The key facts and figures on the income tax system of Pakistan are presented below. These facts will be useful in launching a nationwide campaign for raising more revenues and in identifying the major reforms. Pakistan has a relatively low income tax-to-GDP ratio at 4.2 percent in 2016-17, as compared to 6 percent in India, 8 percent in Malaysia, 5 percent in Nepal, 7 percent in Thailand and 8 percent in Vietnam.
Only one in 160 persons files an income tax return in Pakistan as compared to one in 40 in India. Also, only one third of the companies registered with the SECP file income tax returns in Pakistan. The accrued capital gains in the stock market of Pakistan in 2016-17 are over Rs 2000 billion. The gains realized are almost Rs 540 billion. But the tax paid is only Rs 15 billion.
There are 304,000 farmers in Pakistan with farms of 25 acres or more. Their total income is estimated at Rs 1085 billion, but the agriculture income tax paid by them in 2016-17 is less than Rs 2 billion.
Pakistan has one of the most comprehensive withholding tax regimes, with as many as 64 types of deduction at source. Almost 70 percent of the income tax revenues in 2015-16 were collected through these withholding taxes. This reflects the state of documentation of the economy. In the mid to late 90's, with a much lower share of 40 percent of withholding taxes, direct tax revenues exceeded 4 percent of the GDP.
The revenue loss due to tax concessions and exemptions is as much as Rs 377 billion in 2016-17. This is equivalent to 28 percent of actual revenues. The tax expenditure is due to under taxation of capital gains on shares, treatment of unearned income as a separate bloc of income, tax holidays, accelerated depreciation allowance, exemption of business income of NPOs, tax deductibility of bad loan provisioning by banks and so on.
VIPs like the President, Prime Minister, Federal Ministers, Service Chiefs, Corps Commanders, Supreme Court Judges and senior bureaucrats enjoy various special tax privileges. This tends to send the wrong signal to potential taxpayers.
The domestic wholesale and retail trade sector is one of the largest sectors in the country, with income generated of Rs 3980 billion in 2015-16. However, the revenue collected from the sector is only Rs 60 billion. Therefore, the effective burden is not even 2 percent.
Independent Power Producers (IPPs) enjoy lifetime exemption from corporate income tax, as per the 1994 Energy Policy. Cumulatively this has led to a loss of over Rs 400 billion in revenues since 1995. They also enjoy high rate of return annually on equity of over 26 percent.
Pakistan has no transfer pricing regulation, unlike the tax laws in other countries like India. Consequently, a higher share of profits accrues to head offices of multinational companies, thereby reducing the tax liabilities in Pakistan. This practice is common in sectors like pharmaceuticals and automobiles.
The Income Tax Ordinance of 2001 taxes global income of residents under Chapter VII. In 2014, Pakistanis invested $4.8 billion in Dubai alone. The income from the assets of non-resident Pakistanis in Dubai is fully taxable in Pakistan because there is no income tax in Dubai. This provision is included in the Avoidance from Double Taxation Agreement of Pakistan with the United Arab Emirates. Similar problems exist with income of resident Pakistanis from the other countries.
The Internal Revenue Service (IRS) of FBR has shown a declining trend in raising demand, following assessment, against under-declaration of income. The demand was Rs 88 billion in 2015-16. This represents a fall of 24 percent in relation to the level in 2014-15. Also, the demand is 26 percent of the total income tax paid voluntarily with the returns.
The tax rate on corporate income from foreign direct investment is 20 percent, as compared to the standard corporate income tax rate of 31 percent for the tax year 2017. This difference is in the nature of a fiscal incentive to attract more FDI. However, it increases the likelihood of some 'round-tripping' of capital.
According to an earlier analysis of the Tax Directory for 2014 published by FBR, only 40,764 Associations of Persons (AOPs)/Partnerships filed returns. The total tax paid was Rs 35 billion, equivalent to only 4 percent of the total revenues from the income tax. This highlights the high level of tax evasion by AOPs. The income tax collection is highly skewed. Among the total number of personal income tax payers of 791,456 in 2014, only 20,802 paid an amount of tax in excess of Rs 1 million. However, while these taxpayers represented only 2.6 percent of the total number, they contributed as much 69 percent to the total revenue from the personal income tax. At the other end of the distribution, as many as 297,002 taxpayers or 38 percent paid zero income tax.
Similarly, the distribution of tax payments by companies is also very imbalanced. Only 98 companies, out of a total of 24,186 companies, filing returns in 2014, contributed over 67 percent to the revenues from the corporate income tax. As many as 7,756 companies showed a tax liability of less than even Rs 1 million.
The personal income tax structure in Pakistan is much less progressive than in other countries. The highest marginal tax rate is attained at thirty five times the per capita income, as compared to ten times in India and eight times in Bangladesh. Also, there are as many as eight personal income tax slabs in Pakistan. In other countries there are generally three or four slabs.
Withholding income taxes on imports, electricity, CNG, telecommunications and sales of agricultural products have made the income tax more regressive. These sources account for 30 percent of the total revenues from withholding taxes. Almost 90 million persons pay income tax on their phone bills/cards, howsoever small their income. 18 million are charged on their electricity bills, 41 million on interest income from bank deposits and so on. As opposed to this, the number actually filing returns in 2016 is just above one million.
The Tax Directory for 2016 of Parliamentarians has been released recently. It contains some very interesting revelations. An analysis of returns by representatives of the National Assembly indicates that 12 percent did not even file a return. Only 8 percent paid income tax in excess of Rs 1 million. 19 percent paid tax of Rs 100000 to Rs 1million and over 60 percent paid less than Rs 100000. The implication is either that there is some under declaration of income even among MNAs, who formulate and approve our tax laws, or that, contrary to popular perceptions, majority of them are from the middle class or poorer sections of the community in the various constituencies.
Overall, the conclusions from the above key facts on income tax in Pakistan are that there is absence of a developed tax culture, presence of substantial tax concessions/ exemptions and widespread tax evasion. These facts highlight the main areas of reform in the income tax law and of improvements in the quality of tax administration by the IRS of FBR.
Subject to these measures, the income tax revenues can rise from 4.2 percent to at least 6 percent of the GDP, thereby yielding additional revenue of over Rs 600 billion and reaching the threshold level of over Rs 2 trillion.
(The writer is Professor Emeritus and a former Federal Minister)