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M Munir Qureshi
The Principles of Taxation: Equity.
The tax payable should accord with ability to pay or taxable capacity. – Vertical Equity & Horizontal Equity. – Vertical equity is the idea that taxpayers with a greater ability to pay taxes should pay larger amounts. – Horizontal equity is the idea that taxpayers with similar abilities to pay taxes should pay the same amounts.
How Equitable is the Pakistan Tax System ?
• The Pak tax system has been largely dependent on Indirect Taxation. Even today, the total Indirect Tax Collection (Sales Tax, F.E.D & Customs Duty) is much greater [61%] than the total Direct Tax collection [39%]. • Thus, Regressivity has been a dominant feature in our tax system- which is not a good thing.
Rs 847 Bill
Customs Duties, 132.2, 16% Federal Excise, 71.6, 8% Direct Taxes, 333.4, 39%
Sales Tax, 309.2, 37%
Source: FBR Revenews
Rs in bill
Sources of Revenue
The Certainty principle.
• The taxpayer should know exactly what is being taxed, how much he has to pay, and how and when he has to pay it, meaning that the law should be clear and unambiguous and the tax authorities interpretation of it should be readily available.
How Certain is the taxpayer in Pakistan of his obligations under the law?
• Pakistan has had three direct tax statutes since 1947 and one of the reasons given for repeal has been a lack of clarity due mainly to the many amendments made over time. There has also been no system of “Advance Rulings” to enable a taxpayer to know his liability under the law in advance of filing a Return. • The Tax Ordinance of 2001 is an attempt to introduce greater clarity by using simple, easily understood drafting. Furthermore, it is now possible for a taxpayer to ask for an ‘Advance Ruling’ on any aspect of his tax obligations. • A number of ‘Tax Amnesty’s’ allowed in Pakistan since 1947 has to some extent conditioned the taxpayers to expect their repetition in the future as well and this goes against the principle of ‘certainty.’
• In the case of Indirect Taxation the attempt to replace G.S.T by V.A.T is proving problematic mainly due to problems with adequate taxpayer knowledge with regard to proper documentation of the stage wise transactions.
Principles of taxation: Convenience.
• • The tax should be payable in a manner and at a time convenient to the taxpayer. In Pakistan, in the case of direct taxation, there has been a system of periodical Advance payment of tax, payment of tax with the Return of Income and, since the 1990’s, tax withholding when goods are imported/exported , when certain payments are made and salaries disbursed. There is also the system of “presumptive tax payment” in the case of certain transactions (contracts/imports) in which the payment made deemed to be final discharge of direct tax liability. The general perception of taxpayers is against the system of tax withholding esp presumptive taxation in which there is no ‘adjustment’ of the tax paid at the time of assessment. However the system of tax payment has had a beneficial effect on mobilization of revenues. It has also reduced refund claims esp in the case of commercial importers and also the attendant corruption. The trend now is to reduce tax withholding and esp presumptive taxation.
The Principles of taxation:Economy.
• Enforcement and collection costs should be reasonably proportional to the receipts. This concept is also referred to as ‘Administrative Efficiency.’ • In Pakistan total tax collection cost as a percentage of revenue is well below 1% which is much less than the cost of collection in advanced countries. The low cost is mainly due to low compensation packages for tax personnel and the low level of advanced technology put to use to assist tax collectors esp in the I.T area.
• The yield from taxation should be sufficient for the provision of essential public services and for funding a strong program of economic development. • In Pakistan revenue collection has increased in recent years esp with the introduction of low tax rates and universal self assessment. • However the Pak tax system is still grossly deficient in terms of the “t2gdp:”
FBR’s Revenue Performance
• In the legacy system it took us 43 years to collect the first Rs. 100 billion (1947-48 to 1990-91); • Within the next four years, this amount was doubled and crossed Rs. 200 billion in 1994-95; • Another seven years, the collection crossed Rs. 400 billion in 2001-02; • In the next five years CBR exceeded the target of Rs. 835 billion for 2006-07. In 2007-08 & 2008-09 FBR Collection exceeds Rs  Trillion.
Pakistan Budget Deficit
Tax Principles: Broad basing.
• Taxes should be spread over all sectors / sections of the population, as uniformly as is practicable. • In Pakistan, Taxes have a very narrow base. In the case of Direct Taxation only 2% of the population [just over 3 mill]
pays income tax. • The number of registered sales tax payers is less than 100,000.
Tax principles: Neutrality.
• Taxes should not favor any one group or sector over another and should not be designed to influence individual decision making. • In Pakistan in order to promote industrialization and the geographical dispersal of Industry a large number of fiscal incentives [ tax expenditures] have been put into play and these have facilitated the growth of the manufacturing sector esp Textiles, Sugar, Cement, Steel, Pharmaceutical, Chemicals.
Types of Investment Incentives
• • • • Incentives related to rural industrialization. Concessions for industrial estates. Industry specific incentives. Incentives for undertaking in Export Processing Zones.
Promotion of Rural Industrialization
1. Complete exemption of imported machinery from custom duty, sales tax and import surcharge, if such machinery is not locally manufactured. Import license fee is also being reduced from 6% to 2% for these undertakings. 2. Public institutions will acquire necessary technology from abroad for transferring it to rural enterprises along with technical assistance and marketing expertise. 3. Debit-equity ratio for imported machinery in a project has been fixed to 70:30 while for local machinery it is 80:20. 4. Availability of tax holiday for maximum of eight years on average. 5. Private power plants are exempted from corporate taxes, import duties and sales tax in all these areas. 6. Besides, encouraging power generation by rural entrepreneurs the excess electricity will be purchased by WAPDA.
Concession for Industrial Estates
1. Hundred percent exemption from custom duty for approved industrial estates located in Hub, Mianwali, Bhakkar, Khushab, Tharparkar and Dadu (excluding Taluka Kotri). 2. 50% exemption from leviable custom duty for estates located in Islamabad, Rawalpindi, Gujranwala, Sialkot, Faisalabad, Lahore, multan, ferozewala, Taluka of Kotri and Hyderabad. 3. 75% of the leviable custom duties are exempted for approved industrial estates located in all other areas except Karachi. 4. All of the industrial estates enjoying the scheme of income tax rebates on export earnings and on value added items. The rebate on such export earnings has increased from 25% in 1960-61 to 50% in 1976-77, 55% in 1979-80 and 75% in 1990-91.
Industry Specific Incentives
1. Plant and machinery not manufactured in Pakistan and imported for establishment of key industries like biotechnology, electronics, fertilizers, fiber optic and solar energy are completely exempted from the whole of the custom duty and sales tax thereon. These industries are also available four years tax holiday through out Pakistan. Raw material and components used in the manufacturing of capital goods and machinery for initial installation, Balancing Modernization or Replacement (BMR) are exempted from the whole of custom duties thereon.
Incentives for Export Processing Zones
An Export Processing Zone has been set up in 1980 at Karachi, under EPZA Ordinance, on 500 acres area to attract foreign investment in export-oriented industries. The concessions and other facilities offered by the Government of Pakistan for EPZs include:
1. 2. 3. 4.
Duty free import and export of goods in and from the zone. Special income tax exemptions up to 75% of the normal corporate rate after the expiry of tax holiday period. Five years tax holiday for all undertakings. Availability of infrastructural facilities like, water, gas, telecommunication etc, in the zone.
1. 2. Removal of the restriction on imports from the zone into tariff area. Pakistanis working abroad are equally eligible for investment in the zone while resident Pakistanis can invest up to the limit of 40% of the total investment. Warehousing facilities for goods that are in transit.
Taxation Policy & the geographical dispersal of industry
• The ‘Tax Holiday’ has been used to encourage new industrial projects to move to areas that are otherwise not attractive. The objective is to reduce disparities in the degree of industrialization that is seen as an essential first step in accelerating the pace of economic development.
Tax principles -Promotion of distributive justice.
• The tax system must facilitate reduction in inequalities in income distribution. • The Pak tax system is clearly deficient in this regard as is evident from a Gini Index ranking of 41 and the increase in poverty levels over time [presently 34%]. • The progressive tax rate structure has not proved to be adequate in this regard and this is mainly because of the extremely narrow tax base so that direct tax policy affects very few people. • The repeal of the Wealth Tax Act has also impacted negatively on the reduction f income inequalities. • The burgeoning informal sector has also reduced the efficacy of tax policy initiatives.
Distribution of Income in Pakistan
1980 1987 2006 7.0 6.1 5.7 45.4 49.8 55.0 19.1 16.1 14.0 31.7 35.7 45.0 40.8 42.2 45.0 48.1 45.3 50.0 8.5 7.8 6.0 6.8 7.8 8.5
• • • • • • • • •
% share of GNP going: To poorest 20% To richest 20% To poorest 40% To Top 5% Rural rich Urban rich Rural poor Urban poor
Distribution of Income in Pakistan- the Gini Index
• This Index measures the degree of inequality in the distribution of family income.The Index is calculated from the Lorenz curve, in which cumulative family income is plotted against the number of families arranged from the poorest to the richest.The Index is the ratio of (a) the area between a country’s Lorenz curve & the 45* helping line to (b) the entire triangular area under the 45% line.The more nearly equal a country’s income distribution, the closer it’s Lorenz curve to the 45* line & the lower it’s Gini Index.
Curtailing the size of the informal sector.
• For a developing country with a very large informal sector, tax policy must aim to reduce the size of the parallel economy. • Tax policy has not been successful in this regard as is evident from the fact that the black economy has continued to increase by leaps and bounds in recent years so that presently it may be equal in size to the formal economy. However the latest income tax statute expressly promotes documentation by mandating maintenance of records by all taxpayers and if the requirement is rigorously enforced it could have a salutary effect over time.
• The Tax System reform & re-structuring currently underway emphasizes automation, setting up of data base of vital economic data & the use of specialized technology & software to collate the data. • These may well be the most important steps taken -in conjunction with the compulsory maintenance of prescribed accounts- to reduce the size of the informal sector & enlarge the tax base thereby augmenting revenues meaningfully.
Tax Principles -Facilitating F.D.I • Stimulating FDI mainly thru large TNC’s requires cost minimizing devices that impact favorably on : • i. the rate of return ; • ii. The price of capital goods; • iii. The tax treatment of generated income.
• Stimulating FDI mainly thru large TNC’s requires cost minimizing devices that impact favorably on : • i. the rate of return ; • ii. The price of capital goods; • iii. The tax treatment of generated income.
• Foreign investors look for: • i. Locational advantages like market size, access to raw material, availability of skilled labor & a conducive, safe environment. • ii. Incentives offered by the host countries thru their fiscal policies. • TNC’s evaluate fiscal incentives offered only after they are satisfied with the locational advantages.
• Pakistan offers a range of fiscal incentives to foreign investors including guaranteed repatriation of profit, a foreign tax credit, across the board tax holiday in specified areas [energy sector], liberal exemptions/allowances and deductions against income in the case of different manufacturing enterprises. • Although the adverse security situation has restricted FDI it has not stopped completely but for future inflows a dramatic improvement in the security situation is essential along with significant improvements in infrastructure esp provision of electricity.
Tax Principles -Good Tax Compliance
• An effective tax system will have good compliance levels. • In Pakistan just over 3 million direct tax payers and 100,000 registered sales tax payers are required to file periodic Returns / Statements. About 75 – 80 % do so voluntarily. Considering that the tax base is very narrow, this is not a satisfactory compliance rating.
Tax Principles -Taxpayer facilitation.
• A good tax system must have in- built mechanisms for taxpayer facilitation. • Tax statutes and rules are complicated and there is a body of ‘case law’ that also has a bearing on tax liability. The govt must facilitate taxpayers so that they are fully aware of their rights and obligations under the law. Before 2002 there not much attention was paid to this aspect. However, with the enactment of the I T Ord’2001 the situation has changed and under the functional division of work in the new statute, tax facilitation is recognized as an independent obligation of FBR.
Tax Principles -Low level of Litigation.
• A good tax system should have a low level of litigation. • Before the enactment of the I T Ord of 2001, the litigation level was very high. However the new statute has brought in it’s wake, universal self assessment ‘ for ALL entities.’ Thus in most cases the Returns are accepted as filed.
Tax Principles-Limited Support Staff.
• A modern tax system employs limited support staff. • In Pakistan, FBR has a total strength of some 22,000 with about 1500 officers and 20,000 support staff. In the recent past the support staff strength was 30,000 plus. This is a lop sided arrangement and goes against the requirements of a good tax system.
Tax Principles -Use of modern technology.
• A good tax system will use modern technology as a ‘force multiplier.’ • In Pakistan we have only limited access to the latest, state of the art, technology and sophisticated data processing systems based on such technology. A beginning has certainly been made in the wake of post re-structuring reforms, but a lot more needs to be done.
Tax Principles -Alternate Dispute Resolution.
• In order to quickly resolve taxpayer and tax assessor disputes, a good tax system will have mechanisms to resolve such disputes without going to the formal appellate fora. • In Pakistan we do have an Alternate Dispute Resolution system (ADR) but it’s performance has not been satisfactory and taxpayers do not appear to have much confidence in it.
Tax Principles -Integrity.
• In a good tax system the integrity of tax personnel must be beyond reproach. • In Pakistan corruption levels have been rather high. In order to deal with the problem effectively, the compensation package for ALL tax personnel has been revised and take home pay has been doubled. Action has also been taken under E & D Rules in specific cases of corruption. However, more needs to be done.
Tax Principles -Deterrence to tax evasion.
• A good tax system will have laws, rules and a system of sound tax administration acts as a powerful deterrent to tax evasion. • In Pakistan the huge Informal Sector is proof that the average citizen does not think much of the ability of FBR to nab tax evaders. However the new law does have provisions that make it better able to deal with tax evaders.
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