A joint task force of Securities and Exchange Commission of Pakistan (SECP) and Central Board of Revenue (CBR) is presently reviewing the existing legal and policy regime for corporate tax, applicable tax rates and tax refund procedures to recommend ways and means for de-corporatisation of business and rapid corporate growth in Pakistan. The SECP is mainly focusing on removing hurdles in the slow registration of companies, corporatisation and transparency in the business affairs.
As expected the CBR's representatives in the task force are resisting any reduction in corporate income tax rates. They are of the opinion that decrease of 5-7 percent in the tax rate will not encourage people to register companies with the SECP, as it is solely depends on business community attitude and effective tax laws.
Since the SECP and CBR have jointly started identification of hurdles in the corporatisation of businesses particularly reasons for slow registration of big companies, they should start analysing the problems in corporate tax policy and the reasons hindering corporatisation of businesses. The SECP-CBR joint committee noted with concern the growing deregistration of companies and marked increase in the number of sole proprietorship and firms or Association of Persons (AOPs) as compared to the registration of big companies.
Presently the SECP has data of 48,000 registered companies, which under the Income Tax Ordinance, 2001 [hereinafter "the Ordinance"], have to file return every year no matter whether these have taxable income or not. However, it is a matter of record that a large number of companies are neither filing their income tax returns nor have obtained national tax numbers (NTN). In 2004, out of total 21,500 companies having obtained National Tax Number (NTN) from CBR, about 13,000 companies filed income tax returns. In 2003, only 11,578 companies filed income tax returns. This is an alarming state of affairs.
It shows that companies are hesitant in obtaining NTNs and filing of returns. Does CBR need any further evidence of its hostile policies and unfavourable treatment towards corporate sector in Pakistan?
There are a number of anti-corporate provisions in the tax codes of Pakistan e.g. withholding tax on almost everything. The companies have been treated as slaves who are to act as 'collection agents' of State without any compensation. And on the top of that they are being penalised for small lapses that are neither intentional not wilful.
The perquisites are taxed in the hands of employees at the highest rate and the same amount is disallowed as expenditure in the hands of companies! Notional benefits e.g. concessional loans are treated as perquisites in the hands of employees. In such circumstances, why one should conduct business through a company, especially when audited accounts by independent auditors are rejected just on whims and without bringing any material on record. Litigation is imposed on the companies and they have to hire costly professional to get justice. There is no certainty of taxes imposed.
These malpractices and anti-business provisions are not only the main stumbling block for corporate growth but also mainly responsible for de-corporatisation of business in the country over the last few years. The corporate sector is the worst sufferer of CBR's arid policies, wide spread corruption, myopic outlook of top management and over-emphasis on withholding tax mechanism. It is tragic that our economic managers have never thought of using tax policy as a tool of corporate growth, and their sole stress on revenue targets at the time of making annual budgets has resulted into retardation of corporate sector and enhancement of unemployment.
One of the main tools of tax policy is to increase the level of savings and capital formation in the private sector partly for borrowing by the government and partly for enhancing investment resources within the private sector for economic development, which cannot be achieved without rapid corporate growth. In Pakistan we find a reversal of this principle. Recent years have experienced closure of huge industries. Lack of consistency in the tax policies have forced the business community to move towards safer havens depriving the country of invaluable capital. Similarly, foreign investors feel shy to make use of the tremendous Pakistani talent that goes to waste for lack of proper funding.
Pakistan is one of those very fortunate countries of the world that has an abundance of resources and a climate that is fit for simply any activity throughout the year. But unfortunately and thanks to our tax mangers and economic wizards, our dependence on imported products has been hit with an upward surge in the recent years. Due to harsh tax measures and maladministration, withholding and presumptive taxes being one of them and non-issuance of refunds another; both our agricultural and industrial sectors have suffered so badly that instead of being able to export our goods we are forced to import in order to cater for the demands of the nation. The corporate farming remains an unrealised dream.
Level of taxation in a country is traditionally judged in terms of the ratio, which taxes bear to some measure of national income. This ratio is called tax-GDP ratio and the change in it is determined by variations in both the numerator (total tax revenue) and the denominator (national income). The study of tax-GDP ratio is important because trends in taxation in a country or group of countries are analysed mainly in terms of this ratio, and the composition of tax revenues. Are inter country comparisons of taxation levels meaningful? Some fiscal experts have sharply criticised these attempts. According to critics, the economic, political, and institutional characteristics of individual countries are so different that neither theoretical nor empirical studies provide useful information of policy relevance.
Tax-GDP ratios do not consider the fact that some countries are more favourably placed to levy and collect taxes than other. For example, Lotz and Morssan analysed a sample of 72 developed and developing countries to examine the relationship between tax ratio variations and differences in per capita income and degree of openness. The sample included a wide spectrum of dissimilar economies ranging from Nepal to Singapore. It is prima facie erroneous to compare Nepal's high rural and agricultural economy with a high commercial and industrial city-state of Singapore. Generally the tax revenue to GDP ratio in developed counties has been high and in the less develops countries low. Table 1 gives the tax/GDP ratios for selected countries in 2004.
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TABLE 1
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Country %
Belgium 43.3
Netherlands 42.9
Germany 26.6
United Kingdom 34.2
United States 19.1
Malaysia 19.2
Thailand 16.1
Sri Lanka 16.0
Pakistan 09.3
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Source: IMF - Government Finance Statistics.
The higher ratio for the industrialised countries is primarily due to the higher level of revenue from social security, payroll taxes, corporate taxes and taxes on domestic on consumption while the taxes from international trade and non-tax revenue are lower. In contrast, in the developing countries the major portion of revenue comes from the indirect taxes, particularly the taxes on international trade and domestic consumption, while the direct taxes have a lower share. Pakistan GDP-tax -ratio is even below than Sri Lanka and Thailand, which proves beyond any doubt the failure of fiscal managers and tax collectors.
A principal fiscal aim in any development strategy is to increase the elasticity and buoyancy of the revenue system. Elasticity reflects the built-in responsiveness of tax revenue to movements in national income or GDP. Buoyancy reflects the total response of tax revenue to changes in national income or GDP including the effects of discretionary changes in tax policies over time.
An elastic system will automatically raise revenue at the same or at a faster rate than the growth of national income (or GDP) and facilitate a sustained increase in necessary government outlays. It would also reduce the economic uncertainties associated with frequent discretionary changes in taxes. Frequent ad hoc changes in tax policies create uncertainties among taxpayers and affect investment and production adversely. In Pakistan it has been estimated that both the elasticity and buoyancy coefficients are below unity, hence the tax system is inelastic to reflect changes in GDP or national income.
In Pakistan inflationary and deflationary pressures take three major forms:
• Price inflation due to rises in import prices;
• Inflationary financing by government during boom periods and a consequent pressure on the balance of payments; and
• Deficit financing during periods of deflation resulting in balance of payments pressures.
Tax policy should be aimed at reducing or checking undue private consumption expenditure by the taxation of excess incomes. So there should be lower rate of tax for corporate entities (not more than 25%) and higher rate for individuals as is the case in various developed countries. Income tax being a progressive tax has been well suited to this purpose. Of the indirect taxes, import duties are not as flexible, as these may have the effect of transferring inflationary pressure to domestic prices. Export duties, however, have been far more effective in siphoning off excess income before it gets into the hands of producers during inflation or acting vice versa in times of deflation. If we want to improve corporate growth, we will have to achieve a judicious balance between direct and indirect taxes.
Devising an efficient tax model for corporate sector in Pakistan requires an analytical study of all the irritants prevailing in tax codes, procedures and implementation processes. The main irritant is highhandedness, corruption and unprecedented high level of maladministration in tax apparatus. The SECP-CBR joint committee must analyse the statutory and regulatory framework relating to corporate entities in its totality. It must identify all the anti-corporate tax provisions, which we have discussed in detail in our books, Law & Practice of Income Tax and Law and Practice of Sales Tax.
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