To achieve success in any reform efforts the most important pre-requisite is 'FBR buy in' - Masoud Naqvi

With section 68 becoming famous overnight, BR Research thought best to sit down with the man who has been most influential in moving the government in the right direction, even though the initially proposed steps in that right direction have been - in his words - 'misguided'. As per latest updates (Friday evening when this interview was finalised), the Finance Minister had constituted a 13-member committee for fair valuation of the immovable property in 18 major cities of the country in a bid to resolve the issue of real estate builders and association with the Federal Board of Revenue (FBR). The next meeting of that committee would be held on July 27 and the two sides are expected to reach a consensus.

In this interview, Masoud Naqvi, one of the country's most senior and respected chartered accountants, who headed 22-member Tax Reform Commission (TRC) formed by the Finance Ministry, talks about the ideal way forward on property valuation and other critical measures to reform the country's tax system. Below are edited transcripts of the short meeting.

<B>BR Research: TRC's final report was finalised before the budget, and some of the reform suggestions have indeed been rolled out. How satisfied are you with the process so far?</B>

<B>Masoud Naqvi:</B> Pakistan has had many failed reform commissions and failed reform efforts in the past. Our view was that the ongoing reform process has to be more pronounced and made successful. This is why we had insisted that there should be a mechanism to ensure the implementation of the reforms, for which a monitoring committee has been formed.

However, I am still not very happy with the situation because our efforts have only been included in bits and pieces instead of adopting it holistically. The government says that the holistic reforms will be rolled out in the next budget. But I think the government will find it more difficult to roll out holistic reforms in next year because the general elections will be just around the bend.

<B>BRR: The monitoring committee comprises of three members from the TRC, all members of the FBR, chairman FBR, with its chairman being Haroon Akhtar Khan. Isn't this problematic? The implementation has to be done by the FBR, and yet the monitoring committee is dominated by the FBR.</B>

<B>MN:</B> Unless we make FBR a part of the monitoring process, accountability and ownership will remain missing within the FBR. The reason why FBR members are sitting on the monitoring committee is because they will give the right direction and provide solutions when reforms hit any obstacles. In order to achieve success in any reform efforts the most important pre-requisite is the 'FBR buy in' without which it will not achieve the desired objectives.

<B>BRR: How receptive has been the FBR to TRC's recommendations?</B>

<B>MN:</B> The first thing we did was to identify which of the recommendations does FBR agree with and with which it doesn't. Contrary to the popular perception, a large number of recommendations have been fully endorsed by the FBR. These include PRAL reforms, the rolling out of benami bill, right property valuation, foreign assets declaration, and reorganisation of FBR collection arms, effective alternate dispute resolution and independent and efficient appellate process.

Pakistan has the potential to collect about Rs8 trillion in taxes as against the Rs3 trillion being collected today; tax evasion in just 11 sectors is about $2.6 billion. However, it must be kept in mind that the issue is not merely that FBR is not getting enough revenues. The biggest issue is that compliance level is very poor. The tax department is not in a position to ensure the fulfilment of tax laws. If the compliance level is improved, then all other things will fall into their place.

<B>BRR: What has been the progress in each of these critical areas?</B>

<B>MN:</B> In the case of PRAL, we had recommended that its CEO should not be a member but someone from the private sector on the basis of merit. We recommended that PRAL should be a service provider to the FBR, and FBR should set up targets for them and they will have to perform on based within pre-defined time period, parameters and the KPIs. The new CEO has been appointed. But he has to upgrade the system and also get the right human resources.

The benami law has been placed in the parliament; it is hoped that it will be passed soon. Third, the government has also made progress on the real estate valuation, though some of the initially proposed steps were misguided. We are hopeful that things will move in the right direction.

Then we had agreed that tax collection of all corporations and LTUs will be done on functional basis, and the rest of it will be on the basis of the constituency or circle-based. Sixty to seventy percent of FBR's staff is circle-based and most of those will be used for broadening of tax base. This too has been agreed upon with the FBR and its implementation is in the process of kicking off.

<B>BRR: The evidence in terms of the number of new filers that have been roped into the system due to filer/non-filer differentiation is publicly unavailable; the FBR hasn't released the numbers, nor has the Finance Ministry. The reported numbers based on sources are conflicting. What is your understanding of the situation?</B>

<B>MN:</B> The number of new filers is very little. This is because the differentiation strategy is being used for the wrong purpose. It is being used merely for increasing revenue collection, whereas it should be used to bring more people into the tax net, and once there are more people in the tax net, revenue collection will naturally increase over time.

Our view is that filer/non-filer differentiation should be for the purpose of documentation. It should not be for the purpose of revenue generation. The consequence of revenue generation mindset is that those who pay the non-filer taxes wrongfully perceive that now they are immune from filing the return, whereas the FBR is slow in conducting relevant analytics and based on this sending notices and bringing the non-filers in the formal process.

However, hopefully this scenario will change once structural changes are brought about in FBR. Once the staff from FBR's circles is told to go out in small cities to broaden the tax net, using analytics as a support, then the filer non filer differentiation will start making an impact.

<B>BRR: How long will it realistically take under these planned reforms?</B>

<B>MN:</B> The problem is the lack of will. There are vested interests involved across the board. It is not only the department; it is people from the business community too; it takes two to tango. Most people think these reform process will fizzle out like many others before, which is why it is important for the government to take ownership of the process and keep beating the drum.

<B>BRR: What is your suggested model for National Tax Agency as a long term solution?</B>

<B>MN:</B> Our conception of NTA is that it should only be a collecting body and not an assessing body. It should only collect taxes and immediately automatically through a process transfer it to the relevant federal or provincial tax body. By way of centralising collecting, the agency will have the right databases and analysis that the relevant federal or provincial department can use for their assessment and to send out notices if need be, and so forth.

<B>BRR: Why will the provinces give up their fiefdoms?</B>

<B>MN:</B> This will require trust, confidence and political willingness. These can be achieved by having the right representation on the agency board and by convincing that nobody will suffer any tax loss; in fact, it will only increase revenue collection. If you can demonstrate that the NTA's collection will be immediately sent to the provinces, then they should not have any problem because their cost of collection will go down and they will only have to work on those cases who are not complying. This is something that a number of countries including Turkey, have tried to follow and it has worked.

<B>BRR: The WHT-isation means that even those people whose income below the taxable threshold are being taxed. Is that legally okay?</B>

<B>MN:</B> I will not comment on its legality. But it is morally wrong; it is unfair. A person who doesn't have any taxable income should not be made to pay WHT and other types of advance income tax because he is not a filer, nor is he even mandated to file the return under the law. So he will not get any adjustment of the taxes he has paid. Therefore, WHT regime may be problematic if one looks at it strictly from the lens of citizen rights granted under the constitution.

<B>BRR: Do we really have the quantum of the concessions granted to judiciary, bureaucrats and the army under the second schedule?</B>

<B>MN:</B> That data is not realistically available. But even a cursory analysis shows that perks and plots are substantial portion of their remuneration, which is not taxed under this schedule, though these perks are taxable for other salaried tax payers. This whole situation creates an air of unfairness and inequity.

<B>BRR: Let's talk about property valuation. What was TRC's model?</B>

<B>MN:</B> Initially when they announced real estate taxation, they said the transactions will be recorded at fair value. This rightly caused a fury that if fair valuation is left at the discretion of the FBR official, then there will be too much room for misuse of that discretion. Then they came up with the idea that valuation should be done by SBP approved valuators. However, the real issues that arise in the implementation of valuation have not been resolved.

<B>BRR: What are those real issues?</B>

<B>MN:</B> There are two problems in property. One is the unexplained investment, ie the source of funds, and second valuation. These two major issues need to be resolved.

The initial concept was that this tax to be implemented on the sale and purchase transactions after July 1, 2016. However, the law has not been made in a way that allows for this. Law is made such that if you have purchased a property after 2011 and today if you wish to sell it then you will have to pay capital gain tax.

The problem under this proposal is that it will use the DC rates for purchase of property (because most properties are registered at DC rates instead of fair value) and valuator's rates for sales and thereby result inflate the capital gains and tax thereof. The government needs to give some kind of immunity window under no-questions-asked policy to allow those people who had registered property at DC rates after 2011 to come forward and register the property at fair value.

In the second step, the federal government should sit down with the provincial government and bring the DC rates at par with market value and develop a mechanism to ensure that the DC rates are revised each year, and lower the duty rates.

On that note, our view is that if someone is selling the property after 4-5 years then he or she is not a property trader, though he may be an investor, and that income should not be construed as business income.

<B>BRR: How important is to revise the DC rates, when in fact property is being valued by the valuator?</B>

<B>MN:</B> If the DC rates are not brought closer to the fair value then the government's legal position will always remain weak. This is because anybody can go to the court and say that when one piece of law is accepting my DC value then how is it that the other law doesn't accept it and demands valuation by SBP approved valuators.

Remember also that the valuer will give you an indicative value not a fair value. If the transaction value is near to the indicative value - say about 75% of indicative value - then it's okay. The objective should not be to decide the price at which the transaction is taking place - that is between the buyer and seller and the society has no right to fix the transaction prices. Our objective is that price at which the transaction is made, that price should be documented.

<B>BRR: How soon and how can we reach that ideal?</B>

<B>MN:</B> Well the initial step is that we use the indicative value given by the valuators. But to improve the system further, analytical system of the tax department has to be improved such that the tax department is able to see the payments made via bank accounts and reconcile them with the property transaction. And therefore, it is important to deal with the benami accounts as well.

On the whole, I think it will take 3-5 years to fix the property valuation problem, provided the reforms are effectively implemented sustainably year after year. There is a need to build consensus and think through this, otherwise this matter will remain stuck in the courts for a long time.