Private foreign currency account and Section 111(4) of the Income Tax Ordinance, 2001: The revolving circle

This is a continuation of the articles written earlier in this paper on the matter of perpetual amnesty available in the form of 'No Question Asked Concept' for foreign exchange remittance from abroad. Under this provision of the tax laws, any fund remitted from outside Pakistan through banking channels are immune from any tax and any question about the source of money.
In this particular article, this issue has been examined in a different perspective. Whenever this aberration in the tax policy is discussed, this matter is linked with the availability, being the 'supply side', of foreign exchange in Pakistan. For this reason, this 'sacred' provision is not touched as the same is perceived to disturb the inward flow of foreign currency. Post 'Panama Leaks' and 'Paradise Papers', Common Reporting Standards and new commitments with the OECD, a new world order has emerged. It is high time to re-examine the matter in its complete and holistic perspective. This article discusses the relationship of this provision with availability [supply side] of foreign exchange in Pakistan and other related aspects.
If this policy leads to regular and continuous supply of foreign exchange then that is a good omen from the foreign exchange viewpoint, notwithstanding the aberration in the tax system. However, this picture is to be seen from another angle also. If it transpires that it is a 'revolving circle', in operation that may also be used to finance corruption, and there is no ultimate increase in inflow of foreign currency, except in certain undesired situations, then there is a case to re-examine the matter.
Pakistan is in a dilemma. The crucial question to be answered is to adopt a policy for fiscal inclusion and expansion of tax or to provide perpetual untamed amnesty, if that leads to inflow of foreign exchange in Pakistan.
In this article, an effort has been made to explain the relationship of this policy with the process of whitening of the money obtained through corruption.
In order to fully digest this complex subject, it is necessary to discuss the primary features of present foreign exchange regimes and its relationship with the amnesty available in the tax law by way of provisions contained in Section 111(4) of the Income Tax Ordinance, 2001 and the way these two regimes are conjunctively used to finance corruption.
This unique feature is applicable only in Pakistan. It is author's firm view that it is the appropriate time to abolish all such aberrations from the economic, fiscal and foreign exchange policies/regulations of the country.
This subject cannot be fully appreciated unless we understand the basic features of our foreign exchange regimes and its outflow and inflow mechanism and the purposes for which some of such inflows and outflows are made.
Distinction between whitening untaxed money and proceed of corruption
For this purpose, there is a need to distinguish the abuse of the aforesaid provision of the income tax law for:
(i) whitening the untaxed money earned in Pakistan from business which lies in rupee; and
(ii) the proceeds of corruption where there is no initial inflow in Pakistan rupee.
These are two different forms and subjects. For further clarity on the matter, it is stated that in one situation businesses may have untaxed rupee which is required to be whitened for various reasons, including tax reporting. As against the same, there are receipts in foreign exchange on account of corruption to be available, in untraceable and unaccountable manner, in the guise of the aforesaid regime. This in short is termed as 'Financing Corruption', which in appropriate terms means the 'Legal Ways to Have and Park Corruption Money'.
Two parallel foreign exchange regimes
At present, in Pakistan, two parallel foreign exchange regimes are in operation. First regime is governed by Foreign Exchange Regulations Act, 1947 whereby all inward and outward movements of foreign currencies are to be made through State Bank of Pakistan. In summary, under that regime only SBP is entitled to deal in foreign exchange, and if any Pakistani person intends to deal in any foreign currency transaction, be it inward or outward flow, the same is to be made by and through SBP. Pakistani person will pay in rupee and at the same time receive in rupee. This system was in operation until 1992, when a parallel regime was introduced by way of Protection of Economic Reforms Act, 1992. The present law is amply covered by the 'Foreign Currency Accounts (Protection) Ordinance, 2001'.
In the process of part-deregulation of foreign exchange regime which commenced in early 90s, in addition to this regulated system, another 'half-regulated' system was introduced through which Pakistanis are allowed to maintain foreign currency accounts in Pakistan. Through these foreign currency accounts, Pakistanis can deal in foreign currency without any involvement of SBP. Nevertheless, such foreign currency accounts can only be maintained by individuals.
These private foreign currency accounts can be fed with the foreign exchange from two sources being:
(i) purchase of foreign currency from the money changers; and
(ii) receipt of funds in the foreign currency account from abroad. The second mechanism is generally called 'TT' inflow.
In short, everybody has the right to buy foreign exchange from open market by payment in rupee and transfer the said foreign exchange anywhere in the world as desired. Section 5 of the Foreign Currency Accounts (Protection) Ordinance, 2001 inter alia overrides the Income Tax Ordinance, 2001.
Whitening process of untaxed money
Under the present regime, any untaxed funds in rupees can flow out of Pakistan through this unregulated market. This can be done by acquiring foreign exchange from the 'kerb' market from that untaxed fund in rupees. In other words, the 'foreign currency account' is fed by untaxed rupee funds converted into foreign currency using the available foreign currency in the 'kerb' market. The amount so credited may be sent outside Pakistan. Once the said amount is available outside Pakistan, the same can be sent back in foreign currency to avail the benefit of
Section 111(4) of the Income Tax Ordinance, 2001. Through this process, which is legal under the foreign exchange regulations and also by implications under the income tax laws, untaxed rupee funds convert into white money that can be used in any business or acquire any asset in Pakistan. This is the simple description of perennial amnesty scheme having complete legal protection. From the tax policy viewpoint, this is a suicidal framework. But in perception it suits the other angle, being 'supply side' of foreign exchange. This misperception has been amply clarified in the illustration and description in the following paragraphs.
The amnesty provision, however, only applies when the funds remitted from abroad are surrendered to SBP and converted into Pakistan. In other words, the foreign exchange sent from abroad moves 'out' of the 'kerb' or 'unregulated market' and forms part of the regulated market. This is one of the ways of feeding regulated foreign exchange reserves of Pakistan.
It therefore means that this 'scheme' has been designed, or has emerged through which untaxed money available in Pakistan may be used to improve the supply side of foreign exchange in Pakistan. In other sense, fiscal objectives can be compromised as long as foreign exchange flows into Pakistan. In the following paragraphs, it has been described and proved that this perception, in practical sense, is not correct and is based on incomplete understanding of the whole revolving circle.
Is there actual net inflow of foreign exchange under the present regime?
The aforesaid illustration assumes that untaxed money in the form of rupees is converted into foreign currency and then sent outside Pakistan. This, therefore, means that in case of whitening the untaxed money available in Pakistan rupee, there is no net inflow in Pakistan as it is the same foreign exchange that is sent and brought back. The only benefit to the State is that foreign exchange available in unregulated market falls in the coffins of regulated reserves. This, however, does not necessarily increases the net supply of foreign exchange in Pakistan and resultantly the rupee parity in relation to foreign exchange. This further proves that operation of Section 111(4) of the Income Tax Ordinance, 2001 does not in any manner supports rupee parity against foreign currency, as far as untaxed money available in rupee is concerned. This actually provides a permanent medium to whiten the untaxed money through legal means without any benefit to the State in the form of supply of foreign exchange, as is generally perceived. In short, it is only a tax immunity not a measure to have higher availability of foreign exchange in Pakistan. As explained in the following paragraphs, the real role/objective/utilization of this regime is in relation to financing corruption.
What is meant by financing corruption?
The aforesaid statements are very simplistic description of method in operation for whitening the untaxed money using the foreign exchange regime and the immunity provisions under the income tax laws. The other and the most damaging side is direct inflow of foreign exchange to finance the corruption of various kinds and at various levels. In that case, there is no rupee fund that is required to be sent outside Pakistan to whiten the same. In short, the easiest way to receive 'bribe' or proceeds of crime and corruption in Pakistan is foreign exchange remittance from abroad. The amount so received will qualify for exemption and will be completely legal and white for all purposes. So the fear of hiding the corruption money is finished. At the same time, State is benefited in the sense that its official reserve position improves. This, in short, also explains one of the modes of availability of foreign exchange in the kerb market which, unlike the general perception, is brought into the country in physical form only.
This means that in this country, there is a legal mechanism to receive proceeds of crime or corruption funds and convert the same into legal money without any action. If we continue the same then all our actions against expansion of tax base and elimination of corruption are practically non-viable, illusionary propositions/ideas.
As stated earlier, this mechanism is a major source of inward flow of foreign currency in Pakistan that partly stabilizes our rupee parity, unlike the case of rupee funds discussed earlier. However, it is for the policy makers to decide whether there can be any meaningful increase in the tax base and elimination of corruption unless we deal with these apparent and convenient contradictions in our system. The other important aspect to examine is whether after the changed economic and reporting requirement in the world, would we be allowed to continue these unique undocumented regimes?
Does corruption money flow to the country?
There can be a simple question on this subject. What is the obligation or basis of bringing the corruption money to Pakistan? Why the same is not retained outside Pakistan? This is a very correct observation and it is author's view that a major part is retained outside Pakistan. Nevertheless, there is a permanent need to finance living in Pakistan. Furthermore, Pakistan's taxation and documentation system provides avenues to park undocumented asset better than any other place in the world, therefore, it is a good place to park assets.
It is a universal principle that the only efficient manner of eliminating corruption is to restrict the availability of parking lots for untaxed income or funds, being proceeds of crime and corruption funds. If we analyse our system then it transpires that our foreign exchange regime intertwined with our taxation system provides a very convenient mode of parking the untaxed and corruption money.
Now the last question is the identification of sources from which such foreign currency is made available. This is a separate subject, however, under-invoicing of exports, services remittances diverted to the said mode and commission earned abroad on imports are the regular sources of such funding. These are all inter-related subjects, which require overhauling of regulatory regimes in Pakistan.
Value of rupee versus foreign currency
Like every commodity, the price for the foreign currency is dependent on the available supply and demand. The Pakistan rupee parity is also determined on the same principles. However, as discussed above, for determining that parity both the markets being regulated and half regulated operate indirectly and implicitly in conjunctive manner.
The whole issue can be summarized through a simple illustration as under:
The unholy link
The aforesaid discussion reveals that an unholy link has been created between the foreign exchange regimes, as referred above, and the tax amnesty as well as value of rupee in relation to foreign currency. In summary, it can be stated that by virtue of aforesaid regulations, the increase in tax evasion/avoidance and level of corruption in Pakistan has been directly related to the availability of foreign currency in Pakistan.
At the end, the question is the ultimate priority of the State.
Are we promoting and legalizing tax evasion and avoidance, and corruption at the cost of common people by only concentrating on supply side of foreign exchange?
In author's view, for various known and unknown grounds, the aforesaid apparent conjunctive analysis is avoided for the reason that as a country, we always remain short of foreign exchange. It can be proved that, on overall basis, this policy is not in the interest of the State. We avoid any discussion on the subject for the fear that any action on that account may stop the inflow of funds from abroad. In author's view that analysis is not true for all cases, except financing corruption. It is hoped that this issue will be seriously considered whilst framing policies for the future. In this connection, it is to be taken into account that after the amendments made in
Anti-Money Laundering Regulations, 2010 the issue requires a review in a comprehensive manner. In this situation, the immediate and urgent task is to delink the relationship between Foreign Currency Accounts and Tax Immunity under Section 111(4) of the Income Tax Ordinance, 2001. The solutions are:
(a) Section 5 of the Foreign Currency Accounts (Protection) Ordinance, 2001 be re-examined and the overriding effect of the same over the Income Tax Ordinance, 2001 be reviewed. There was no objective under any policy framework to allow such accounts for tax avoidance purposes; and
(b) Present procedure of feeding Private Foreign Currency Account be re-examined with respect to feeding the said accounts by purchasing foreign currency from the open market.
In short, the step for correction is to delink the two provisions being private foreign currency account regime and tax immunity under Section 111(4) of the Income Tax Ordinance, 2001. A conjunctive operation of these two regimes, in the present framework, is not a desirable option.