Progress on tax reform implementation: "average": an interview with Masoud Naqvi, Chairman Tax Reform Commission

With the incumbent government nearing its tenure, BR Research decided to follow up with Mr. Masoud Naqvi, the Chairman of the Tax Reform Commission formed by former Finance Minister Mr. Ishaq Dar. Mr. Naqvi, also a member of the Tax Reforms Monitoring Implementation Committee (TRIC), is one of the country's most senior and respected chartered accountants who recently hung his boots after more than 46 years of service with KPMG Pakistan.
In this interview over tea and biscuits at Sindh Club's Bistro, Mr. Naqvi shares his thoughts on the pace and quality of tax reforms as well as the recently announced amnesty scheme. Below is the edited transcript of a rather long and winding discussion over taxation.
BR Research: Shall we begin from the amnesty scheme? What's your outlook given the political considerations and the window during which it can be claimed?
Masoud Naqvi: I understand that the government is expecting around $2.5 billion to be raised from the amnesty scheme, which I think is achievable. This amount includes both the amount of tax to be collected and the amount expected to be repatriated under the scheme. However, very little is expected to flow within FY18 due to uncertainties including the involvement of the Supreme Court of Pakistan.
The current window of amnesty scheme most probably would need to be extended, because until everyone is clear about the direction of the apex court, no one is expected to submit any declarations. In my view, the extensions to the amnesty schemes, if any, should not be more than two to three months.
BRR: Yours and TRC's input was the key behind this amnesty scheme. How would you respond to the morality of the issue since this amnesty leaves honest taxpayers worse off than the evaders who might now come clean wholly or partially?
MN: You are right. This kind of amnesty scheme does leave the honest taxpayer worse off. It's a discrimination against the honest taxpayers. However, it must also be considered that tax evaders were already enjoying exemptions for any undeclared assets acquired more than five years ago. Free flow of funds and the legal cover for this was also available up to the date of the amnesties.
Therefore, there is a rationale to provide an opportunity for declaration of domestic assets and assets held outside Pakistan, particularly in view of the automatic exchange of information under OECD multilateral agreements. Let me emphasize that any amnesty, once granted, should be an exception and not a norm along with an effective process of implementation and penalties on those who still do not comply.
BRR: Granted that the tightening global environment might force people to bring back their untaxed money to Pakistan. But unless the FBR has the capacity to brandish a stick at those tax evaders who may not claim amnesty, can the scheme yield desirable results?
MN: The amnesty scheme will be successful only if it is implemented very diligently and effectively. The opportunities have been provided in a number of jurisdictions and have succeeded only where people have trust in the capacity and database available with the relevant authorities.
In India, soon after their amnesty scheme ended, it was followed up by raids on celebrities and business persons, etc to send the right message across to all about the seriousness of the government in this regard. Our earlier schemes, other than the one issued in 1958, were unsuccessful due to the lukewarm acceptance and implementation by the authorities, and a tacit understanding amongst the business, trade and authorities to make some declarations and get away with it.
The intention of the current amnesties scheme is to follow a carrot and stick framework including amending and plugging all available loopholes. In our opinion, those who do not seek to fully benefit from this scheme would need to be subject to severe penalties including prosecution.
BRR: What other lessons are there to be learnt from the Indian experience?
MN: The most important lesson learnt from the experiences of the Indian reform process, and the reform process being followed by a number of other countries, is a need for a cohesive approach with a "full buy in" from all and sundry. The other important message has been the effective use of technology and its analytics.
Successful implementation of any amnesty scheme would depend on a master plan to reduce the size of Pakistan's informal economy over a period of time. In India, they achieved success despite higher tax rates by implementation of monetary schemes and demonetization policy.
These two steps, together with restrictions on the cash transactions, except for small amounts, helped with documentation of the economy, and increased the number of filers and tax payers. Even small-scale restaurants that sell tea and other snacks on the roadside have now been given devices to ensure that the trail of payments and sales are recorded. Even rickshaw drivers are sending and receiving payments through digital systems.
Here in Pakistan, the informal economy abounds and there is no master plan to address this issue. The TRC did recommend setting up of a high-level committee to identify components of economy resulting in its growth and to determine measures to direct the flow of transactions to formal economic sectors. Some of our recommendations have already been accepted and are being implemented, including measures to register the bearer securities such as prize bonds.
BRR: In 2015, the TRC had proposed that even if single-stage taxation makes it to the interim recommendation, your final recommendation would be that VAT in its true form should be rolled out over the next two to three years. What's the update on that?
MN: The idea behind simplifying taxation as a single stage tax was to increase the efficiency of tax collection. What's the point of going through the hassle of multiple stages, if the tax yield is low? However, the world is moving towards VAT-mode taxation because of obvious reasons, of which documentation is one of them. It was, therefore, decided that our final recommendation would be to roll out VAT in its true form within next two to three years and in the meantime address the issues and gaps which exist in the current sales tax regime.
BRR: What do you think needs to be done to roll out VAT?
MN: In order to successfully roll out VAT-mode taxation, everybody in the supply or value chain will have to be in the tax net - from manufacturers, distributors, and wholesalers to retailers - to be able to make input-output adjustments under VAT-mode taxation. The fact that the services taxes lie within the domain of provinces also makes matters more difficult.
A country like Pakistan should have a national tax collection agency that should have the mandate to collect tax on behalf of both the federal and provincial governments and to simultaneously allocate collections for the respective taxation domains. Until such time there is a national tax collecting agency, the country will continue to have problems in reconciliation, collection and varying processes.
BRR: Are you suggesting the shutting down of FBR and creating a new agency altogether?
MN: The national collecting agency will not be a substitute for the federal and provincial tax authorities. We do need a far more efficient FBR with a different mindset and improved set of capabilities.
BRR: Is the FBR now being managed as per Key Performance Indicators (KPI) as was earlier planned?
MN: There is a clear need to revise FBR's human resource (HR) policy, which may include recruitment and development of adequate set of human resources, revision of the performance evaluation process, setting up of realistic KPIs and focus on specialized training on audit and similar functions.
As for the KPIs for FBR officials, they were finalized in 2017. However, they have not been properly implemented, as the progress, promotions, increments and incentives of FBR officials have not been effectively linked to the KPIs as yet.
However, I think the KPIs will need to be revisited carefully. The KPIs are always made with a broader objective in mind; only when the overall objective is clear, you make sub-objectives and make the KPIs in light of those sub-objectives. Currently that exercise is missing.
BRR: In 2016, you said 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. Have those changes now been made?
MN: It has been partially implemented. The companies/corporations and the LTU are in the process of being managed on functional basis. The rest of the FBR staff is now proposed to be circle-based and a large proportion of these people will be used for broadening of tax base. This has been agreed upon with the FBR and it is being implemented.
BRR: In 2015, you said that all exemptions will be removed in 2-3 years. What's the update on that?
MN: Things have moved forward insofar as exemptions under direct taxes are concerned, although exemptions under the second schedule that pertains to salaries, the military, the judiciary and the parliamentarians still exist. Other exemptions that still exist today are either those that are well thought out, for instance a few charitable organisations, or those that are intended to attract investments in a certain economic sector. But the exemptions for indirect taxes, notably customs, are still an unfinished agenda.
BRR: The courts have previously rubbished the idea of composite audit for lack of legal framework; then how will the government manage the latest budget proposal to have composite audit every three years?
MN: Taxpayers had a genuine complaint that just as one tax audit ends, another begins, which creates room for harassment by FBR officials. Based on this, it was recommended that their audit will be done once in three years. But to avoid one audit after another, it was decided that all forms of audit - income tax, sales, and customs - will be done in a composite fashion.
The notion that audit will be done in a composite way is only to respond to the concerns of the taxpayers. The process of composite audit has not been set because the parameters and factors for all forms of audit are different. It has now been decided that all three audits will be done simultaneously under their respective framework but not in composite way.
BRR: But that will not be an efficient way to operate.
MN: You are right. The concept of composite audit is not present in the law. Efficiency will generate once all three departments work in a composite way. However, an FBR committee is already working to draft a legal framework for composite audit. If the composite audit is approved by the assembly, then it will become a part of the law, which means that until such time the legal framework is made, audit will not happen. But there is a way to work around until such time the legal framework is drafted, by auditing it simultaneously under their respective frameworks.
BRR: Given the election season, do you think there may be delays in the drafting of that legal framework?
MN: Yes, there may be issues. However, on the positive side, in some cases, the FBR's discretionary powers have been reduced and in other cases the powers have been reallocated from the junior level of FBR officials to relatively senior levels. Previously, if a certain power vested with the commissioner, now it is the domain of chief commissioner. Similarly, if previously a certain power vested with chief commissioner, now it rests with the FBR.
BRR: Further tax has been increased in this budget. Is that really a sagacious move when its originally-intended purpose of increasing the number of sales tax registrations has not been achieved?
MN: The concept of further tax was to bring more people into the tax net. But in terms of new registration, not much has been achieved over the years.
BRR: The TRC had classified its recommendations in short, medium and long term. How long is the short term and how short is long. And how many of those have been met to date?
MN: By short term, we meant twelve months. Two to two and half years were considered medium term, and anything over that is long. Out of those 19 points of short, medium and long term, a number of points have been incorporated either through SROs or administrative measures, and others through the most recent finance bill.
BRR: How is the report card for data analytics that FBR was supposed to use?
MN: To start with, PRAL has seen substantial improvement. We now have a professional as the CEO of PRAL. Secondly, Nadra, I understand, has also now started sharing data with the FBR; the FBR now knows the ownership status of luxury cars and real estate properties.
The systems are already in place to triangulate data. Now there is a need for investment to roll out initial versions of automatic assessment, where the FBR can inform assessees about the information it already has about the assessees. If the FBR can utilize this data, then they can get a lot of things done. Recently, a project has been finalised to upgrade FBR's systems, and we understand that the donor agencies are committed to provide the funding.
BRR: Why are all these improvements not reflecting in the numbers? On-demand collection is still poor, where WHT and other indirect collection of direct taxes is on the rise.
MN: There appears to be substantial issues of reconciliations of WHT and corruption in WHT audits. As for the contribution of on-demand collection to total direct tax collection, it will not reflect in total numbers because the issues in WHT have also been fixed; which is why total WHT collection has also increased.
Unfortunately, FBR's yearbooks don't reflect these. The purpose of yearbooks is to showcase your performance - both success and failure - and especially in the space of reforms. The FBR needs to work on that front.
BRR: What are the sector-wise refunds currently stuck with the FBR?
MN: The estimate of total refunds stuck with the FBR is more than Rs 300 billion including advance taxes obtained and delayed refunds. We believe that there is a need to take one-time hit and any unpaid refunds should be included as liability in the budget documents.
BRR: What improvements have been brought about in the appellate system?
MN: The FBR staff usually avoids resolving the cases through its own appellate system, and instead goes to the Supreme Court or High Court because it wants to avoid being unnecessarily questioned or nabbed by NAB or FIA for actions they took in good faith.
In order to resolve this, a law needs to be framed whereby decisions taken by the FBR in good faith cannot be challenged by NAB or FIA. FBR officials are currently reluctant to take decisions; files are being pushed around from one officer to another, and therefore causing delays.
A key improvement in that direction is the rolling out of Alternate Dispute Resolution Committee (ADRC).
The ADRC was supposed to be only a recommendary body and it was up to the FBR whether or not to choose the recommendation by the ADRC. The latest budget has made ADRC's decision as binding on both appellant and the FBR. This will help solve a lot of pending cases.
The good thing about ADRC is that their decisions do not become a precedent for subsequent cases.
BRR: FBR's tax directory shows that SECP and FBR's datasets are not talking to each other, hence the difference between number of corporations and number of corporate tax filers. Has there been any progress on that end? And what about the AoPs, for which even the baseline data is not publicly available?
MN: The SECP and FBR's datasets are now talking to each other. The FBR has also sent notices to those non-filer companies. However, the data is being cleaned because a lot of companies are inactive.
The SECP has also changed its laws whereby companies at the time of filing their annual return with the SECP will now also declare whether they have filed their tax return with the FBR.
As for the AoPs, the department of industries at federal and provincial level is now sharing data with the FBR since FY17 onwards. The sector-wise data of AoPs is being shared with FBR not because of revenue mobilization because as an anti-terrorist exercise out of international compulsion. Soon, the FBR will start using it for tax compliance purposes.
BRR: How would you rate human resource improvement and reduction of corruption at FBR, say on a scale of 1 to 10?
MN: Until we fix HR and corruption at FBR, there will be little progress. For HR, I would give 4 out of 10, whereas not very much has been achieved to reduce corruption. The whole of tax system is target-based. That approach means that as long as the target is met, it doesn't matter how it is being met. That tradition has to change.
BRR: How would you rate overall reform implementation on the following scale: very bad, bad, average, good and very good?
MN: Average!
BRR: Isn't that an optimistic view; some of your fellow TRC members don't share that view.
MN: I have nothing for the government or against it. Six months ago, I would have said zero percent implementation. I am not saying substantial changes have been brought out, but in the last three to four months, reasonable progress has been made.
I am an optimistic person by nature. One of the key lessons from my over 46 years of experience is that despite the worst of problems you can get something positive.
I believe that the international imperatives, technological developments, progressive change in relationships between taxpayer and tax authorities and change of mindset, although at a slower pace than needed, would be the factors that would result in a more efficient tax structure. The process of reforms is dynamic and needs to have a permanent oversight role to timely respond to developments at home and abroad.