Digitizing tax

The new income tax law for any company making cumulative annual payment of beyond Rs250,000 from any single account not permissible to be declared as admissible expense under the income tax law unless it is digital will be implemented tomorrow. This could be a game changing event provided it is applied to the non-company (AOPs, Partnership etc). According to the FBR, in 2018-19, mere 312,361 traders filed tax returns out of estimated 3.5-4 million traders in the country. And the share of retail and wholesale trade in FBR direct taxes is not even 5 percent. The gap is huge, and the best way to capitalize on the gap is to use digital means. The good thing is that there would be no harassment or bribery in this method.

The usual practice in the unorganized sector within the industry is to have a mechanism of revolving open cheques. Usually, companies deal in cross cheques and deduct WHT on behalf of FBR.

But there could be incidences where companies do not use cross cheques, which is only possible if they have undeclared bank accounts in the chain. FBR fears that there is a grey channel within companies as well, and accelerating digitization through business payments sets the stage for formalizing the grey economy within the supply chain.

These revolving cheques circulate as promissory notes without actual flow of funds and there is no way for the tax authorities to keep a check on payments. FBR wants to do away with this method of open cheques to map up invoices against payments for better auditability.

Nonetheless, the trader community is reacting against this move. They have both legitimate and illegitimate reasons behind this unease. Traders reason that they are not getting enough time for the readiness which is a legitimate concern. This can be solved through trainings and awareness sessions. And the other legit reason for companies is that cross cheques are used as zero cost credit guarantee instrument. There is no mechanism in the digital system to have that implicit credit. Another reason is they fear that they would have to declare the invoices and would not be able to disguise their sales. The tax liability therefore, would be assessed on actual sales. And some traders might not be willing to pay their due share of taxes.

FBR must put its foot down in implementation the law of digital payments. The timings can be altered for traders and retailers to get ready. But no more kicking the can further down the road. The road is ending. The cash economy is growing big. The average currency in circulation (CIC) to deposits ratio was 29 percent in FY10-15 and has increased by 38 percent to FY16-20, and the ratio was 40 percent in FY21. Historically, the ratio was too high in Pakistan. With fear of taxman cracking down, the shadow economy has grown further in the past few years.

The retail market in Pakistan is estimated at $125 billion and the amount rollover three times – from manufacturers (or importers) to distributors, from distributors to retailers and from retailers to consumers. Predominately, the payments are paper-based. There are not only taxation gaps in it but also efficiency gaps for the businesses. There are costs of handling cash. Businesses save money on what is charged as a float by banks on keeping funds overnight. Then there are costs of riders and all in terms of visits from offices to banks. The cost per invoice in Pakistan is estimated at Rs1,000 and this can be reduced to Rs250-300 by digitizing the invoices.

(For details read ‘Digitizing supply chain transactions’ published on 16th September 2020).

The FBR revenue potential is beyond this. According to Dr Ikramul Haq calculations, by applying 4 percent GST and 1 percent income tax on gross revenues, the total calculation from retail and wholesale traders should be around $5 billion (Rs875 bn) assuming the retail market at $100 billion. During FY19, wholesale and retail sector paid mere Rs48 billion in direct taxes. And even including the advance income tax paid at imported stage by all importers and all categories was Rs221 billion. Mind you, this list includes non-trader community as well.

The point is: whichever way one looks at it, the gap of taxation and economic efficiencies are huge from digitization of the supply chain transactions. The traders and retailer community hue and cry are to evade taxes. But at the same time, they are forgoing the economic efficiencies which could fatten their bottom line. If the digitization of transactions is implementing in letter and spirit, the FBR can slowly reduce the GST rate which at 17 percent is perceived to be too high for economic competitiveness. Otherwise, the GST rate would keep on increasing and the undocumented economy will keep on spurring.