The Pakistan government is striving for foreign investments. Recently a delegation of foreign investors visited Pakistan. Speaking to them President General Pervez Musharraf said that the country holds immense promise for return to foreign investors.
He said that all sectors of the economy are open to foreign direct investment.
The government has introduced a number of structural and stabilisation reforms and took measures to improve governance in the country.
It introduced several modern concepts in taxation through the Income Tax Ordinance 2001, because a taxation system of a country plays a pivotal role in attracting foreign investment.
The taxation policy of the government is one of the deciding factors for foreign investors for putting their capital in a country.
The country's open investment policies offer attractive opportunities to the foreign investors in all sectors.
As the investment package evolved there is no restriction on the quantum of equity, joint ventures with local partners, no restriction on remittance of royalty, technical and franchise fee, capital, profits and dividends.
But the tax collecting machinery has created such a dangerous show that a foreign correspondent wanted to know if it is a criminal act to be in a tax net in Pakistan?
This impression is visible from the fact that despite Pakistan offering an attractive and secure investment environment for foreign investors, they are shy of making large-scale investment, especially at a time when the multinational companies are striving for relocating their manufacturing and service industries in developing States.
Interestingly foreign investment has fallen sharply despite all multilateral agencies like IMF, WB and ADB lauding our investment policies, and international credit rating having improved.
There are several reasons for this unfortunate situation, one of them is discussed in this paper.
Before proceeding to the real subject matter, let the readers know a little bit about the taxation system of Pakistan.
The Income Tax Ordinance 2001 (Ordinance) has divided the taxpayers into two categories (1) resident, (ii) non-resident, based on residential status. An individual is a resident u/s 82 for a tax year if he was present in Pakistan for 182 days or more in aggregate or is an employee or official of the federal or provincial governments posted abroad in a tax year.
A company u/s 83 is a resident company for a tax year if it is incorporated in Pakistan and the control and management of the affairs of it are situated wholly in Pakistan at any time in a tax year.
A non-resident is defined u/s 80 as a person who is not a resident person for a tax year.
The other major change in the Ordinance is the basis of income liable to tax. A concept of geographical source of income has been introduced u/s 101 of the Ordinance.
Any income shall be of foreign source to the extent to which it is not a Pakistan source income as enumerated u/s 101.
Non-residents are taxed on their Pakistan source of income whereas a resident is taxed on both, his Pakistan as well as foreign source of income.
The foreign investors usually face difficulty in ascertaining the tax components of their project, who are interested to know the chargeability to tax their income at the time of preparing a feasibility of new projects or industries to be set-up in Pakistan or he intends to merge or amalgamate with any of the project or business or acquisition of a business in Pakistan.
To meet this demand of the non-residents and in line with international practice the Ordinance has introduced a concept of advance ruling u/s 206 A with an object to provide to foreign investors to know in advance the impact of income tax on their proposed plan for investment in Pakistan.
According to provision S.206A a non-resident investor is required to apply in writing to the Central Board of Revenue with full and true-disclosure of the nature of all aspects of the transaction proposed or entered into by the applicant.
Based on such full and true disclosure of the nature of all aspects of the transactions relevant to the ruling, made by the taxpayer in his application and the transaction has proceeded in all material respects accordingly, the CBR will award an advance ruling setting out the Commissioner's position regarding the application of income tax law on the transaction referred to it.
The ruling awarded by the CBR will be binding on the Commissioner with respect to the transaction of the law in existence at the particular time of application.
It is also provided that the ruling will have overriding effect if there is any inconsistency between a circular issued by the CBR and such advance ruling.
The draft SRO provides for withdrawal of advance ruling in case the fact disclosed in the application is subsequently found incorrect.
This provision was inserted by the Finance Act 2003 on June 17, 2003, but the CBR has now after over one half tax year has passed, circulated a draft SRO whereunder it has devised procedure and modalities for implementation of advance ruling for foreign investors who require it in preparing feasibility reports of their new projects or industries to be set up or merged into the business in Pakistan in advance.
It is learnt that meanwhile applications for advance ruling have been moved to the CBR by non-resident companies for avoiding tax disputes in future on chargeability of tax on the transaction entered into by them.
In the absence of any laid-down procedure, one of the applications since the last over five months is in transit between tax authorities in Islamabad and Karachi.
It's anybody's guess to think over the bad impression to be carried by the non-resident who moved the applications since the long and the CBR having failed to issue him ruling even after five months have passed.
The new draft rules provide finalisation of application on advance ruling within 90 days of its filing.
The question to ponder is whether the foreign investors will have to wait for a period of three months for obtaining an advance ruling from the CBR?
This undue delay will distort their feasibility, and is one of the reasons that discourages the foreign investors to invest in Pakistan.
Moreover as the advance ruling will be given on the transaction already entered into, therefore, in case the ruling is delayed, the applicant may be made liable for payment of penalty or additional tax on the amount involved for non-compliance of the provisions of the Ordinance in respect of such transaction.
Although the current investment policy offers a host of incentives to the foreign investors, unless special care has been taken to avoid delays and bureaucratic red-tapes in the way of business, the government's efforts to enhance foreign investment will be a futile exercise.
The government has to provide the facility of advance ruling to non-residents within a specified time of not more than fifteen days of its application made so that a meaningful decision is taken by the foreign investors.
It is suggested that the time-limit for 90 days proposed in the rules be reduced to fifteen days with which the CBR shall give its ruling on the application made to it by a non-resident for advance ruling.
No doubt any ruling will have considerable impact on exchequer. Because the ruling sought by a non-resident will either result in exempting from tax of his income or payment of tax on the transaction will result at reduced tax rate.
The tax authorities, therefore, will be cautious in taking their decision on the matter and will try to involve as many tax collectors as may be possible, which has been the case in processing the above cited case that has caused so much delay in giving the ruling.
In order to issue advance ruling a committee has been constituted for the purpose is comprising three members, the CBR Chairman, member direct taxes and additional secretary of law and justice and human rights division.
It will be observed that out of the three members, two of them are from CBR itself that is chairman and member direct taxes.
Thereby CBR has undertaken upon itself both executive and judicial powers. In the circumstances how the foreign investors will expect that the system will ensure a level playing-field for them.
In order to build their confidence in the system it is necessary that discretion and favours are replaced by fair rules.
Advance ruling is a judicial function which can only serve the purpose if this function is assigned to an independent authority to be constituted for the purpose.
It is a imperative that a high-powered statutory advance ruling commission be formed comprising tax experts from the judiciary and professional bodies, high ranking members from the Board of Investment, Ministry of Finance and Law and Justice, including Chairman CBR or a member, direct taxes.
This commission will ensure transparency and professional advance ruling which will inspire confidence in foreign investors.
The commission should reduce the waiting period to get advance ruling in the maximum of fifteen days.
The Federal Finance and Economic Affairs Minister Shaukat Aziz speaking at the launch of an auto assembly plant said that the government is now focusing on primary elements of good governance, besides eliminating unnecessary delays.
Since the CBR is his baby so he should also concentrate on it to ensure that these objectives are achieved in this institution.
Accordingly the commission upon receipt of an application from the foreign investor for advance ruling should be afforded an opportunity of being heard which will facilitate the commission to understand the nature of transaction.
It will reduce the waiting period of getting the ruling significantly. A provision in this respect for the applicant being given an opportunity of being heard be made in Section 206-A.
Moreover, in order to expedite the disposal of an application of advance ruling, a format of application has been proposed in the schedule of the draft notification which the CBR considers necessary to understand the nature of all aspects of the transaction relevant to the ruling.
The rules should prescribe the documents to be attached with the application so that the applicant is not bothered to furnish the explanation or documents from time to time which may delay the matter.
The advance ruling is restricted to the foreign investors only. The resident investors are not entitled to apply for such a ruling.
This discriminatory treatment with the local investors is not justified in view of their huge contribution to the exchequer by way of government levies without relief and incentives that are available and enjoyed by the foreign investors.
Therefore, the residents and non-residents be considered to be brought at par for the facility of advance ruling.
The advance ruling policy should be transparent, fair and favourable to the foreign investors.
The CBR should take measures to implement reforms introduced through the Ordinance in true spirit and to improve its governance, eliminating unnecessary delays and creating an impression that the tax collectors are friends and not masters of the taxpayers.
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