Tax burdens and fiscal discipline

After an inflation-ridden Fiscal Year 2023-24 (“FY24”), wherein the average inflation for the FY24 was 23.4%, there was some hope that the budget for the FY25 may bring respite to the public-at-large.

However, the Fiscal Policies enacted by the Federal Government (“FG”) were proven to be largely revenue driven, and for short-term purposes; thus proving the common man to be naive once again.

Pakistan can achieve growth and stability through a homegrown strategy rather than relying on the IMF’s complex policies. Moreover, uncertainty arises with the Fiscal Deficit and Current Account Deficit (“CAD”), compelling us to seek IMF assistance and adhere to stringent policies like interest rate hikes, which hinder Pakistan’s economic growth. The recent decision of the State Bank of Pakistan (“SBP”) to reduce the interest rate to 19.5% is a welcoming sign; however, it is still infeasible for businesses to operate at 19.5%.

Through the Finance Bill 2024-25 (“the Bill”) and thereafter the Finance Act 2024-25 (“the Act”), the purchasing power of the salaried class has been suffocated by increasing the effective tax rates on them; a measure that has rightly met peaceful protests across the country. The salaried class is one of the most documented sectors in the country, as their tax is deducted at source by their employer.

It has been reported by Shahbaz Rana, in his article published on the 25th July 2024 titled “Salaried class taxed record Rs368 Billion” that the salaried class paid PKR 368 billion income tax for FY 24, whereas exporters and retailers paid a combined PKR 111 billion in income tax. It may be noted that exporters only paid a minimal income tax of PKR 93.5 billion against an earning of USD 30.6 Billion.

Further, as per our estimates, considering the additional taxation measures taken, the electricity and gas price adjustments done or that may be done in the immediate future, the inflation for the FY25 may record at 25% instead of 12% as projected by the FG.

Moreover, the FG proposed imposing a record PKR 1.7 trillion in additional taxes to achieve an ambitious PKR 12.97 trillion tax revenue target for FY25, which is expected to unleash an inflationary storm in Pakistan due to heavy indirect taxation and further reductions in individual incomes.

Further, the Government expects to collect another PKR 1.5 trillion through automatic increases in collection due to the inflation projected by the Government. Despite heavy taxation, there remains a PKR 512 billion tax gap between the measures taken in the budget and the new tax target.

Way forward:

In view of the above, it is proposed that tax on the salaried income up to PKR 1,200,000/- must be a bare minimum PKR 100/- or 500/- considering the inflation in the previous two Fiscal Years and our estimates for the inflation in the ongoing FY. The reason for a meagre income tax on salaried income up to PKR 1,200,000/- is so that they remain within the tax net.

There have been some difficult and positive steps taken by the FG that are balanced, which will help document the economy and generate good amount of revenue for the Government. These measures are as under:

A. Bringing the exporters into the minimum and normal tax regime

The FG has, vide the Act, brought exporter of goods into the Minimum Tax Regime and the Normal Tax Regime. This measure was proposed by the Reforms and Resource Mobilization Commission of Pakistan (“RRMC”) through its interim report submitted in April 2023.

Before the said amendment, a 1% income tax was levied on the exports proceeds of goods exported from Pakistan.

The said 1% levied was full and final discharge of tax liability of the exporter of goods. Now, the said 1% income tax levied shall be minimum tax, and an additional 1% advance tax shall also be withheld on the exports of goods. Therefore, exporters shall now file their income tax returns at the end of the fiscal year and compute their normal income tax liability, and will also be subject to super tax.

This measure encourages documentation; however, had this measure been taken vide Finance Act 2023, the FG may have generated an additional PKR 300 - 400 billion in tax revenue in the FY24 on account of an additional PKR 1.7 trillion windfall gain due to currency devaluation.

Economic impact:

Transitioning exporters to the minimum and normal tax regime can significantly increase government tax revenue, which can be used to fund public services and infrastructure projects, driving economic growth. Requiring exporters to file detailed income tax returns will promote greater documentation of economic activities.

This measure will help increase inclusion of the wholesale, trade, and agriculture sectors into the formal economy, improving transparency and enabling better economic planning and policy-making.

A more equitable tax regime ensures all exporters contribute their fair share, fostering a more competitive business environment. This move can discourage tax evasion, create a level playing field, encourage fair competition, and potentially attract more investment into the sector.

===================================================
PKR in     FY24     FY25 E     FY25      Additional
Billion     A                  T        Revenue Tax
                                           Required
---------------------------------------------------
            A       B=A*1.156     C          D= C-B
---------------------------------------------------
FBR Tax     9,306   10,758     12,970         2,212
Collection
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Way forward:

The government must ensure that any income tax refunds that may accrue/arise of the said exporters, may not be delayed unnecessarily. This will ensure that there is minimal trust deficit between the Government and the exporters.

B. Levy of 0.5% withholding tax on all distributors, dealers, wholesalers and retailers

The FG has levied a 0.5% (for ATL) and 2.5% (for non-ATL) withholding income tax on all distributors, dealers. wholesalers, and retailers. This measure was also proposed by the RRMC through their interim report.

The RRMC had suggested a Withholding tax rate of 1%. Further, it was also recommended by the RRMC that once the 1% Withholding tax is implemented in letter and spirit, the withholding tax agents shall be required to provide the CNIC number and details of the purchasers.

The said measure is a positive measure, as it will generate revenue for the FG and increase documentation in the economy.

On 22nd July 2024, the Government made amendments to the Tajir Dost Special Procedure 2024 (“said Procedure”). Further, through the said Procedure, the Government has levied a monthly advance tax on the traders and shopkeepers (other than those who own a shop of 100 sq ft. or less in a residential area) ranging from PKR 100 up to PKR 10,000/- based on the location of the shop.

A similar scheme was proposed by the Tax Reforms Commission back in 2016. A similar concept was introduced vide Section 99A of the ITO read with Ninth Schedule of the Income Tax Ordinance 2001 (“ITO”).

The said monthly advance tax has been levied on indicative income that has been estimated by the FBR on the basis of factors including but not limited to rental value of the property, its location and fair market value.

The said measure seems to be an inequitable measure as it is based on presumptions that may not be rooted in ground realities.

Economic impact:

This measure promotes a fairer tax system, reduces inflationary pressure, and eases the burden on more documented sectors like LSM and Small-Scale Manufacturers. Additionally, it enables better economic planning and boosts economic stability by attracting more investment through increased transparency and reduced tax evasion.

Way forward:

Once there is sufficient documentation of the captioned sectors, reliance on the withholding tax can be eased by registering more distributors, dealers, wholesalers and retailers into the tax net with the FBR.

Other measures that can be taken to improve the fiscal space

For Pakistan, that has a mammoth economic profile, merely adjusting interest rates and exchange rates will not suffice. Pakistan needs to achieve self-discipline by reducing the CAD and the Fiscal Deficit through policies that are efficient in practice.

Our valuation places the PKR at 233/USD. As reported by AUGAF research media, a well-known global media house has also estimated the PKR’s true value. An analysis indicates that a depreciation of 10 rupees increases the inflation by 2%.

Currently, the PKR/USD exchange rate is 278/USD, reflecting a 45-rupee difference. This difference corresponds to an approximate 9% increase in inflation for FY25. If the current exchange rate is adjusted by 45 rupees, inflation is expected to decrease by 9%, potentially leading to a 9% reduction in the interest rate. A 1% reduction in the interest rate would decrease domestic debt interest repayments by PKR 472 billion. A 9% reduction would lower debt interest servicing by approximately PKR 4,248 billion, which currently consumes 52% of the total budget outlay.

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Current   Inflation   Re-profiling   Outstanding     Net saving           Total
Policy    Impact      Policy rate    Domestic Debt   on 1%               Saving
rate                                                (PKR in Billion)
===============================================================================
A         B           C = A-B        D               E = 1%*D           F = E*9
19.5%     9%          10.5%          47,160          472                  4,248
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