead of short-cuts like amnesty schemes, exercise vigilance and finally to co-ordinate in exchanging of the data and relevant information of the persons in respect of their income etc. among them.