Recouping tax losses judiciously — III

The tax system that will work smoothly for Pakistan, keeping in view our peculiar socio-economic circumstances and mindset of masses, must be a flat rate with no compliance hassles. All taxes should be merged into one single tax with complete assurance to the masses that they would be free from any kind of harassment; and money collected would be spent towards their welfare. The agenda of fair taxation cannot succeed if wastage of public funds and its abuse by the rulers continue unabated. The quid pro quo for paying taxes is as important as the system to collect tax. Where the public is blamed for not payment of their due share, public authorities are equally, if not more, responsible for indulging in corrupt means taking cover of complicated procedures that eventually lead to poor collection of revenue.

The tax base with respect to direct tax vis-à-vis fair distribution of incidence can be achieved by imposing a 10% flat rate tax on net income of individuals and 2.5% of tax on net wealth of Rs 10 million, whichever is higher, and reducing corporate tax rate to 20%. This simple taxation would induce voluntary compliance provided all the citizens are aware of the fact that a competent and effective tax machinery exists having a tax intelligence system that can easily detect tax avoidance. Without this deterrence even the new system which is a great deal simpler, will be unworkable. Nowhere in the world is proper collection of taxes possible without a strong enforcement apparatus. However, the apparatus should be friendly and firm—friendly, to the extent of educating and guiding the people for fulfilment of their tax obligations, and firm to the extent of punishing wilful defaulters.

As far as sales tax is concerned, Pakistan needs harmonized sales tax which should be single-digit. All tax collections should be through a National Tax Agency (NTA) which should replace all existing authorities at both federal and provincial levels. Further details of simplified taxation can be seen in ‘Towards Flat, Low-rate, Broad and Predictable Taxes’ (PRIME Institute, Islamabad, 2016, its revised and enlarged version of December 2020 is available free at: https://primeinstitute.org/towards-flat-low-rate-broad-and-predictable-taxes/) and in Tax Reforms in Pakistan: Historic & Critical View, published by Pakistan Institute of Development (PIDE) (available free at: https://www.pide.org.pk/pdf/Books/Tax-Reforms-in-Pakistan-Historic-and-Critical-View.pdf.

The National and provincial assemblies should pass a law agreeing on establishment of NTA responsible for collecting all taxes imposed by the federal and provincial governments. This would facilitate people to deal with a single revenue authority rather than multiple agencies at national, provincial and local levels. The mode and working of NTA can be discussed and finalised under Council of Common Interest (Article 153) and its control can be placed under National Economic Council (Article 156).

The provinces should also feel responsible for better and efficient tax collection. Presently, they are isolated and rely on distribution from the divisible pool whereas the Federal Board of Revenue annually collects less than the assigned revenue target. The responsibility to collect revenues should be joint and several giving a participative sense to all federating units.

The NTA should consist of officers and staff representing the federation of Pakistan as in taxes, both the centre and provinces have equal stakes. If the size of the pie grows every federating unit will get more and the Centre will also have more money at its disposal. For NTA, an all Pakistan Tax Service should be established. Recruitment for All Pakistan Tax Service must be independent of the present Central Superior Services structure. Competent people having knowledge in accounting, law, IT and administration should be selected through a special board, comprising members from the existing federal and provincial public service commissions and private sector having experience in these areas.

The optimum collection of taxes fairly and without hampering growth should be the focus of tax reforms. For this purpose, establishment of NTA and automated Tax Intelligence System are prerequisites. The system should be able to send quarterly information to potential taxpayers about their economic activities so that they can be informed in advance as to how their incomes and expenditure should finally look like in their tax declarations. At the same time, the State must demonstrate with actions and not mere words that there is prudent spending of public money through a transparent process enjoying the confidence of the people. The following areas need to be strengthened:

Audit

1.1 Objectives and basic requirements

Audit under all tax codes — income tax, sales tax, federal excise and customs, etc. — should be structured in the light of order of Supreme Court [CIR Sialkot v Messers Allah Din Steel & Rolling Mills and Others 2018 PTD 1444]:

a. The basic aim of audit is to provide a system of checks and balances and ensure that the taxpayer in whom the system reposes confidence acts justly, fairly and transparently. It is therefore imperative that:-

i. selection of cases through computer balloting should be based on transparent risk-based criteria and bench-marks should be made public prior to filing of returns

ii. selection of cases by Commissioner/Collector should be on the basis of cogent reasons/evidence approved by Member Audit

b. Upon selection, taxpayer should be dealt in an even-handed, impartial and transparent manner:-

i. shall be granted ample opportunity to justify, substantiate and defend the information provided in the return that he voluntarily filed

ii. a general timeframe is necessary in order to ensure that the tool of the audit is not abused or misused to pester, torment or harass the taxpayer on account of reasons not attributable to him

iii. adherence to guidelines and timeframes would enhance confidence of the taxpayers in the system and at the same time act as a check on lethargy and inefficiency on the part of department functionaries

1.2 Training of Auditors: The taxpayer audit function plays a critical role in the administration of tax laws. In addition to their primary role of detecting and deterring non-compliance, tax auditors are often required to interpret complex laws, carry out intensive examinations of taxpayers’ books and records, while through their numerous interactions with taxpayers operating very much as the “public face” of a revenue body. These factors, as well as the sheer size of the audit function in most revenues bodies, provide a strong case for all revenue bodies paying close attention to the overall management of the tax audit function. FBR must concentrate on training of auditors as its top priority.

1.3 The main aim of audit should be tackling non-compliance. The primary goal of a revenue body’s compliance activity is to improve overall compliance with their tax laws, and in the process instill confidence in the community that the tax system and its administration are fair. Instances of failure to comply with the law are inevitable whether due to taxpayers’ ignorance, carelessness, recklessness and deliberate evasion, or weaknesses in administration. To the extent that such failures occur, governments, and in turn the communities they represent, are denied the tax revenues they need to provide services to citizens.

Paradigm shift in adjudication

2.1 In developing economies like Pakistan, one of the biggest problems is a relatively small tax base and the reluctance of ordinary people to file tax returns and thus submit themselves to scrutiny of their affairs by the tax administration. However, once a taxpayer professes faith in the effectiveness of legal remedies against an unjust tax levy or unjust action of the taxation authorities, he would be more likely to be truthful to the taxation authorities, and willing to accept a reasonable levy of tax.

2.2 To a tax collector, an efficient tax judiciary ensures that demands arising out of legitimate tax assessments, which can stand scrutiny of law, are not unnecessarily locked up in litigation. As long as there is a pending litigation in relation to a particular tax levy, there is a natural, and quite understandable, desire on the taxpayer’s part not to pay the disputed amount during pendency of litigation. An efficient tax judiciary resolves disputes quickly, quashes demands which are not legally sustainable, and thus segregates serious tax demands from frivolous tax demands, as also giving finality to legitimate tax demands. This in turn ensures that taxpayers cannot resort to dilatory tactics for paying these genuine and legitimate tax demands which have received judicial approval. An efficient tax judiciary thus helps remove impediments to the way of collection of genuine tax demands by the State, which, once again, results in greater resource mobilization. An effective tax judiciary does not only settle tax dispute between a taxpayer and the State, but it also lays down principles on the basis of such resolved disputes which provide guidance for the future. These decisions, which have precedence value in the sense that same decision has to be taken on materially identical facts, also have normative effect thus helping in correcting the judicial course. This way, an effective tax judiciary also contributes to smooth functioning of the tax machinery.

2.3. To make Tribunal a truly independent forum, it is imperative to replace the existing 4-tier appeal system under the tax laws—direct and indirect—with two-tier system. The Customs Tribunal and Appellate Tribunal Inland Revenue should be merged into a single National Tax Tribunal. Like the Services Tribunal this too should work under direct supervision of the Supreme Court. Appeals against its decisions should go directly to the Supreme Court. After merging Appellate Tribunal Inland Revenue and Customs Tribunal, the new entity should be renamed as National Tax Tribunal. Appeals against the orders of the Tribunal should lie with the Supreme Court alone. Members for Tax Appellate Tribunal should be recruited in the same manner as judges of High Court. The pay, perquisites and salary structure of Chairman, members and staff should be at par with the Judge of a High Court.

2.4 Recovery of tax demand should be made only after decision of the Tribunal and not before. Bank accounts should not be attached without prior notice to the taxpayer and after seeking approval in writing of Commissioner in the light of reply submitted by the taxpayer.

The above steps alone can establish what the honourable judge of the Supreme Court in a recent order has highlighted that no state can work smoothly where the rule of law, separation of powers and effective and independent judiciary is non-existent.

(Concluded)

(The writers, lawyers and partners in Huzaima, Ikram & Ijaz, are Adjunct Faculty at Lahore University of Management Sciences (LUMS))

Copyright Business Recorder, 2021