FBR reforms - I

On paper, Federal Board of Revenue (FBR) is an autonomous body created by an act of Parliament, the Federal Board of Revenue Act of 2007, but in practice it is considered handmaid of the rulers of the day and protector of the tax evaders and non-filers. Since 2007, FBR in view of Article 165A of the Constitution was to file tax returns, even if earning no taxable income, but it did not bother to abide by the law that it enforces on the others! FBR must apply for National Tax Number now and file missing returns!!
The saga of FBR's reforms reveals that it mercilessly wasted borrowed funds of millions of dollars given by the World Bank and other donors. Since the inception of Tax Administration Reform Project (TARP) and even after its conclusion, FBR has failed on all fronts-in meeting revenue targets, broadening of tax base, implementing sales tax obligations across the board, increasing share of direct taxes and improving tax-to-GDP ratio. At the end of TARP, our tax-to-GDP ratio nose-dived to 8.8% from 9.4% in the year when the programme started! Despite having both money and expertise, FBR could not introduce an effective automated tax intelligence system to bridge the huge tax gap. The World Bank in its report, "Implementation, Completion and Result Report" issued on the completion of TARP observed that "the current narrow-base of general sales tax (GST) in Pakistan remained almost entirely unchanged throughout 2005-2012, despite efforts to overhaul the indirect taxation structure by introducing a reformed GST featuring few exemptions and wide coverage of goods and services."
The World Bank report, while highlighting the poor performance of FBR, notes: "different from other sources of tax revenue in Pakistan, administration of GST entails a full-fledged operation of major FBR functionalities, including registration, monthly tax return processing, collection, refunds, audit and enforcement. GST operation also integrates joint effort from both internal revenue administration and customs since GST import tax is collected at the borders and zero-rating is targeted for export operations, besides other activities."
For evaluating FBR's overall performance during the TARP, the World Bank used GST administration as an indicator. The results compiled were highly disappointing-GST productivity turned out to be only 23 percent, compared to an average ratio of 34 percent world-wide. According to the World Bank, "the estimation covering the project life reflected an overall decreasing trend during 2005-06 to 2010-11 suggesting feeble tax administration efforts throughout the reform period." Shockingly, throughout the reform implementation period, there was "a declining performance in both tax policy and administration." Even during the economic boom (2005-08) GST productivity index "showed a rather declining trend despite modest buoyancy gains in FBR revenue collection, signalling relatively poor tax administration performance amidst relatively favourable overall economic conditions," says the World Bank.
The World Bank concluded that "during the economic crisis period and subsequent years (2008-11), GST productivity index declined at a higher rate compared to FBR tax-GDP despite a swift turnaround in project implementation and concomitant positive trends in some outputs by the last two years of project life." The report while pointing out weak compliance levels, lacklustre results in reform implementation, especially those related to short-term actions aimed at curbing evasion through more effective enforcement actions by the final year of project implementation, noted "performance from 2008 onwards, far from the project's objectives envisioned at the outset." At the end of TARP, all indicators of sales tax and income tax were extremely poor. Out of total population of 180 million less than 1.45 million filed returns in 2011-disturbingly the share of business returns was only 35.5%. In 2014, the number of filers nose-dived to 856,229-a decrease of 593,771 in just four years! In the same manner, sales tax actual contributors were about 50,000.
FBR claims that it is broadening the tax base, whereas the reality is that it is trying to regain the lost return filers. There was a time when FBR used to get nearly two million returns! They need soul-searching to find out what has gone wrong and where these taxpayers have vanished. Can FBR stalwarts explain why out of registered companies of nearly 67,000, only 24,188 filed returns for tax year 2014? For tax year 2013, total number of companies that filed returns was 25,152. Is it an issue of broadening the tax base or enforcing tax obligations? Law requires that every company has to file tax return irrespective of whether or not it is earning any income.
We have been warning about the devastating effects of high indirect taxation and excessive burden of withholding taxes. Yet the IMF and the government insisted on these even on low income levels and the result is now before us: there is a tax revolt as evident from decreasing number of filers and massive tax evasion in withholding tax regime. Successive governments have been emphasising the importance of increasing tax revenues, mainly on the dictates of the IMF, but flawed and irrational tax policy has destroyed our economy. In Pakistan, the financial system is for the rich or to lend money to the government, thus, small- and medium-sized enterprises (SMEs) do not get credit for growth. In such circumstances, demanding the businesses to pay huge taxes in advance through various withholding provisions, ahead of time, before they even know what their income is going to be, is a sure recipe for disaster. This may be well-intended to counter tax evasion, but is actually only destroying SMEs.
This is the sordid story of tax reforms in Pakistan even when enormous funds-over US $100 million-and best professional advice was available. As confirmed by the report of the World Bank, as an organisation, FBR has not only lost its credibility and usefulness, but has proved to be counter-productive for the very purpose for which it was established.
According to reports, FBR is having another engagement with the IMF "to discuss the crucial tax reforms of indirect taxes including Single Stage Sales Tax (SSST) and examine possibility to replace SSST with existing standard rate of 17 percent sales tax". FBR is reportedly seeking "guidance of the IMF experts in implementation of the Single Stage Sales Tax in Pakistan" as recommended by the Tax Reform Commission (TRC). This would be another wrong step. We have been suggesting introduction of harmonised sales tax as in vogue in Canada and elsewhere, but neither FBR nor TRC has considered it. The real reform agenda, suggested in these columns from time to time, is establishment of National Revenue Authority and implementation of simple income tax law and harmonised sales tax to facilitate taxpayers and boost economic growth. But nobody is listening-the reasons best known to them who are self-styled experts in all areas of taxation and tax administration!
The performance of these so-called experts is before the entire nation. FBR, despite imposing additional taxes of Rs 360 billion, is allegedly blocking over Rs 220 billion taxpayers' refunds and taking advances of many billions; it has failed to meet the third-time revised target for fiscal year 2014-15, showing a shortfall of Rs 222 billion vis-à-vis original target of Rs 2810 billion, which was first reduced to Rs 2691 billion and then to Rs 2605 billion. According to FBR, net collection for 2014-15 is Rs 2588 billion, whereas independent sources claim that the State Bank of Pakistan (SBP) has confirmed collection of only Rs 2581 billion. According to FBR, the difference of Rs 9 billion is due to book adjustments that SBP had not taken into account. Even if the claim of FBR is correct, the huge shortfall of Rs 222 billion (the original budgeted target was Rs 2810 billion), will increase fiscal deficit beyond 4.9% of GDP breaching the agreed limit with the IMF. However, as in the past, there will be no difficulty in getting a waiver to qualify for the next tranche.
(To be continued) (The writers, tax lawyers and partners in Huzaima, Ikram& Ijaz, are Adjunct Faculty at Lahore University of Management Sciences (LUMS).)