Bringing shopkeepers, retailers into tax net: restoration of assessment-based system is the way out

The only way to bring shopkeepers, retailers and small business outlets into the tax net is through restoring the old assessment-based system whereby the income tax inspectors were empowered to conduct survey and physically visit the business premises for allocation of tax certificates or National Tax Numbers (NTNs) to the concerns.
Recently, the Ministry of Finance reportedly proposed income tax on agriculture and displayable income tax token for small shops as part of its 'Austerity Plan'. Analysts told Business Recorder on Thursday that it is impossible to encourage voluntary compliance by small and medium shopkeepers under the self-assessment scheme.
The tax department cannot motivate shopkeepers to file returns in view of prevailing tax culture of the country. The income tax officials can only issue letters/notices to the non-filers under self-assessment system without going to their business premises.
The Universal Self Assessment Scheme (USAS) has been massively misused and encouraged taxpayers to indulge in under-reporting of taxes. All kinds of schemes including minimum tax scheme have failed to attract shopkeepers to come into the tax net. Traders also failed to respond to the lucrative 'minimum tax scheme' announced in budget 2007-08 to document the entire retail sector.
Since promulgation of Income Tax Ordinance 2001, a large number of business plazas, shopping centers and markets have been developed across the country. However, taxpayer education and facilitation has totally failed to subsequently increase the numbers of taxpayers through voluntary compliance.
The level of non-compliance in Pakistan is so high that 83 percent of the Association of Persons (AOPs), 76 percent taxpayers falling within "individual" category and 54 percent companies and business entities have failed to file their due income tax returns for Tax Year 2008. On the sales tax side, the situation is even worse, as only 100 top retailers are paying the major chunk of the total sales tax paid by the retail sector.
An enforcement mechanism is needed at the grass root level for allocation of NTNs or filing of returns. The present centralised system has restrained the tax department from physically going to the markets, business centers and shopping plazas due to limitations under the self-assessment scheme.
Under the repealed Income Tax Ordinance of 1979, income tax inspectors were allocated specific areas to ensure filing of returns by retailers falling within the jurisdiction of their 'income tax circle'. The inspector or notice server has enough information about all taxpayers falling within the jurisdiction of his area. The concerned income tax inspectors regularly visit the markets of his jurisdiction and pursued the shopkeeper to file return.
Otherwise, income tax inspectors issue ex parte-assessment orders against the non-filers. The income tax inspector was considered to be so powerful that the retailers were forced to file returns on the basis of day to day monitoring of business markets. Prior to self-assessment scheme, people acknowledged that it was the duty of income tax inspectors to ensure filing of returns by them. Therefore, the level of resistance was comparatively less.
Whenever police or army has been involved in the documentation of national economy, the exercise has failed as these agencies are not trained to deal with tax matters. The survey of markets on regular basis for stock checking and evaluation of sales/turnover is necessary to ensure accurate declarations made in the income tax returns. If the element of corruption has been eliminated, the old circle-based system could be more successful as compared to functional-based system.
Thus, the department can force the shopkeepers to prominently display their NTN at their sale outlets etc. About the agricultural income tax, analysts said that agriculture is a provincial subject under the Constitution and only provincial government can levy the tax. The federal government cannot levy agricultural income tax due to limitations in the Constitution. If the Constitution is amended, the federal government may empower the FBR to collect agricultural income tax.
The federal government may depute FBR officials in the provincial governments to assist and train provincial officials on the subject of agriculture income tax. Tax experts pointed out that the FBR has to thoroughly analyse data of last year pertaining to agriculture income tax collected from provinces to figure out the estimated tax in case the FBR collects the levy on behalf of federal government from all the four provinces.
A revenue impact needs to be worked out in case the tax authorities are empowered to collect provincial agriculture income tax in the provinces on the basis of income from sale of agri-produce. Sources said that the collection of agri-income tax on the basis on income earned from sale of agri-produce in the provinces would enable the government to generate handsome amount of funds in each province as compared to the marginal collection from this head.
All the provinces ie Sindh, Punjab, NWFP and Balochistan are collecting this provincial tax on the basis of land owned by the farmers. However, if the FBR is empowered to collect this tax on behalf of the provinces then there is a possibility that this tax may be collected on income earned through sale of agriculture produce. However, it seems an uphill task for the federal government to persuade the landlords to accept the introduction of such a levy.
The World Bank (WB) 'Pakistan Tax Policy Report' has proposed creation of a withholding system for the agriculture income tax (AIT), where tax is withheld on the purchase of agricultural inputs, with an exemption limit for small farmers or alternatively for the sale of cash crop outputs.
The WB had considered two land-based reform scenarios and one income-based reform scenario. Under the first option, progressive rate structure (independent of crop): 7.5 acre exemption for irrigated or un-irrigated land; 7.5 to 25 acres taxed at Rs 100 per acre, 25 to 50 acres at Rs 150 per acre, 50 to 150 acres at Rs 200 per acre, and Rs 300 per acre for farms greater than 150 acres.
Un-irrigated land would be taxed at half the rate of irrigated land and orchards would be taxed at Rs 300 per acre. The simulations by farm size give a result of an 11 percent revenue increase in NWFP and a 21 percent increase in Punjab. The resulting distribution of tax burden is more progressive than the present system under this reform scenario.
As per second option, flat rate structure by crop type: 7.5 acre exemption for all farms (except orchards); wheat taxed at Rs 100 per acre, cotton taxed at Rs 200 per acre, rice taxed at Rs 300 per acre, and sugarcane taxed at Rs 350 per acre. These amounts were chosen based on the relative level of profitability of these crops. Un-irrigated land taxed at Rs 150 per acre regardless of the crop.
Orchards would be taxed at Rs 300 per acre. The WB simulations show that revenues would increase by 27 percent in NWFP and 37 percent in Punjab. This option imposes a tax structure based on farm size, but adjusted for crop type. Adjusting the land-based rates by type of crop is admittedly a more complicated way to go. However, this type of reform brings the AIT closer to a tax on potential income than the tax structures based on land alone. The estimates have been made considering four crop types: wheat, cotton, rice, and sugarcane.
Under the third option, tax presumptive net income based on crop yield and profitability, with exemption of Rs 100,000 and progressive rates from 5 to 15 percent. The projections show that revenues would increase 20 percent in NWFP and 10 percent in Punjab.
Finally, under this option, it has been estimated that the revenue potential of a tax based on potential income, where income is estimated based on the average profit/loss including land rent per crop, per acre. As per estimates, the potential revenue assuming an average net profit per acre of Rs 4,000 (lower bound of all crops) and Rs 8,000 per acre (an upper bound estimate of the average crop yield).
With a threshold of Rs 100,000 for tax purposes, on average, only farms of 25 acres or more would be taxable. The revenue analysis suggests that this structure could yield Rs 280 million in NWFP (a 20 percent increase) and approximately Rs 2.9 billion in Punjab (a 10 percent increase), assuming that such a tax could be fully administered. The smaller increase in Punjab is due to the relatively large number of farmers that would be exempted due to the threshold set at Rs 100,000.
The income-based presumptive reforms have the benefit of keeping the AIT a direct tax on income. This would allow such a tax to be ultimately integrated with the general income tax. However, given the constitutional issue related to the taxation of agricultural income, it might be difficult to treat agricultural income like other forms of income for tax purposes, the WB report added.