Small corporate taxpayers, AoPs: FBR mulling replacing functional-based system with hybrid system

The Federal Board of Revenue (FBR) is working on a proposal to replace functional-based system with hybrid system to assess small corporate taxpayers, Association of Persons (AoPs) and others under the circle-based system and big units and corporate entities under functional system at the Large Taxpayer Units (LTUs). Sources said Saturday that the functional-based system and circle-based system were discussed threadbare during the meeting of the Tax Reform Commission (TRC) held at the FBR House.
A proposal was discussed to introduce some modifications in the existing functional-based system at the FBR field formations. One of the proposals was that the LTU would continue to assess large taxpayers under functional-based system, but the small corporate taxpayers and others would be assessed under the circle-based system. The TRC has recommended that the government had constituted Task Force Tax Administration (TFTA). A very powerful recommendation of TFTA was to reorganise the operations on functional specialization lines. TFTA noted "essential aspects and administration of income taxes have remained unchanged for nearly three-quarters of a century," TFTA was critical of the Circle based system and identified a number of problems namely that: (a) Tax collector had little assistance for management of information; files were lost and could be manipulated;(b) many ITOs/DCITs professionally were ill equipped for the job, in particular to deal with complex tax returns of business as no system existed of profiling a taxpayer and risk assessment of taxpayers; (c) the tax collector had too much discretion(d) the discretionary system caused coercion and collusion and resultant loss of revenue (e) due to unethical practices taxes were negotiated resulting in significant loss of revenue.
The TFTA recommended a new system based on functional specialization. It was envisaged that under functional system "fundamental responsibility for declaring income and assessing taxes should lie with the taxpayer;" but this should be accompanied with "selective and professionally conducted audit supported by survey and research capability and databases" and strongly supported by Information Technology. The role of IT was critical for the success of the proposed system. At administrative level, TFTA recommended reorganisation of all field operational units including: (a) Information Management System; (b) Operations and Audit; (c) legal and Prosecution; (d) Survey and Research; (e) Customer Service, Enforcement and Collection; (f) Inspection and Audit, it recommended.
Under the World Bank supported Tax Administrative Reform Project (TARP), investments were made in change management and human resources to support the implementation of a new organisational structure on functional lines in FBR. Prior to these administrative reforms in the organisational structure, FBR (CBR) units operated in "Circle" system comprising work units, the jurisdiction of which was by and large based on "territorial" specifications, TRC said.
This basic Unit was a Circle whose Officer In charge was entrusted with all the responsibilities of maintenance of record, receipt and enforcement of income tax returns/statements, conducting audit and assessment, recovery of taxes, filing of appeals at various appellate fora, issuance of refunds and assisting the Commissioner in issuance of exemption certificates etc. In hindsight although all the work was entrusted with one person, there was a unity of command, better understanding of issues and a sense of ownership among the tax officials, yet there was a general perception amongst all the stakeholders of the system that a circle officer was over burdened with work and dissatisfied with his working conditions and there were complaints of misuse of powers, it recommended.
The analysis portrays a very dismal picture of the tax base in Pakistan. The present functional system it seems has totally failed to expand the tax base or enforce law as the number of non-filers is 4 times that of the number of filers. TRC remarked that what is very worrisome to TRC is that instead of increasing the tax base, the FBR is losing Active Tax Payers: As per Active Tax Payer List (ATL) on FBR website (14-10-2014) relating to Tax Year 2013 the taxpayers on ATL were : 8,35,220. As per Active Taxpayer List (ATL) on FBR website (11-04-2015) relating to Tax Year 2014, the taxpayers on ATL were: 7,26,160. Hence FBR has lost about 109,000 Taxpayers in one Year If one merely looks at the Income Tax Collection for Tax year 2013, and break up the gross Income Tax Collection of Rs 1,312,663(M), the share coming from Tax withholding and voluntary payments is Rs 656,334(M) and Rs 591,961(M) respectively. Only Rs 64,368(M) was tax through assessment out of which Rs 57,551(M) was contribution of the 3 LTUs. The contribution of balance 18 RTOs in Income Tax through assessment was only Rs 6,817(M).
In respect of the Sales Tax return filers, out of 101,526 Sales Tax Return filers for June 2014, 47,724 were Null filers. Hence, the number of payment filers, nil filers and short payment filers was 53,802. The TRC finds the number of Sales Tax Return filers to be extremely low keeping in view the provisions of Sales Tax laws and the scale of economic activity in the country.
If one compares the total Administrative cost and salary of individual RTOs with Tax through assessment, only 3 RTOs were covering their administrative costs and salary as compared to the tax demand raised through assessment. The comparison is to some degree incomplete as Sales Tax demands have not been included but the fact for reflection is the tax administration in RTOs has not been setup only to cover their own costs, but the recover legitimate taxes for the nation. However, it had its weaknesses as well. Changing times require us re-think the design of old Circle-System replacing it with horizontal functional support structure. In this case, IRS-Districts/Divisions based on Territorial Unit(s) could be a potential solution.
The TRC said that modern challenges concern auditing of MNCs, industrial conglomerates, national corporations, autonomous bodies, industrial firms, manufacturers, specialized sectors, importers and exporters, which are usually involved in tax planning to avoid/reduce their tax burden either by tax evasion or by shifting profits across borders through transfer pricing or employing tax havens/shelters. The specialized functional system could still address such complex issues and challenges of modern taxation with effective and integrated IT support and data analysts for high revenue yielding/corporate cases.
Keeping in view the past experience concerning abolition of wealth tax was, merger of sales tax with income tax, and conversion of circle based system to functional system, the organisation should ensure preservation of valuable records, which in the earlier periods of change, were lost in the process. It is recommended that the following precautionary measures be taken on immediate basis and should be completed in next 6 months: Stock registers of all units/zones be updated and computerised; lists of all current and arrears demand be computerised; record of all appeals cases be computerised; record of all audit paras be kept in safe custody; unit-wise/zone wise lists of Taxpayers paying advance tax (under section 147) be computerised; list of pending audit cases be computerised; list of Set-aside cases be computerised; existing record of assessment proceedings (IT/ST/FED) be scanned/kept in safe custody and appeal records should be computerised.
The present operations of the FBR field units are neither operating on fully functional basis nor on territorial jurisdiction based. Only one LTU is at present operating on fully functional basis (LTU-Islamabad) as envisaged under the TARP. Other RTOs and LTUs are functioning on hybrid system which lacks accountability and has eroded authority.
The TRC feels as a result that the present hybrid system is dysfunctional. After detailed feedback from various stake holders is of the opinion that the present hybrid system is dysfunctional. The TRC recommends that over next 6 months call LTU should be made to operate on fully functional basis with specialized verticals and strong horizontal system support in IT and HR. There should be strong focus on customer services and facilitation.
Three zones, one each in three major cities should be setup to operate on territorial jurisdiction basis. Even in these units, strong IT and HR support should be made available. Revenue for these units be pre-assigned, geographic jurisdiction be fixed and the major task of these units should be broadening the tax base. The existing taxpayers should be documented and business mapped and data based on secondary sources should be used to broaden the tax base on the one hand and deepen the tax base on the other.
These pilots should be properly resourced and be allowed to function for 6 months, the progress closely monitored and results documented.
In the pilot zones, the Commissioners should be made the administrative head of units with financial and administrative authority. There should be full accountability of all staff and officers and KMIs should be established. The PRAL should in next 6 months complete the exercise of establishing and digitizing the records not only for all existing tax filers but also for those booked on NTNs.
The TRC recommends that LTUs should continue to function on functional specialized system with stronger IT support and better customer services FBR should seriously consider placing Custom services for LTU clients in LTU. Depending on the success of the pilot phase (an indicator of success could be increase in the number of taxpayers by 33 percent), the FBR could move towards establishing field operations on territorial jurisdiction basis, with strong IT and HR support. The prime mandate of the units would be to broaden the tax base. The FBR should for next five years deploy about 30-50 percent of its field IRS work force to broaden the tax base. Massive use of IT and data should be used to broaden the tax base and FBR should also consider external surveys after dialogue with stakeholders.
In each of the major cities, Medium Taxpayer Unit (MTU) should be established, where the cases be assigned on taxpayer segregation. Corporate cases and high income case other than those assigned to LTU as an example could be assigned to the MTU. These MTUs should also continue to operate on functional specification system. The FBR should continue to invest in human capital development, identify and fill up skill gaps. The FBR could consider recruiting highly skilled staff on contract from the market through a transparent recruitment process.
This interim setup of mix of functional system and territorial jurisdiction units should be allowed to continue for five years till the tax base is sufficiently broadened and reliable, IT support becomes a reality and better taxpayer services are introduced. After five years, there should be a gradual phase-out and the system should fully revert back to functional specialization system of operation, the TRC recommended. The FBR should also seriously consider conducting the external survey to broaden the tax base, the TRC added.