Yet another amnesty?

On January 1, the Voluntary Tax Compliance Scheme (VTCS) the Prime Minister announced was a New Year gift for the trader community and also earned a "gold medal there for, but since VTCS will amend the Income Tax Ordinance, and therefore require parliamentary approval, the same day the Finance Minister placed this bill before the National Assembly.
Based on VTCS, the Income Tax (Amendment) Bill-2016 seeks to legalise amnesty for the trader community (excluding those convicted for involvement in narcotics trading, terrorism, or money-laundering) upon payment of nominal taxes by its members whereby they can whiten their wealth accumulated during the last decade without paying any tax - an initiative that has raised many questions.
To begin with, is giving amnesty to tax-evaders morally justified? Did the previous amnesties deliver the results that justify offering another amnesty? Don't such amnesties reflect the continued failure of the FBR to nab tax-evaders, and didn't amnesties induce tax evasion because this crime was forgiven despite going on for years? Finally, what message such initiatives convey to the honest taxpayers?
While presenting the Federal Budget in 2013, the Finance Minister had promised to bring 100,000 new entities into the tax net every year to fulfil IMF's demand for expanding the tax net. However, as per FBR data, since June 2013 only about 33,000 new taxpayers entered the tax net. But FBR expects that VTCS will bring over 2 million new taxpayers into the net.
While the VTCS seems a desperate attempt at meeting IMF's demand for increasing the tax net, what seems as likely is that it aims to end a deadlock over the presently imposed 0.3 percent tax on banking transactions because, in exchange for agreeing to this tax being raised to 0.6 percent, the VTCS offers the traders exemption from tax audit by the FBR until June 2018.
While increasing the tax net is imperative for improving Pakistan's tax-to-GDP ratio - lowest in South Asia - the VTCS is targeting only traders and leaving out the huge retail sector that consists of over 3.4 million entities. It therefore remains to be seen how much will the VTCS expand the tax net and lift the tax-to-GDP ratio though the FBR has high hopes.
Besides excluding the retail sector, the VTCS also excludes entities earning from activities defined as "income from business", profit on debt, dividend income, and income from property rental. While profit on debt and dividend income is taxed at source (via withholding tax), bulk of the property rental income - huge amount in major cities - remains untaxed.
Under VTCS, traders have been divided in two segments: those who didn't file tax returns during the decade ending on December 31, 2015, and those who are NTN holders and tax return filers but didn't file tax returns regularly during this period. This is the only logical aspect of the VTCS whereby non-filers will be penalised more that the filers.
Under the VTCS, non-filers can legalise their working capital up to Rs 50 million by paying 1 percent tax thereon before January 31, but traders with working capital exceeding Rs 50 million will be taxed according to existing tax rules. NTN holders, who filed returns occasionally without pay any tax while filing their last tax return, must pay a fixed amount of Rs 30,000 as "income tax" to legalise their working capital.
Traders who did file returns for 2014-15, can file revised returns by paying 10 percent higher tax than that paid as per their filed returns. For 2015-16 too, the above rate shall apply if the declared "turnover" is thrice the working capital declared during 2014-15. Otherwise, for tax years 2015-16 to 2017-18, turnover-based tax will be 25 percent higher than that paid in the preceding year.
During 2015-16, 2016-17 and 2017-18, for non-filers with turnover below Rs 50 million, recoverable tax would be just 0.2 percent. If the turnover is in the Rs 50 million to 250 million range, the recoverable tax would be Rs 100,000 plus 0.15 percent of the turnover exceeding Rs 50 million, and where turnover exceeds Rs 250 million, recoverable tax would be Rs 400,000 plus 0.1 percent of the turnover exceeding Rs 50 million.
On traders falling in the filer/NTN holder category, in 2015-16 the tax levy shall be 25 percent higher than the tax paid in tax year 2013-14 or for the last tax year for which a return was filed on the basis of taxable income, or as per turnover-based tax rates specified in the VTCS. Besides these laxities, for the tax years 2015-16 to 2017-18, these traders have been given three working capital-turnover based tax payment options.
But what defies logic is making working capital and turnover the bases for levy of "income tax" because, instead of income, the levy will be based on the value of year-end net current assets (working capital) and sales (turnover). It is surprising how the Finance Minister (a Chartered Account by profession) agreed to and proposed the levy of "income tax" on these bases.
In early December, the Finance Minister had promised an "out-of-the-box" solution for bringing millions into the tax net; it seems that the flawed VTCS is that solution. But to bring the un-taxed trader and retailer sectors into the tax net, FBR needs to do something totally different which will require that wholly imperative ground work that it has thus far avoided.
Firstly, a reliable database on all wholesalers and retailers must be developed. Next, for a 3-year period, all wholesalers and retailers must be required to obtain annually renewable Trading Licenses by paying a fixed tax. To make this fixed tax fair, all cities should be divided into three categories viz. small, medium-sized and large, and in each category, logically graduated license fees be levied on small, medium-sized and large entities.
In this 3-year period, with help from audit firms and tax advisors, FBR must design books of account (in Urdu, English and the four provincial languages) that wholesalers and retailers must maintain, and ensure their country-wide availability to help these sectors acquire the ability to maintain them for being taxed according to their income ie inform retailers and wholesalers in time on what is expected of them after three years.
Contrary to this logical strategy, VTCS is a compromise on basic issues - taxing on fair bases and bringing these entities into the tax net. Yet, it seems likely that the National Assembly (having PML-N's majority) will approve the Income Tax (Amendment) Bill-2016 based on VTCS, though it will keep the tax net pathetically small, tax-to-GDP ratio dangerously low, and the state dependent on debt - all manifesting bad governance.