An agro-industrial budget

The government is drum-beating its tall claim that it has achieved a growth rate of 8.4% after considerable struggle and thus has achieved the welfare of the people, whereas the people are searching, in broad daylight with candles the illusive prosperity and the improved standard of living as claimed by the government. The growing inflation which reached 9.3% with food prices up at around 13%, has robbed the purchasing power of the poor, so the prosperity which would have accrued to the people of Pakistan as a result of the economic growth, remained exclusive presence of the rich to become richer.
The economic policies of the government are indicative of leading the country to the concentration of wealth in a few hands. The government in formulating the budget, has concentrated on two major sectors of the economy viz, agriculture and textiles. It has offered them numerous fiscal benefits and incentives.
The growth of the agriculture sector in the GDP was 7.5% and of the manufacturing sector at 12.5%. The agriculture and manufacturing sectors have 21.5% and 15.9% respective shares of the GDP. Whereas the agriculture yields only 1.2% in taxes; it eats up the taxes paid by the taxpayers, while the manufacturing sector pays 61% taxes, and with the exception of the textile sector whose contribution to tax is meagre.
These two sectors are creating distortion by not paying tax proportionate to their share of GDP. The government, in order to boost the confidence of the landlords, offered incentives to them in 2004-05, like: supplied imported fertiliser to them at cheaper rate, provided relief of Rs 3.8 bln, paid loan of Rs 100 bln, import of tractors are allowed free of duty, and so on.
At the same time it increased the prices of wheat and cotton to add to the misery of the common man. Mohammad Ali Jinnah, the father of nation said... "I should like to give a warning to the landlords and capitalists, who have flourished at the peoples expense by a system which is so vicious, which is so wicked, and which makes them so selfish that it is difficult to reason with them. The exploitation of the masses has gone into their blood.
They have forgotten the lessons of Islam." While offering enormous incentives and benefits to these sectors, the government did not provide any measure ensuring a trickle-down of benefit of good production and the reduction of input cost to the common man.
Some relief to the common man would have justified the incentives offered to the above two sectors by the government. Some of the major proposals of the Finance Bill 2005-06 in respect of income tax are discussed for the benefit of the readers as under:
BENEFIT OF AMALGAMATION TO INDUSTRIAL UNDERTAKINGS: (S 2 (1A The Finance Ordinance 2002 inserted sub-section (1A) to Section 2 whereby banking companies and NBFC were allowed the facility of amalgamation. This facility was subsequently extended to the insurance companies by the Finance Act 2004. Now by virtue of the proposed amendment this facility is extended to the companies owning and managing industrial undertakings.
Previously public companies or companies incorporated under any law, other than the Companies Ordinance 1984, were entitled to amalgamation and the scheme of amalgamation was required to be approved by the State Bank of Pakistan and SEC on or before June 30. Now these conditions have been removed. However, the condition for approval under respective laws from relevant regulators will continue to be operative.
This amendment will facilitate an amalgamated corporate company to claim to set off accumulated business losses of an amalgamating company or carry forward these losses for adjustment against the business profit of the amalgamated company for a period of six tax years. Similarly it can carry forward un absorbed deprecation till it is fully claimed.
However, new conditions have been introduced that these losses can now be set off provided the amalgamated company continues the same business of the amalgamating company for a period of five years from the date of amalgamation and complies with the conditions of approval of the scheme.
The proposed amendment is in line with the demand of the business community who were facing hardships in their assessment of tax in case of amalgamation. It has brought an industrial undertaking at par with the financial sector for the purpose of amalgamation, thereby the disparity created between them is eliminated.
It will encourage the amalgamation of sick units with sound units, which will strengthen the corporate sector and enhance the employment opportunities, which will be a step forward to alleviate poverty in the country. However, keeping in view our corporate culture possibility of misuse of the facility of amalgamation may not be ruled out, particularly when the scheme does not carry any condition to avail tax benefits of amalgamation.
We are behind India in this respect that has allowed in 1961 the corporate sector, as its policy for revival and rehabilitation of sick industries, merger of companies and offered them tax incentives for the purpose. But it acted very cautiously and made this benefit with certain conditions.
It is, therefore, suggested that the Ordinance should provide for the amalgamated company to prepare a scheme identifying the real causes of the non-viability of the amalgamating sick unit whether it is attributable to non-availability of working capital or needs upgradation of plant and machineries, or suffering from technological or managerial deficiencies, or lacks marketing net-work and such other related matters.
It should spell out the ways and means to overcome these issues. The scheme so prepared appropriately has to be approved by the shareholders of the amalgamated company.
The Central Board of Revenue (CBR) or the Securities and Exchange Commission of Pakistan (SECP) may scrutinize the proposed scheme. Moreover the amalgamated company may require to produce a certificate from the statutory auditor to the effect that adequate measures are taken by it for rehabilitation of the sick unit so as to enable it to avail the tax benefits of the scheme.
SMALL COMPANY (S.59A): The bill has for the first time determined the status of a small company and medium enterprise (SME) through precise definition of small company u/s 59A and 80.It is to be hoped that this definition will be acceptable to all stakeholders.
Before that the State Bank of Pakistan and Medium Enterprises Development Authority (SMEDA) had totally different definition of SMEs. According to the proposed definition a small company for tax purposes will be a company registered with the SEC effective from July 1, 2005, with a paid-up capital plus undistributed reserves not exceeding Rs 25m and an annual turnover, not exceeding Rs.200m.
The tax benefit offered to SME includes a concessional corporate tax rate of 20%. It is neither liable to pay minimum tax u/s 113 @ 0.5% nor is it required to withhold tax from payment made to a resident person or permanent establishment of a non-resident person in Pakistan.
These incentives are very attractive and will attract large number of companies to register with SEC to avail these tax benefits. In the industrial development of the country importance of the SME sector cannot be under estimated particularly when the SMEs constitute nearly 90% of all the enterprises of Pakistan which employ 80% of the non-agricultural labor force and its share in the GDP is approximately 40%.
However, it is apprehended that under the existing situation, when the corporate tax rates applicable to other companies are in the range of 35-41% that is at higher rates than what has been proposed for the SMEs, this will encourage the existing companies to change their status to avail these tax reduction and other benefits. Moreover, the introduction of a special regime for the SME sector may be misused by the companies.
GROUP RELIEF (S 59B): The Finance Act 2004 introduced the concept of group relief in respect of a set of assessed losses, other than brought forward losses, of a group subsidiary company owning and managing of its holding company. An industrial undertaking of a public company listed on stock exchange of Pakistan, in favour of its holding company. The proposed amendment seeks to extend this benefit to an undertaking engaged in providing services, who may surrender its assessed loss for the tax year, other than brought over losses, to its holding company, subject to fulfillment of the conditions provided in the section, in respect of holding company to hold 75% or more of the share capital of the subsidiary company in addition to others mentioned above.
The service sector has contribution of 52% to GDP and shown impressive growth from 4% in 1995-00 to 7.9% in 2004-05. It has become the most important source of employment. This trend has encouraged the government to offer them tax incentives to enhance its generation. The said incentive will encourage the service providers to corporatise themselves.
TAX ON RETAILERS (S. 113B): The section 113A has been inserted by Finance Act 2004 whereby a retailer being an individual or association of persons, having annual turnover up to Rs 5 mln has been allowed an option to pay income tax at the rate of 0.75% of the declared turnover as final tax instead of tax on their normal business profit.
Through the proposed amendment, this benefit is extended to such retailers of textile fabrics and articles of apparel including ready-made garments or fashion wear, articles of leather including footwear, carpet, surgical and sports goods, being an individual or AOP, with turnover exceeding Rs 5 mln for any tax year, shall pay final tax @ 1% of turnover. The tax so paid shall form part of the sin glee stage sales tax @ 3% of the declared turnover. Such retailers instead filing of return of total income shall be required to file a statement u/s 115 declaring turnover and tax thereon.
WITHHOLDING TAX ON EXPORT: (Cal (1) -Seventh Schedule; The bill has added new entry (4) in the table in clause (1) in Division IV under heading Export listed in Part IV of the Seventh Schedule by way of transfer of the items from Part I and III to Part II and IV, which have been zero rated, enhancing their tax rate by 0.25% to 1.50%. The reason given is that zero rating schemes introduced in the budget on supply of whole chain of textile related products and services for export oriented industries, resulted in revenue loss. In order to bridge this revenue loss, the Federal Textile Board had proposed to increase withholding tax by 0.25% to 0.75% on textile export proceeds as against present levy of 0.75% -1.25%. Accordingly accepting their proposal the government has increased rate of tax to 1.50% on export of total chain of textiles and other goods which have been made zero-rated.
ANNUITY PLAN AND PESNSION FUND: (S.3A, 3B, 3C, 19A & 29B); The SEC has issued Voluntary Pension System Rules 2005 (VPSR) with a primary objectives to allow the creation of Pension Fund Scheme (PFS) so that the individuals may accumulate funds for their retirement. The bill has introduced the definitions of the Annuity Plan, Pension Fund, and Contribution to the Fund, Eligible Person and Individual Pension Account. The maximum contribution to the Fund by an individual or by the employer on behalf of an individual has been increased from Rs 200,000 but will not exceed Rs 500,000 in a tax year. The section 63 has been proposed to be substituted allowing an eligible person deriving income from salary or under the head income from business, to a tax credit for a tax year in respect of any contribution or premium paid in the year in APF under VPSR. The existing Retirement Annuity Scheme has been deleted and APF Scheme has been introduced which will be approved by SEC under VPRS. It will be managed by asset Management Company registered under Non-Banking Finance Companies (Establishment and Regulations) Rules 2003 or a life insurance company registered and approved under VPRS to manage the APF. SALARIED TAX PAYERS; the government has reduced income tax rates of salaried persons from 7.5% to 3.5% and the higher slab is reduced from 35% to 30%. On one hand this benefit is felt much short of expectation, on the other hand this benefit in reduction of tax rates has been taken away by withdrawing the reduction in tax liability available to salaried individuals. Considering the growing food prices increase at 13%; the benefit of this reduction in tax rate will not be felt by the salaried class. Thereby the economic managers did not give indication of any change in their philosophy in order to bridge widening gap between the rich and the poor rather it reflects the consistency and continuity of their policy of sympathy with the richer class.
STOCK EXCHANGE: The income of an individual derived from transfer of his membership rights or shares of a stock exchange to a company during the year July 1, 2005 to June 30, 2006 has been exempted from tax. Furthermore, in order to encourage enlistment on the stock exchange, reduction in tax rate by 1% is allowed to the companies, enlisting on any stock exchange in Pakistan during the year July 1 2005 to June 30, 2006 Moreover, capital gains have been exempted from tax in the hands of insurance companies up to tax year ending on June 30, 2007 derived on sale of maharaja certificates or any instrument of redeemable capital, listed on any stock exchange or shares of a public company and the Pakistan Telecommunication Corporation vouchers issued by the GOP.
The above measures would go a long way to boost the index of stock exchange. However, the bill does not provide any tax proposals for stockbrokers, as it was anticipated from the public speeches of the Chairman of CBR who had conceded that the stockbrokers make huge profits but they remained untaxed. It was also reported that CBR had, in principles agreed to levy central excise duty as service tax on commission earned by the stockbrokers. But the budget allowed them to enjoy tax-free incomes.
BACK TRACK: before the announcement of budget, there was hue and cry from CBR forum that the government has determined to enhance tax base, by hook and crook. It was publicized that non-filers of tax return would be detected through the scrutiny of secondary sources such as housing authorities, travel agents, mobile phone service providers and others.
Contrary to this exercise to be undertaken to hunt for potential tax payers, the bill has relaxed the conditions to furnish annual return of tax u/s114 by removing owners of motor vehicle, subscribers of telephone, foreign travelers and member of a club, who were required to furnish return of income but now they are excluded from tax net. Although each of them is resourceful and a potential taxpayer.
Probably it has been done to cover the inefficiency of the tax collectors who have failed to bring these people into tax net. Any way, it is not comprehensible as to what was wrong if these provisions had remained on the statute, even at a risk of failure in resort to them. Similarly the Chairman of CBR was critical that property dealers made huge profits yet they still remained untaxed. But after announcement of the budget they still remained untaxed, which is not comprehensible why there was such and cry on the subject.
OPTIONS AVAILABLE: The budget is considered to have provided the only solution available under the present scenario of the economy. We must ponder upon the issue whether there are other options available, application of which would have benefited the masses in a better way instead of concentrating on selected sectors/class.
The facts and figure speak for themselves as projected in the budget. The budget sets a target of tax revenue of Rs 690 bln which is composed of direct tax and indirect tax receipt at Rs.215 and Rs 475 bln that is 31% and 69% respectively. It shows that heavy reliance is placed on indirect tax receipt. The indirect tax has the characteristic to pass this tax to the common man who eventually suffers the burden of such tax.
Thus this tax policy is leading the country towards concentration of wealth into a few hands; resultantly rich becomes richer and vice versa. This situation suggests a modification of the tax policy whereby the ratio of direct taxes should exceed indirect tax. In order to achieve the objective of increased reliance on direct tax, it is necessary to enhance the tax base.
Further distortions in tax law in respect of levy of tax are to be removed. The agriculture growth achieved in 2004-05 at 7.5% to GDP as against 2.2% last year reflects that this sector has matured enough to contribute to the national exchequer.
The Constitutional protection of exemption from tax given to agriculture income be withdrawn and it should be brought under the net. Similar is the case with capital gain income derived from sale-purchase of immovable property which by virtue of Constitutional limitation is out of the scope of income tax. It is the need of the time to bring this source of income under tax net through Constitutional amendment.
If the Constitution can be amended for the interest of an individual allowing him to wear specific clothes, then why it is not amended for national interest? Moreover there are exemptions available in the Second Schedule to the income of mutual funds and to capital gains from sale of shares of public companies listed on stock exchange which need review to continue their exemptions, in view of present scenario when the mutual funds are diverting their funds to acquire banks and industries, which shows that they are potential taxpayers and need no exemption. Similarly the index of stock exchange has crossed over the 10,000 threshold which is a pointer that the level of income has reached a level that allows a withdrawal of this exemption.
In fact these exemptions were allowed in 1983 and onward when they needed tax incentive to establish the capital market. Now the situation has entirely changed accordingly tax law should be changed too to meet the demand of the time.
The above measures are not exhaustive. Overhauling of the Second Schedule will provide more avenues, nevertheless the above measures will broaden the tax base and will allow the reduction in tax rates which are the highest compared the other countries. The Federal Reserve Chairmen of USA Alan Greenspan said broadening the tax base and lowering the tax rate would enhance economic efficiency and prosperity.
Moreover other measures include import tariff reduction in a way which may not lead to closure of local industries; it should be kept within limit to pay off the import bill out of export proceeds. Further in the present scenario of WTO and globalisation, the competitive prices and quality of the product play decisive role. The input cost must be reduced, the power tariff should not be allowed to increase frequently at the inefficiency of WAPDA and KESC, as power cost constitutes major part of the production cost, which hamper competitive pricing of the product.