Broadening tax net

Written By Ehtishamuddin Khwaja

The Finance Bill 2011 having presented before the National Assembly in early June 2011, is now available for comments. The proposed changes in the Income Tax Ordinance, 2001 are the subject matter of this analysis. The Finance Minister has an extremely difficult task to generate revenue in the prevalent chaotic economic conditions where the entire country is suffering from soaring prices and water and energy shortage, surrounded by internal and external threats and natural calamities.

In the backdrop of the above scenario, certain legislative changes have been proposed to achieve the basic objective of broadening the tax base vis-à-vis generating more revenue:

— The basic object is to broaden the tax base and it is anticipated that the proposed measures are expected to generate some 700,000 new taxpayers, who possess colossal assets and have remained outside the tax net.

— It is claimed that around 70,000 notices are being issued by the Federal Board of Revenue, and others are in the process and this measure will culminate in achieving the projected results.

It appears that this wishful dream is unlikely to come true. There is nothing in the Draft Bill to propose taxation of undisclosed assets, the existence whereof does not attract taxation unless an assessee/taxpayer is unable to provides legitimate source of investment.

The provisions relating to taxation of unexplained assets/expenditures have remained on the statute book all along since the Income Tax Act, 1922 which was adopted as a fiscal law governing direct taxation soon after the independence. Accordingly, the mechanism to detect the untaxed has remained available to the bureaucracy, which has miserably failed to check the growth of parallel undisclosed economy.

To be fair to the FBR, it appears that the proposed legislative measures are directed to grant relief/exemption and tax credits, reduction in duties, levies on luxury goods, tax holiday/credit for new industrial setup and balancing and modernisation of the existing industries.

The basic exemption for salaried and business individuals has been raised from Rs 300,000 to Rs 350,000 and withholding tax on cash withdrawals has been reduced. However, income from agriculture is still beyond the scope of taxation and so also home remittances; while capital gains (beyond twelve months) on stock exchange etc also enjoy complete exemption. On the face of these ground realities, the confidence of the Finance Minister in the efficiency of the FBR appears to be misplaced.

Specific Amendments

Some of the proposed changes as contained in the Finance Bill 2011 are completely out of context, such as amendment in the provisions relating to submission of wealth statement by a taxpayer which was the statutory requirement in all cases having income of Rs 500,000 or more.

This mandatory limit is now being raised to Rs 1,000,000 whereas by yet another amendment it has been suggested that persons having income between Rs 300,000 and Rs 350,000 shall file the return of income as well as the wealth statement. The purpose of this suggested change is perhaps to protect the tax evaders as the persons having income between Rs 350,000 to less than Rs 1,000,000 have been completely exonerated to submit wealth statement. One must appreciate that in the determination of real income vis-à-vis wealth reconciliation on a year to year basis is extremely important for the FBR to monitor the accretion of wealth.

As a matter of fact, for all resident persons having large assets in Pakistan and beyond, the legislature should have the will and courage to proceed against them simply by requiring them to submit their wealth statements. The existing provisions of law are sufficient enough to take care of such defaulters.

By extending the base limit for filing the wealth statement is supporting the continuance of tax evasion activity. No doubt, the FBR is empowered to call for the return and the wealth statement in every case of the taxpayer, however, exercise of such discretionary powers in appropriate cases is missing perhaps due to political pressure, lack of courage, or corruption.

The next proposed introduction of section 65D relating to tax credit for equity investment is a measure to provide as an incentive for setting-up new industrial undertakings. Perhaps the availability of this credit is also extended to balancing, modernisation and replacement (BMR) in an established industrial undertaking in Pakistan.

However, the proposed amendment is so confused in its language that any meaningful interpretation is difficult to draw. It needs to be redrafted for the purpose of clarity and understanding to serve as an incentive. As a matter of fact, tax credit on account of BMR for existing undertakings is already available by virtue of the provisions of section 65B of the Income Tax Ordinance, 2001 though it is not specific to equity investment.

The next proposal relates to deeming the tax deducted from payments on account of services rendered (presently @ 6%) which in the case of non-corporate sector was earlier a final liability and subsequently, it was treated as minimum tax. The corporate sector was ousted from this presumptive regime since in their cases, it was treated as an advance tax.

This was also clarified by the FBR in its Circular No 6 of 2009 dated 18 August 2009. However, in April 2011 i.e. after almost two years, the FBR has reversed its opinion as contained in Circular 6 of 2009 and without there being any change in the law, opined that the minimum tax shall also be applicable to corporate sector. This reversal was patently unlawful and this mistaken interpretation is now proposed to be given the lease of life by the suggested amendment in law.

It appears that the repercussions emerging from this amendment have not been taken into consideration at all so much so that non-residents having permanent establishments in Pakistan are also roped into this regime of minimum taxation.

It needs to be realised that there are various corporate entities engaged in rendering of services like cellular and telecommunication service providers, container terminals, transportation through pipeline systems who have large turnover but their profitability is less than 5%, and therefore, it is not clear how these sectors can survive with this minimum tax of 6%. Even in cases where part of the turnover is subjected to stipulated tax rate of 6%, the allocation between the two categories of income would be a colossal job resulting in hardship in many cases.

Such legislation may lead to constitutional petitions challenging vires of this proposed amendment. It is suggested that this measure should be reconsidered before it brings about colossal damage to our chaotic economic condition.

It has further been proposed to enhance the scope of levy of penalty in the cases of late filers or non-filers of returns of income. Since inception, this penalty was linked with the tax payable along with the return of income i.e. where the tax has already been paid and the return is filed late, a token penalty was prescribed.

This has also recently been upheld by the Sindh High Court which has held that penalty for late filing of return can only be imposed with reference to the tax payable along with the return and not with regard to the gross tax payable on ultimate assessment. It has, however, now been proposed that this penalty should be worked out with reference to the gross tax payable without taking into account taxes already paid by a taxpayer.

It may be appreciated that penalties have never been used as a tax collection measure rather they are only imposed as a deterrent. Even otherwise for genuine taxpayers, it would be very harsh and unjust to burden them with the enormous amount of penalty where there does not remain significant amount of tax payable along with their return, the tax having been already paid. Even in cases, like importers and exporters, where their receipts are subjected to tax by way of withholding by banks and they are not required to pay tax at the time of filing of return, levy of penalty in the manner now proposed has no justification for the reason that whatever tax that was due from them has already been paid and filing of return is only a formal requirement for them. The following example will better illustrate the proposed changes in the penalty regime:

Existing Proposed
Gross tax chargeable 100,000 100,000
Taxes already paid 80,000 80,000

Balance tax payable along with return

20,000

20,000

Days of default

15

15

Penalty amount

300

1,500

Under the existing provisions, the penalty would be levied on the balance tax payable of Rs 20,000 being the tax due along with the return of income, which was not paid on time i.e. when the return was due to be filed. In this manner the penalty would work out to Rs 300. However, after the proposed amendment, the penalty would be worked out on the gross tax payable of Rs 100,000 without considering that out of this, a sum of Rs 80,000 has already been paid. In this manner, the penalty would work out to Rs 1,500. Further, in the event the tax authorities discard the returned version and pass an amended order thereby enhancing the income and tax thereon, the penalty would then be worked out on the tax payable as per the amended income.

It is therefore suggested that the proposed amendment should be reviewed.

This proud nation which is blessed with abundant resources and hardworking people equipped with fertile land and nuclear capability, is presently in serious turmoil necessitating major surgery.

It is never too late to realise that the time has come to reframe our objectives and tighten our belt and make all efforts to:

— Establish the rule of law

— Bring about green revolution

— Utilise investment from overseas Pakistanis in agriculture and industrial sector

— Seek moratorium of 5/10 years from international lenders.

— Promote education, research and development, health and transportation facilities.

It is thus imperative that the government should adopt measures to revive the economic activity not only through legislative changes but by way of introducing practical and fruitful schemes involving not only Pakistanis living abroad but also taking into confidence the local sincere people giving them confidence so that they can invest heavily in infrastructure projects which would lead to the desirous economic goals providing employments to the unemployed and producing skilled labour to be exported for earning foreign exchange. These goals may not be achieved by the existing resources/set-up available with the government and therefore, the possibility of constitution of an Economy Revival Board comprising of experts in various fields, the stakeholders and patriotic politicians, vis-à-vis Pakistanis living abroad may be considered.

(The writer is a lawyer)

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