Tax reforms, initiated at the command of foreign donors in 2000, have started yielded some positive results. In fiscal year 2004-05, CBR surpassed even the revised target of Rs 590 billion by 2.2 billion. It appears that now society as a whole has started realising the importance of paying taxes so that the country can come out of grim fiscal deficit that has been haunting us for the last many years.
However, evolutionary changes, suggested by foreign donors in the existing tax system, will bring Pakistan at par with many developing countries in achieving a desirable tax-to-GDP ratio of over 15% (presently it is 9%) after at least a decade.
On the contrary some radical changes - like broadening of tax base and reduction of exorbitant sales tax rate, simpler and fairer tax codes - will encourage investments and savings. Pakistan needs to re-prioritise its tax goals for fiscal year 2005-06 to improve tax-to-GDP ratio, attain better compliance and collections, coupled with rapid industrial and business growth.
It is tragic that in a country where billions of rupees are being made in speculative transactions in real estate and shares, tax-to-GDP ratio is pathetically low [just 9% in fiscal year 2004-05 despite record collection of Rs 592.2 billion by CBR] and the Government is least bothered to tax undocumented economy and benami transactions. The mighty sections of society are engaged in these transactions and CBR being their handmaid has neither will nor ability to tax them.
It exposes the uselessness of CBR as an institution to tap the real tax potential of the country. It should be given full autonomy as is available to State Bank of Pakistan and only then the cherished goal of taxing the mighty and the ruling elites can be achieved. There should also be public campaign that the absentee landlords and mighty military rulers and their civilian (sic) handpicked members of parliaments should also be divested of all the privileges and exemption enjoyed under various tax codes.
The Finance Act 2004 made some significant pro-business changes in the Sales Tax Act, 1990 (hereinafter "the Act") and Income Tax Ordinance, 2001 (hereinafter "the Ordinance"). One such change was deregistration of persons having a turnover up to Rs 5 million under the Sales Tax regime and giving them an option to file statements under the Income Tax law by paying 0.75% on their declared annual turnover. According to conservative estimates there are at least 2.5 million retail outlets having a turnover of up to Rs 5 million. It is sad to note that despite this unprecedented concession, the overwhelming majority of such retailers did not file statements under section 115(4) of the Ordinance in 2004 and 2005.
Since all these outlets pay advance income tax with electricity bills between the range of Rs 60 to Rs 2000 per month, the CBR must issue notices to those who did not file regular returns under section 114 or statement under section 114(5) of the Ordinance for tax year 2004 and 2005. This exercise alone will bring at least 1.5 million new persons on the tax roll. If a retailer is paying Rs 24,000 annually as advance income tax under section 235 of the Ordinance, one wonders what prevents him from taking advantage of section 113A that requires payment of 0.75% on annual turnover.
If he has a turnover of Rs 5 million, tax liability under section 113A comes to Rs 37,500. In other words, he is required to make balance payment of Rs 13,500 with the statement under section 115(4). Is it not surprising that such a person, even after paying Rs 24,000 as advance tax, wants to remain a non-filer? This shows the real malady of the existing system. Instead of enjoying the status of a taxpayer, he seems apprehensive of being harassed by the tax officials if he files a return or statement.
According to the Economic Survey of Pakistan - 2004-05, the total number of persons paying advance income tax with commercial electricity bills is 4.2 million. CBR's mission to broaden the tax base must start by bringing all such persons on the tax roll. These "taxpayers" are non-filers and need to be coaxed into becoming part of the national tax roll.
Their non-reporting testifies to the failure of the tax reform process so far pursued by the government. Out of total registered companies [foreign and local with SECP] only 20% are filing income tax returns, which exposes the efficacy of CBR.
It is undeniable fact that there prevails massive sales tax evasion coupled with non-reporting of income in Pakistan. CBR needs to enhance sales tax collection and broaden income tax base. The people should be given tax benefit/incentive which will help expanding tax base, improve documentation and better collection of taxes without hue and cry from any segment of society. A well-thought-for scheme is required that should not only check leakages in sales tax collection, but also encourage the people to file their income tax returns. The dual aim of expanding tax base and combating tax evasion should be achieved.
At present every person while making taxable supplies is required to charge sales tax @ 15% on the value of supply and is required to deposit the same into Government Treasury after adjusting input tax paid by him.
It is common practice that due to corruption/mismanagement in sales tax administration and unwillingness on the part of people to obtain sales tax invoice, registered persons are not depositing full amount of sales tax recovered from the end users. By not depositing sales tax into government treasury, government is being deprived of:
Sales tax which the end users are paying to registered persons.
Income tax which that registered person should pay on his income since that portion of sales is not recorded in their income tax affairs.
Since CBR has now developed an online mechanism of checking registration of persons, government can announce the following scheme:
Anybody who pays sales tax in a financial year should be entitled to claim refund of 20% of the amount paid. The procedure for claiming refund should be simple ie he should send invoices to Sales Tax Department, which will authorise refund from a nearest branch of National Bank, after verification of genuineness of the invoice (by checking sellers' registration number). In this way CBR can develop data base about sales of all registered persons and then cross verify the same with the particulars declared by them in their sales/income tax returns; or
Any person who pays sales tax can claim credit of part of sales tax paid say 20% against his income tax liability by producing all sales tax invoices obtained by him throughout the year. Detailed mechanism can be devised to cater the situation where income tax liability is less than amount of credit of sales tax.
In this scheme, the people may choose not to claim full credit of sales tax paid by them since they could not justify sources of their full expenses. To overcome this situation the government can announce immunity for 3 years from scrutiny of their expenses declared through sales tax invoices.
This scheme will encourage people to obtain sales tax invoice for each transaction, which is presently not being insisted. The evasion of sales tax is mutually beneficial. If payer is given the above incentive, he will insist for sales tax invoice and the government without expending any money or making extra efforts will be able to expand tax net.
The CBR needs a "radical camp" (or at least a "prudent" camp) because the "traditional camp" has failed to broaden the tax net and accelerate the pace of tax reform ensuring tax-to-GDP ratio at a respectable level. This ratio cannot be improved with the present income taxpayers (roughly1.2 million) and just over 100,000 registered sales tax persons. The tendency to squeeze more and more from the existing taxpayers and giving a free hand to non-filers has eroded the tax base to the extent where voluntary compliance and tax enforcement have lost their relevance.
Nullum tributum sine lege expresses the requirement that rule of law must be applied to assessment and enforcement of taxes. CBR must comply with the enacted laws (eg should issue refunds as promptly as it collects taxes at source) and taxpayers must be able to predict in advance the consequence of their transactions. In case of non-compliance with the rule of law, legal remedies must be provided to protect the individual or the corporate body concerned. Faith in the system will never be restored unless rule of law is enforced both for the tax machinery as well as the taxpayers.
How to achieve tax compliance is the main challenge before the government. The State must remember that if taxation is viewed as being unfair or favouring some taxpayers, it remains counter productive in the long run.
The crisis with Pakistan is that general acceptance of tax system is undermined. Special efforts and rational policies are needed to restructure the tax system and restore public confidence in the tax officials. Even a good tax system will not work if the prevalent negative mindset of the tax official persists. There is an immediate need to improve both the system and the human fabric that controls it.
THE TAX SYSTEM MUST PROVIDE:
Rule of law and predictability of the authority to tax.
Principles of proportionality, efficiency, effectiveness, flexibility, continuity, reciprocity, fairness and equity.
-- Tax harmonisation.
-- No double taxation or intentional non-taxation.
-- Non-discrimination.
-- Strict anti-tax evasion rules.
The present tax system imposes greater and undue incidence on the poor and middle-class people (eg 15% GST takes larger portion of low-income groups compared to high- income groups). The rich and mighty are enjoying complete tax exemption as their colossal agricultural income and enormous profits made through speculative transactions made in real estate and on the money/share market are outside tax net.
Since they are not paying a single penny as tax, the vast majority of citizens argue that why should they be subjected to exorbitant and multiple taxes? In 2004 and 2005 we miserably failed to improve universal tax compliance and the situation will not improve unless the government takes some concrete and positive steps in taxing capital employed in unproductive areas thus ensuring its shift to productive sectors that generate more goods and services and bring a lot of employment possibilities.
The definition of 'business' given in the Income Tax Ordinance, 2001 covers "adventure in the nature of trade" and yet our tax machinery is sitting idle causing colossal loss to the national exchequer by not bringing adventures in the nature of trade in real estate into tax ambit and giving undue tax exemption on gains arising on speculative transactions in shares and stocks. Our tax-to-GDP ratio can rise to 20% in one year if we take speculative dealings in real estate (this will also help in promoting construction industry as prices of land will come down) and bring black economy into tax net.
Instead of performing its prime duty, that is levy of tax where it is due, the CBR is busy in constituting committees to ponder over many issues relating to tax policy and administrative reforms, which are in fact the job of Parliament. It appears that the CBR is more eager to do the job of legislators rather than performing its primary function of levy and collection of taxes.
The Chairman Central Board of Revenue while addressing a gathering in Karachi in August 2004 claimed that tax-to-GDP ratio of Pakistan was 11.3% for the financial year 2003-2004.
This claim was in conflict with official figure of 9.3% as per page 55 of Economic Survey of Pakistan 2003-2004. The Central Board of Revenue (CBR) has now confirmed, in a report submitted to International Monetary Fund that tax-to-GDP ratio is below 10% and it will go into double digits by financial year 2007-08. A recent report published in Press (given below) is an admission on the part of the CBR that it has miserably failed to improve tax-to-GDP ratio during the last decade and even in the future it will remain dismally low.
Some months back a 'task force' was formed by CBR to suggest measures for improvement in the taxation structure by speeding up sales tax refund payment to the business community and analysing the scope of expansion in the GST net to cover more services.
The task force was given a mandate to analyse performance of the existing tax system with particular emphasis on broadening the tax base. In the past, CBR wasted a lot of time and money in the formation of many such task forces, committees and what not, but the result has always been nil. We have declining trends in tax-to-GDP ratio and now we will have to wait for many years more to come up to the level of many developing countries [see Table]. This is indeed a sorry state of affairs. The root cause is CBR's unwillingness to do what is its duty and indulgence in activities that fall outside its mandate or domain.
The Central Board of Revenue (CBR) has transmitted mid-term 'tax projections' and 'revenue-to-GDP ratio' from fiscal 2004-05 to 2008-09 to the International Monetary Fund (IMF).
Official sources told the Press that 'tax projections' and revenue-to-GDP ratio for the next five years had been submitted to the Fund mission on the conclusion of 9th review by the Fund under the Poverty Reduction Growth Facility (PRGF).The CBR has informed IMF that the target is to achieve 0.2 percent per annum growth in the tax-to-GDP ratio on account of ongoing reforms. This growth would be achieved as a result of the reform process.
The CBR has worked out new projections on the basis of revenue to GDP ratio, which excludes petroleum levy. CBR revenue to GDP ratio constitutes 85 percent of total taxes. According to projections, the CBR is committed to collect Rs 590 billion during current financial year, keeping in view the revenue to GDP ratio of 9.5 percent.
The collection would be Rs 675 billion in 2005-06, taking into account CBR revenue to GDP ratio of 9.7 percent. The CBR would have to collect Rs 750 billion in 2006-07 keeping in view CBR revenue to GDP ratio of 9.9 percent. The revenue collection has been projected at Rs 850 billion in 2007-08 based on the estimated CBR revenue to GDP ratio of 10.1 percent. The CBR revenue collection target would be Rs 960 billion in 2008-09 taking into account CBR revenue to GDP ratio of 10.3 percent.
According to the notification issued by the CBR, the newly-formed task force was to:
(i) analyse the performance of tax revenue and its major components in relation to GDP;
(ii) study the corporate tax structure and recommend strategy to encourage corporatisation and public listing;
(iii) examine sales tax taxation structure and suggest measures for speedy disposal of refunds and increase revenue generating capacity;
(iv) study the structure of personal income tax and recommend measures for broadening of taxpayers' base;
(v) study the scope for mobilising resources through expanding the general sales tax to cover more services;
(vi) examine customs tariff structure, duty drawbacks and incentives for exports to facilitate the trade;
(vii) suggest measures for increasing the tax-GDP ratio to the level comparable to countries in the region; and
(viii) suggest viable tax administrative measures for implementation of the recommended tax policy.
TAX-TO-GDP RATIO OF SELECTED COUNTRIES
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Country %
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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
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SOURCE: IMF - Government Finance Statistics.
NOTE: 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.
The task force has not yet released its report which shows that such efforts cannot be helpful unless a proper parliamentary process is adopted to make a long term tax policy and its adoption by public debate and participation.
The elected members of Parliament should take note of these actions on the part of bureaucrats sitting in the CBR. It is purely the domain of the Parliament to make tax policies and CBR is only required to implement them.
On the directions of foreign masters, who are giving us huge loan of US $120 million for tax reforms (sic), CBR has assumed the role of legislator and policymaker which is highly lamentable. It should be an autonomous body insulated from outside political, financial and administrative pressures, but in no way it should assume the role of policymaker, which under the Constitution is sole prerogative of people of Pakistan through their democratically-elected representatives.
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