Improving tax compliance

Tax reforms, initiated in 2000 borrowing US$100 million from the World Bank, even after 15 years, have failed to improve voluntary compliance and tax-to-GDP ratio. In fiscal year 2014-15, Federal Board of Revenue (FBR) failed to achieve, for the seventh consecutive year, the third time revised target of Rs 2,605 billion-there was a huge gap of Rs 222 billion vis-à-vis original target of Rs 2,810 billion widening the fiscal deficit beyond the projected figure of 4.5% of GDP. Ten years back (2004-05), the then team of CBR surpassed even the upward revised target by over 10 billion, which was an all time record. In 2014-15, not only number of return filers reduced drastically, below one million mark, the main source of collection was indirect taxes, over 65% came from sales tax that included exorbitant sales tax from 32 to 42 percent on POL products and 92% under the income tax regime came through withholding taxes (mainly pass on) advance tax or tax with returns. Income tax collected through own efforts by Inland Revenue Service members of 22,000 plus was less than 10%.
Independent analysts have been expressing serious concerns about poor voluntary tax compliance, pathetic tax-to-GDP ratio and increasing tax burden on the poorer section of society through regressive taxes. There is a consensus between official and independent quarters that Pakistan needs to improve tax compliance to be economically viable and it must achieve respectable tax-to-GDP ratio of 15% (presently it is dismally low at 9.5%) in the coming three years. Some radical changes like ending the existing overwhelming reliance on indirect taxes reduction of exorbitant sales tax rate, efficient enforcement and simple tax codes are required along with providing incentives to encourage investments and savings. The government needs to re-prioritize its policies to improve tax-to-GDP ratio, attain better compliance and collections, coupled with rapid industrial and business growth. Mere emphasis on taxes without growth is highly imprudent thinking on the part of economic managers.
It is tragic that huge profits are generated through speculative transactions in real estate and shares on daily basis, but the government is least bothered to crack down on benami transactions. The mighty sections of society are engaged in these transactions and they enjoy protection of obnoxious laws such as section Protection of Economic Reforms Act, 1992 and section 111(4) of the Income Tax Ordinance, 2001. No bill is introduced by the champions of democracy in the National Assembly or Senate to end these immunities and confiscate all untaxed assets after due process of law. Non-taxation of the rich and mighty and extraordinary tax-free benefits to the ruling elites is the real dilemma faced by Pakistan. It is high time that civil society, media and intelligentsia launch a campaign pressing the government to end extraordinary privileges, perks and perquisites available to militro-judicial-civil complex. Non-payment of due taxes by elected members, absentee landlords, businessmen-turned-politicians and public office holders is an established fact-as evident from Tax Directory 2013 and 2014 published by FBR. Since FBR is not taking any action against them, there should be a demand from public that all their assets created beyond declared means should be confiscated and they should be banned from taking part in politics.
After dealing with the rich and mighty, the attention should be concentrated on combating tax evasion and avoidance and plug all loopholes to bridge prevalent huge tax gap. It is an undeniable fact that there prevails massive sales tax evasion coupled with non-reporting or under-reporting of incomes in Pakistan. The people should be given tax benefit/incentive which will help expanding tax base, improve documentation and better collection of taxes without any hue and cry from any segment of society. A well-thought-for scheme is required that should not only check leakages in sales tax collection, but also encourage the people to file their income tax returns without any fear or hassle. The objectives of expanding tax base and combating tax evasion should be achieved simultaneously.
At present, there is a massive evasion in sales tax regime as registered persons charge sales tax on the value of supply but understate sales and deposit laughable amounts into State Treasury. It is common practice that due to corruption/mismanagement in sales tax administration and unwillingness on the part of people to obtain sales tax invoices, registered persons are not depositing full amount of sales tax recovered from the end users. By not depositing sales tax into government treasury, government is being deprived of sales tax which the end users are paying to registered persons. In this way, income tax which that registered person should pay is also evaded since only a part of sales is reported.
The following measures can be adopted to improve sales tax and income tax compliance:
-- Anybody who provides proof of payment of sales tax as end user should be entitled to refund to the extent of 20% of the amount paid with no questions would be asked about the source. The procedure for claiming refund should be simple. The payer should send invoices to Central Depository of FBR which after verification should authorise refund by direct transfer in the account of the payer. In this way, FBR would develop data base of all outlets and can cross verify the same with the particulars declared by vendors in their sales tax/income tax returns; or
-- Any person having sales tax invoices as end user be allowed to claim credit of 20% of amount paid against income tax liability. Where liability of income tax is less than amount of credit, balance should be refunded in the manner suggested above.
This scheme will encourage a person to obtain sales tax invoices, which is presently not being insisted. The evasion of sales tax is mutually beneficial. If payer is given the above incentive, he will insist for sales tax invoice and the government without expending any money or making extra efforts will be able to expand tax net. The tendency to squeeze more and more from the existing taxpayers and imposing erratic withholding taxes like section 236P of the Income Tax Ordinance, 2001 and giving a free hand to the rich and mighty has eroded the tax base to the extent where voluntary compliance and tax enforcement have lost their relevance.
Faith in the system will never be restored unless rule of law is enforced both for the tax machinery as well as the taxpayers. How to achieve tax compliance is the main challenge before the government. The State must remember that if taxation is viewed as being unfair or favouring the rich, it remains counterproductive in the long run. The crisis with Pakistan is that general acceptance of tax system is undermined. Special efforts and rational policies are needed to restructure the tax system and restore public confidence in the tax officials. Even a good tax system will not work if the prevalent negative mindset of the tax official persists. There is an immediate need to improve both the system and the human fabric that controls it. The tax system must provide:
-- Rule of law and predictability of the authority to tax
-- Principles of proportionality, efficiency, effectiveness, flexibility, continuity, reciprocity, fairness and equity
-- Tax harmonisation
-- No double taxation or intentional non-taxation
-- Non-discrimination
-- Strict anti-tax evasion rules
The tax reforms should be through Parliament with the consultation of all stakeholders. Presently this is being done by the bureaucrats sitting in the Ministry of Finance and FBR. It is exclusive domain of the Parliament to enact tax laws and frame tax policies. FBR has presently assumed the role of legislator and policymaker which is highly lamentable. It should be an autonomous national tax agency, insulated from outside political, financial and administrative pressures and run by an independent Board, having 50% representation from public. The Parliament should appoint members of Board of FBR and devise, through democratic process, a rationale and acceptable tax policy after taking input from all the stakeholders and experts in the field. This alone can help broadening tax base and improving tax-to-GDP ratio.
(The writers, lawyers, authors and partners in HUZAIMA IKRAM & IJAZ, are Adjunct Faculty Members at Lahore University of Management Sciences (LUMS).)