Tax evasion

Pakistan, a highly cash starved country depends on foreign assistance even to meet day-to-day expenses. No serious attempts so far have never been made to curb tax evasion and to apprehend tax dodgers. Under the Income Tax Ordinance, 2001, prosecution (Part XI - sections 191 199) is an alternate to imposition of Penalty Part X sections 183 to 189) ie, no prosecution proceedings are initiated if penalty under chapter X has been imposed.
Thus fine and imprisonment prescribed on account of non-compliance of statutory obligations, concealment of income, making false or misleading statement etc are nothing more than decorative provisions which in fact have beautified the Income Tax Law. No tax cheater in history of Pakistan has been prosecuted so far.
It is very sad to say the World Bank report was published in March this year but so far no serious thought has been given to this report. It has neither been tabled in the Parliament nor discussed in the media which has now become the most powerful pillar of the State. As mentioned earlier, in USA, tax evasion is considered a serious crime yet thousands of taxpayers are involved in tax cheating.
The Government of USA, like other developed nations is trying to catch tax thieves and recover evaded public money. Pakistan where tax cheating is not a serious crime and the cheaters are treated as most dignified personalities, size of tax evasion may be more than that estimated by World Bank. We see no serious attempt to recover the stolen public money, or book at least big fishes involved in tax evasion and to take preventive steps.
Through an amendment in section 177, the Commissioners of Income Tax have now been authorised to appoint firms of Chartered Accountants or Cost and Management Accountants to conduct the audit of the income tax affairs of a person or classes of persons. The Finance Minister has recently announced conducting audit of thousands of taxpayers from January, 2010. It appears that the Government is very hopeful of recovering big amounts from the tax dodgers but the outcome may be different from such expectations.
Much time will be lost in selection of cases and audit firms and quality of such investigative audits will depend on the quality of staff and personnel deployed by the audit firms. Routine examination of sales, purchase, manufacturing and other expenses will hardly bring any fruitful result unless the tax auditors are fully acquainted with the nature of business and industry, global prices of raw materials required by the business, its products and its end uses, raw material mix, input/output ratio etc.
Therefore, instead of appointing tax auditors on year to year basis, it will be more appropriate and beneficial if qualified chartered and cost and management accountants are inducted in FBR service on a permanent basis. Many wholesalers, retailers, transporters and professionals providing various type of services usually avoid issuing cash memos to their customers/clients against services provided and goods sold.
Hence a sizeable amount received by them remains unreported and untaxed. As per World Bank report, service sector makes almost one half of economic value added, but its contribution to the national exchequer in the form of taxes amounts to one quarter of central taxes, only due to low tax receipts from wholesale, retail and transport sub-sectors. Therefore, under the circumstances, the FBR has to explore ways and means whereby all receipts by the services sector are properly documented and right tax is collected on income of sector.
Presumptive Tax Regime (PTR) was introduced in early nineties mainly to maximise documentation of economy. But ultimately, it proved to be a source of legal tax avoidance. For example, previously manufacturers were allowed to file tax returns under PTR ie, tax deducted at sources 3.5% was considered as their final tax liability.
The manufactures whose taxable income was more than 10% of their sales were filing tax returns under PTR, thus income tax amounting to billions of Rupees were avoided during 13/14 years when option to file return of income tax under PTR was available to the manufacturers. The traders still fall under the PTR, hence, the PTR not only continues to be a of legal source of tax avoidance but also may be a safe source of tax evasion.
Since statements filed under PTR are not subject to further investigation by Tax Authorities, therefore, smart businessmen may inflate their expenses at a cost of 3.5% only. They would deduct tax @ 3.5% on fake bills obtained from ghost individuals/firms at a certain commission (2% to 3%) and pocket the remaining 93%-94%.
Therefore, i) statement filed under PTR during the last five years should be examined thoroughly, the tax cheater be probed, and looted national wealth be recovered; and ii) like imports, tax deducted on local sales should be treated as minimum tax and the traders should be required to file normal tax returns.
Transfer pricing may be another source tax evasion. Multinational companies operating in Pakistan, usually procure raw material either from their principals or from selected international sources, therefore prices paid may be higher when compared to global price quotations.
It will more appropriate if a Data Bank is set up by FBR where global prices of the raw materials used in Pakistan are updated regularly and matched with the prices at which raw materials are procured by multinational and other manufacturing companies. Besides, taxpayer wise information regarding their human resource, products, customers, local suppliers, product wise raw material usage, input/output ratio etc should also be maintained and updated regularly. Any missing link should be investigated and probed thoroughly.
In the US, if a person is found guilty of tax evasion, the Internal Revenue Service may recommend his case to the Criminal Investigation Division (CID). The CID is a part of the enforcement mechanism for the IRS. The CID has broad powers and usually acts secretly and conducts extremely thorough investigations. Most of its agent are accountants and may have attained CPA qualification. They are trained in law enforcement techniques and, may contact a taxpayer's friends, employer, co-workers, neighbours, spouses and bankers during their investigation.
The Federal Board of Revenue (FBR) should follow this way and to strength enforcement division, employ professional accountants preferably Cost and Management Accountants who are trained and enough knowledge of costing systems and financial accounts. Any high profile taxpayer found guilty of tax evasion should be prosecuted under wide media coverage. Publicity of such cases may prove as a good deterrent for others contemplating committing a tax crime.
Broadening tax base is a need of the day and the Government should work on it seriously. Service and Agriculture sectors' contribution to the national exchequer is far behind the contribution made by the manufacturing sector while their combined contribution to GDP is three times higher than the share of manufacturing sector to GDP. Agriculture sector provides employment to 45% of the total labour force and its share to GDP is 20% yet its contribution to taxes is less than 1%.
Contribution of Service Sector to federal taxes is only 0.25%. Resultantly, the industry carries the brunt of tax burden. Its share of tax is three times higher than its share to GDP. Another reason for lesser tax collection may be its complication and lack of trust in the present tax system. Many people avoid filing tax returns because of their fear of harassment by tax authorities.
Despite meeting tax obligations honestly, a taxpayer in Pakistan feels unsecure and the state does not come forward when he needs support and help. The country has a potential of increasing tax-to-GDP ratio by 3.5% for next five years. The objective could be achieved through making the system public friendly and equitable.