The Overseas Investors’ Chamber of Commerce & Industry (OICCI) is an important stakeholder in the economy of Pakistan. It has prepared a brief report that takes a broader approach and focuses on long-term issues. The report gives a comprehensive overview of the recommended changes and the rationale for suggesting the same. The report outlines policy and procedural amendments that are intended towards strengthening the taxation system in Pakistan and hence require serious consideration. A brief description of these proposals is presented in the executive summary
The proposals have been categorised under two main headings aimed at:
* Broadening the tax base
* Improving tax collection and enhancing the investment environment
Broadening the tax base
Concrete measures on the part of the government are needed to enhance revenue collected via tax receipts. OICCI recommends doing so by increasing the number of taxpayers as opposed to taxing the already taxed.
This section aims to highlight measures that, if initiated and properly implemented, will encourage individuals as well as entitles to come in the tax bracket and consequently increase the revenue generated via tax receipts, OICCI proposes:
(a) Abolish incentives to evade taxes
Improvement in the tax base essentially requires elimination of all discriminations between tax payers with adequate penalties for delinquents. In Pakistan this works in the opposite direction by way of periodic tax amnesty schemes offered by the government.
Possibilities of whitening untaxed by misuse of provisions provided in the law such as ‘inward foreign remittance’ also encourage the unorganised sector to continue with tax evasion. These provisions discourage taxpayers from making positive shifts and hence need to be abolished through constitutional amendments.
(b) Introduction of tax credit against personal taxation
There should be introduction of ‘tax credit’ on submission of evidences of expenses incurred on medial, education of children and food. Such a proactive will provide incentives for the users of these services to obtain evidence of payment which will simultaneously force the recipient to be within the documented sector. In Pakistan, this system had been introduced in the past but due to procedural difficulties, positive results were not yielded and the exercise was discontinued. It is, therefore, recommended that the government reintroduce this practice, however, with improved service delivery mechanisms.
(c) Mandatory documentation for all sectors
It is recommended that documentation be made mandatory for all sectors. Entities that provide documentation of their transactions or deal only with organised suppliers and customers should be given 5 per cent rebate in income tax among other incentives to encourage wider adoption of this good practice.
(d) Reconcile bank accounts with NTN
It is suggested that returns filed via the National Taxation Number (NTN) be evaluated against amount deposited in the bank account. This will assist in maintaining a system of check and balance. However, it is essential to overcome issues of banking confidentiality and trust deficit before implementing the aforementioned regulation. It must be noted that this is a key long-term initiative that will help increase the tax base significantly.
(e) Reduce differential in corporate tax
(for small companies (20 per cent) and corporations (35 per cent)
In Pakistan a reduced rate 20 per cent for corporate taxation has been introduced for small companies. The differential of 15 per cent viz-a-viz general corporate rate discourages corporatisation and expansion of companies. This differential has to be reduced to counter this disincentive towards expansion.
(f) Automation and establishment of PRAL
The establishment of the Pakistan Revenue Automation Limited (PRAL), is an excellent initiative. However, there are significant implementation issues in STARR (Sales Tax Automated Refund Repository). It is recommended that to get full benefit of automation, linkages need to be developed between the databases of customs, excise, income and sales tax.
Improving the tax collection and investment environment
A country’s tax system and its hassle free implementation are key determinates of its investment environment. In Pakistan, the opposite is experienced as the organised sector is subject to high levels of compliance whereas the unorganised sector appears to have an implied amnesty.
To overcome these gaps, several mechanisms have been outlined in this segment. These proposals will not only assist in reducing the burden on the already taxed, it will aid in improving the tax culture in the short run and increase the tax base in the long run, OICCI proposes:
(1) Reduce rate of corporation tax
Pakistan has one of the highest rates of corporate tax in the region. This discourages investors from coming in the country as regional competitors not only offer lower rates but also better security and infrastructure facilities. It is, therefore, recommended that the corporate tax rate be gradually reduced from 35 to 28 per cent over the period of 2 to 3 years to make it compatible with other countries in the region (average is below 30 per cent)
At present, even before, an investor looks at risk adjusted returns, Pakistan is at a disadvantage by over percent.
(2) Rebates and tax credits
Rebates and tax credits are provided to encourage reinvestment of capital in the business. Through such measures the effective rate may be reduced with corresponding economic benefits. In Pakistan all such benefits, except accelerated depreciation have been removed. Therefore, it is imperative to re-introduce rebates and tax credits to encourage re-investment of capital in the business.
(3) Outsourcing of audit function
An audit can never be a tax collection measure, especially where there is inelasticity in constituents and delinquents are effectively outside the tax-net. Moreover, the high levels of compliance set for taxpayers usually result in harassment rather than having any value addition. It is therefore suggested that a process of independent audit outsourced to professionals can be implemented as an interim measure to build confidence level within the taxpayer community.
(4) Cascading in import duty structure
Throughout the world subsidiary and allied industries flourish when a sustainable base for the primary manufacturing sector is provided. However, it has been observed that over the past decades, cascading adjustments for local industries have been fundamentally disturbed. The current duty structure encourages the import of finished goods rather than manufacturing even in those cases where reasonable manufacturing facilities are available in Pakistan.
FBR and the National Tariff Commission (NTC) need to undertake a long-term holistic exercise for the development of an industrial and manufacturing policy for the country to encourage the manufacturing sector.
(5) Zero-rated import
Up front duties and taxes on the import of plant equipment and machinery, Spares and raw materials not locally available hamper industrial growth by limiting the amount of Foreign Direct Investment (FDI) and suppressing the export potential of industries by raising costs. Zero rated import of all plant equipment and raw materials which are not locally manufactured will result in foreign direct investment, local skill development and incremental revenue to the government from alternate revenue sources such as sales and corporate taxes with would more often then not offset the revenue lost by the government .
(6) Ceiling on imports for Afghanistan (ATT)
Agreement of a quantitative ceiling for imports for Afghanistan (Afghan Transit Treat) and streamlining of exchange control mechanism is required so that administrative and economic barriers are placed to control smuggling.
(7) Consolidation of all labour levies
In Pakistan, the corporate tax rate is 35 per cent. An additional 2 per cent Workers Welfare Fund (WWF) and 5 per cent workers profit participation Fund (WPPF) is levied. This effectively makes the rate equal to 42 per cent which is one of the highest corporate tax rates in the world.
OICCI recommends consolidation of all labour levies with a rate of 2 to 3 per cent in line with regional standards, or allow companies to utilise the contribution for the welfare of labour in the form of providing health, education and housing for their factory employees or in the areas their factories/industries are located.
(8) Presumptive tax regime be eliminated
An effective tax system requires identical procedures for the same kind of business, without any discrimination between sectors. PTR has been made inapplicable for the manufacturing sector. It is recommended that this practice should be extended to other sectors which are properly documented and should eventually be abolished completely. Continuation of PTR is a major bottleneck in the sustainable growth of Tax to GDP ratio.
(9) Overall rate of indirect taxes to be reviewed
At present effective indirect tax rate is 28 per cent (16 per cent GST + 12 per cent FED). This high level of taxation encourages a substantial part of the manufacturing base to operate in the unorganised sector. There is a need to review the issue of overall incidence of indirect taxes so that possibilities and comparative advantages of evasion are reduced and minimised. It is also recommended that the rate of Value Added Tax (VAT) be brought down to 10 per cent over a period of two years encompassing all sectors and segments of the economy specially the services sector.
(10) Overhaul or Introduction of sales tax
Sales tax of 2 per cent at the import stage has been levied on all products. The rationale for this levy is that in the case of imported products, the subsequent supply chain is unorganised and therefore, tax on the whole chain of value addition needs to be collected at the import stage. Additionally, there is no contribution by the medium and small scale manufacturing sector which is responsible for 40 to 50 per cent of all manufacturing taking place in Pakistan.
Such an instance, therefore, highlights the need for overhaul or introduction of sales tax on the whole supply chain.
(11) Promotion of retirement benefits
There should be encouragement for promotion of retirement benefit schemes complemented with schemes for investment by such funds in investment required for industrial growth.
(12) Special benches for tax cases
Delay in ultimate decision by the appellate authorities and their quality is a hurdle in the development of a tax base. To improve quality and capacity of the first stage of appeal, it is recommended that special benches for tax cases be set-up. It has been noticed that even after judgment is received, execution is delayed. This needs to be reviewed.
(13) Allowability of NPL for banks
Debts in considered as ‘loss’ under the Prudential Regulations as issued by SBP (as applicable at that time) be allowed as deduction (pre-7th schedule). The amendments in the Prudential Regulations (post 7th schedule) revived the ‘Forced Sale Value’ (FSV) of collateral which was not accounted for before. Now the State Bank of Pakistan for its own purposes has allowed credit for proportion of FSV.
(14) Allocation of expenses
There are inconsistencies in the treatment of allocation of expenses for income exempt from tax. This issue attains importance for banks as there is substantial investment in shares where capital gain is exempt from tax. It is suggested that the matter of disallowance of allocation of expenses against exempt income should be streamlined. Specific rules need to be introduced to the effect that allocation of expenses has to be made on the basis of ‘amount invested’ in exempt securities rather than earning there from.
(15) Transitional provisions
(for banks and provision for consumer loans)
Unabsorbed depreciation and written down value for assets on finance lease outstanding as at December 31, 2007 should be allowed over a five year period.
Furthermore, there is a need to revise the limit of 3 per cent for consumers’ loan for all the years prior to tax-year 2009. In the Seventh Schedule such deductions be allowed as are approved under the Prudential Regulations.
(16) Clarification for reinsurance premium
Finance Act, 2008 has introduced withholding tax on ‘Reinsurance Premium’. Such withholding is not applicable where the recipients protected by the Double Taxation Treaty (DTT). A clarification needs to be issued that where there is DTT protection and the re-insurer is not in Pakistan, either directly or through agent, provision relating to withholding shall not apply; In all other cases, standard requirement of information will apply.
(17) Withholding for insurance companies of recipient
In the case of banking companies subject to Seventh Schedule, an exemption has been provided to banks from withholding as ‘recipient’ as such entities are all in the organised sector and are subject to advance payment of tax. Same principle requires to be adopted for the insurance sector.
(18) Tax on transfer pricing
Since the introducing of the Income tax Ordinance, 2001 there are very few cases where tax proceedings have been finalised under the new provisions of the Ordinance, all the cases from tax-year 2004 to tax-year 2008 are effectively exposed to action by tax officers on the matter of transfer pricing.
However, fiscal issues relating to non-aim’s length consideration are a matter of determination of fact rather than application and interpretation of any law. The OECD model also supports the same principle. It is suggested that agreed upon processes be undertaken to prescribe the procedures for implementation of fiscal measure for taxing non-arm’s length transaction.
(19) Resolution of input tax adjustments
In Pakistan, credits for input taxes are treated as inadmissible whilst determining the overall tax liability in many cases. This results in higher rates for sales tax and federal excises. This problem emanates on account of improper implementation rather than any provision of law. It is required that implementation issues in the admissibility of input tax in sales tax be resolved and proper guidance on that
Matter be obtained from other countries where such systems are already in operation.
(20) Federal excise duty
In Pakistan, input tax for Federal Excise Duty (FED) for many sectors is not allowable under the law. This places the said tax outside the ambit of VAT regime.
It needs to be decided by the government whether such a levy is to be operated as VAT or a straight indirect tax. If the second option is to be implemented, that rate of tax will have to be reduced. OICCI considers that implementation of a full-fledged VAT with same rate, is a better option.
(21) Franchise fee
‘Royalty’ payments have been subjected to FED. The term used in the law is ‘Franchise’ fee which is at time distinguishable with royalties in strict commercial and practical sense. This has lead to serious issued of interpretation and misapplication in many entitles. It is, therefore, recommended that FED procedures for franchise fees be streamlined and the same be brought in line with SBP’s regulation. Such measures will resolve the issue correctly as most of the organised entitles remit such fees through SBP and there are well laid down procedures for the same.
(22) Capacity building of personnel-group taxation
Over the last two years, positive provisions have been introduced in fiscal laws for promoting the formation of holding companies and introduction of group taxation.
However, like any other fiscal measure, problems are being faced in the implementation of group taxation as the issues are unique and new.
Therefore it is recommended that capacity building at FBR and SECP by way of training and study of such measures in other countries be undertaken to take full advantage of such a positive provision.
(23) No taxation on inter-corporate dividends
Group taxation requires elimination of inter-corporate dividend taxation. This matter has been taken care of in the present law. However, over the last two years virtually no group structure has evolved on account of problems relating to inter-corporate dividends. No industrial group will endeavor to switch to holding company structure unless there is a clear position with regard to no taxation on inter-corporate dividend.
(24) Stock options
In order to promote proper disclosure and taxability of stock option, it is recommended that stock option given by MNCs for Pakistani employees be treated similar to stock option given by Pakistani companies. Moreover, stock option should be taxed as capital gains.
Policy and procedural changes aimed at strengthening the overall taxation system are needed so the system can be improved in the short run and the tax base be broadened in the long run.
This is of utmost importance as Pakistan risks losing foreign investors to regional competitors that not only offer attractive tax rates but also provide better security and infrastructural facilities.
The policy and procedural recommendations made via this report are aimed at improving the overall tax culture of the country. If implemented, the proposals will assist in improving the tax system in the short run and broadening of the tax base in the long run and ultimately make Pakistan an investment friendly destination.