Since July 1, 2015 withholding tax on banking transaction is under serious discussion. Notwithstanding the merits and demerits of this measure, this tax leads to the identification of the major issue of tax evasion and avoidance in retail and wholesale trade sector of Pakistan. As per preliminary estimates, this sector contributes to around 25 to 30 percent of the GDP of the country and 'direct tax' share of this sector is less than 2 to 3 percent. Although the margins in this sector are low as compared to manufacturing, earnings even on a conservative basis will lead to a contribution of at least 10 percent. This leads to a figure of around Rs 400 billion which is not being paid. The admirable part of the discussion post-July 1, 2015 is that there is an acceptability in general that there is mass evasion of tax in this sector. It is designed evasion supported by legislation and system weaknesses. Let us appreciate this fundamental point which this writer has been stressing for the last three decades.
Tax on direct income of retail and wholesale trade has been ignored as subject for over three decades. Conceptual framework for non-documentation started in 1979, again by Ziaul Haq, when a defective self-assessment scheme was introduced. Under that scheme tax liability was related to what has been paid in earlier years. From 1979 to 2015 numerous policy and administrative actions, for political expediency, were undertaken that lead to non-documentation, especially in that sector. We continued with a wrong legacy.
During a discussion on this matter on media the Finance Minister of Pakistan and one of the representatives of the retail and wholesale trade accepted that fundamental issue in this case is not tax withholding and being a filer or non-filer. It is the matter of 'benami' transactions being undertaken in this sector. For a general reader this means that a substantial part of transactions undertaken with or without banking system are those which do not form part of the tax system. These transactions are effectively out of records of tax system. The gap and the quantum as per author's view is massive. In the following paragraph the factors which led to this massive evasion are summarily discussed to identify the real issue of heavy under reporting of income and transactions by the retail and wholesale trade.
Income is equal to gross receipt less cost of goods and expenses. In the case of retail and wholesale trade the problem lie is the value of cost of sales. We have many inherent problems due to which retailers and wholesalers are and will not be able to declare their correct income. There will always be discussions to divert the matter from the core issue of serious defects in economic transaction system in this sector of economy. However, in fact the whole structure is based on a structure where documentation is virtually impossible.
A retailer or wholesaler deals in various kinds of goods. One of the break-up of the composition of total sales in this sector is given in the following table that would lead to identify the crux of the matter. Out of the total sale of 100 percent the composition of sources of goods traded in general is as under:
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1. Imported goods: (heavily under-invoiced); Around 25 percent;
2. Smuggled and Afghan Transit trade goods; 20 percent;
3. Goods originating from agricultural produce; 15 percent;
4. Goods acquired from un-documented manufacturers; 20 percent;
5. Goods acquired through proper invoice; 20 percent;
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There is no definite basis of this composition and in various trades the composition of first four heads may change. However, there is almost a consensus that such persons only have documented purchase invoice with correct value for only around 20 percent of the goods sold. If this is the position then sales can and will never be declared. This is the basis and rationale of resistance against imposition of transaction-based sales tax and any other measure of documentation. Now even the representatives of traders accept it and all of us know on day to day basis.
In short, during the last three decades the system of non-documentation for the aforesaid reasons has been so well entrenched that any attempt for determining the income of retailer and their direct tax contribution become an academic exercise. The purpose of this article is to identify the primary problem. Accordingly, whenever there is any attempt to bring the whole orbit in tax system the resistance primarily emanates from retail and wholesale trade on account of their model of business.
When the shelves of retail shops are filled with products for which shopkeepers do not have proper invoice then documentation will always be resisted. This tragedy had been further accentuated by the fact that we have devised many systems of presumptive taxation where something other than income is considered as taxable. Nevertheless, this honeymoon cannot go on forever and there has to be a time when income-based taxation will have to be done.
The arguments about highhandedness of taxation officers, corruption in the system, illiteracy of taxpayers, etc, are partly valid; however, these are effectively made to disguise the real issues identified above. The affluence we see around the country within few hands is partly due to the reasons that around 30 percent of the GDP contributors are effectively paying no income tax. This jeopardy is multiplied by the fact that such low incidence of taxation on retail and wholesale trade effectively promotes trading versus industry. Effective tax rate of documented industry is plus 50 percent. In this situation it is an advisable proposition to undertake trading business in Pakistan, preferably in imported under-invoiced products than engaging in industrial venture. This is not only a taxation issue. It is a wider subject of economic priority for the country.
In this situation, the advisable solution for the government is to dispel the impression that this tax is being imposed for collection of revenue. The objective is only to identify the quantum of transaction and persons undertaking such transactions which are outside the taxation system.
Banking system is also required to be aligned to documentation. In this particular case the best answer will be to prescribe that all bank accounts of a person undertaking business transaction will be opened on submission of a National Tax Number. If it would be so a substantial part of the issue will be resolved. However we all know that a lot of 'business bank accounts' and transactions in such accounts are undertaken by persons not having an NTN. Once a person in on NTN then the next step will be to take action against NTN not filing the return. This looks simple in theory however we know for a fact that this cannot be done immediately. There would have to be a transition. Im my view the solution will be to state that effective from a prescribed date there will be a requirement of identifying a business and non-business bank account in the banking system. In the case of a business bank account there will be a compulsory requirement of filing a NTN before opening such account. For all other business bank account where there is no NTN a time period of one to two years can be given to streamline the process. The solution laid down above may seem to be too revolutionary. However the ground reality is so serious that if no concrete step is undertaken then economic sustenance and stability of the country will be compromised. All these steps are to be duly supported by extensive and concrete action to curb under-invoicing, abuse of Afghan Transit Trade, smuggling and unrecorded production. Both these actions will have to be undertaken simultaneously.
There are many developing countries which have passed through these phases and they have settled their problems indigenously. We have the capability and strength to do so. However as a first step we have to know the ground reality in apolitical manner. Solution will emerge automatically.
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