A large number of categories of taxpayers including contractors, commercial importers, commercial suppliers of goods, contractors, commission agents, publishers, suppliers of goods, income earners from profit on debt and income from CNG stations, who were filing a simple statement under the Final Tax Regime (FTR) will now file income tax returns/wealth statements, pay minimum tax and face documentation and possible audits.
ProPakistani talked to several tax experts, chartered accountants and taxpayers operating under the FTR to understand the implications of the departure of taxpayers from the Final Tax Regime to the Normal Tax Regime.
On the other hand, top FBR officials told ProPakistani that the actual tax potential from the business transactions of these categories of the taxpayers has not been fully realized due to the presence of the final tax regime.
Here’s What Has Changed
So imagine if you are a commission agent! Your income tax used to be withheld at source at a rate of 10%. With this deduction, that was it for you and no book-keeping or record maintenance was required as 10% tax under FTR was the ultimate liability and that was it.
Now, starting this year, you will have to show your revenue, expense and everything to ultimately calculate the profit. Once a profit is determined, a normal tax rate (of usually 25% for small business, individuals and companies or 29% for bigger firms) will be applicable.
Imagine your commission revenue was Rs. 10 million and 1 million was withheld at source at 10% rate. To file returns, with this new regime, you will have to show your expense, which for example stood at Rs. 2 million. In such case, your profit would be Rs. 8 million (revenue minus expense) and a normal tax rate of 25% will be applicable on Rs. 8 million profits.
In this example, you will be liable to pay Rs. 2 million in taxes (25% of profit) however, since Rs. 1 million is already deducted at source, you would be required to pay another Rs. 1 million to meet your tax liability.
Tax Matters Just Got More Complicated
Under the Final Tax Regime, prior to Finance Act 2019 these taxpayers, operating under the FTR were paying a fixed rate of tax which was considered as their final discharge of liability (no additional tax could be imposed or increased).
They file a simple statement and deposit a fixed rate of tax. There was no requirement of maintaining books of accounts or documentation under the Income Tax Ordinance 2001 and rules made thereunder. There were powers under the law to conduct audit of the taxpayers operating under the FTR.
Under the income tax law, detailed scrutiny through an audit was not required where tax deduced was considered as the final tax.
After the Finance Act 2019, this year these taxpayers have been shifted from the final tax regime to the normal tax system.
The tax collected or deduced (at source) from these categories of taxpayers shall be treated as ‘minimum tax’ excluding exporters and persons winning prize bonds and sellers of petroleum products. Everyone else will now have to file income tax returns and wealth statements. They will also be required to maintain books of accounts and documentation.
Now, they can be subjected to an audit to increase their tax liability or payment of additional tax. The tax withholding tax deduced from them will not be the final discharge of tax liability. This means that their tax could be increased. The progressive tax rates would now be applicable on the categories of taxpayers earlier operating under the FTR.
Extension expected in Tax-filing deadline
As taxpayers are expecting an extension in date for filing of income tax returns up to December 2020, a large number of taxpayers have yet not started filing income tax returns for the tax year 2020.
Tax experts explained ProPakistan that the Income Tax law in Pakistan has adopted two methods of taxation of the taxpayers.
The first method is the classical method of assessment of income and the payable tax and is known as the Normal Tax Regime (NTR) and the second that was introduced in the early 1990s is known as the Final Tax Regime (FTR). Taxpayers who fall in the domain of the Normal Tax Regime pay their taxes on the basis of their net profit.
The net profit is determined by first arriving at their total revenues and then subtracting expenses incidental to the earning of the revenues and also taking into consideration various other factors such as allowances, credits, depreciation and rebates, etc that reduce their net profits and hence the taxable incomes and the tax required to be paid.
In the case of the taxpayers falling under the Final Tax Regime, their tax liability is determined by withholding a fixed percentage of tax from the gross amount of certain specified economic transactions.
The withholding tax collected at the source becomes their final tax liability irrespective of what income or profit has been actually made as it has no relevance in the determination of the tax liability. Income from contracts, the supply of goods to prescribed persons, commercial imports, exports, commission income, petrol and CNG filling stations are some of the prominent sectors falling in the FTR.
In most cases the tax liability worked out under the FTR is higher than what would have been payable on the basis of computing net income as under the FTR tax is collected on the gross revenues and the taxpayer does not get the opportunity to deduct allowances and expenses from his revenues to reduce his payable tax.
However, the taxpayers falling in the FTR despite some initial legal challenges have accepted this mode of taxation as it allowed them freedom from quite a few hassles and irritants. They are not required to bear the costs of maintaining intricate and detailed records prescribed under the law.
They also do not have to face the rigorous tax audits as the only relevant information for the tax collector in their cases is the gross receipts and the tax withheld from these receipts. Their gross receipts having already been subjected to deduction or collection of tax by the withholding agents also do not need to be verified.
From a purist point of view, FTR represents a departure from pure income taxation and has been subjected to criticism by economists who have been demanding for its phasing out. However, since it provided a mechanism for the FBR to maximize its collection from these sectors and also facilitated the taxpayers, it was allowed to continue.
FBR in the past tried to give an option to the persons falling in FTR to opt-out of this regime and come under NTR with a certain percentage of the tax withheld from them to be treated as an adjustable tax against their final tax liability determined on the basis of their net profits and they could also get a refund of the adjustable tax if it exceeded their tax liability determined on a net income basis.
Majority of the taxpayers preferred to remain within the FTR
However, the overwhelming majority of the taxpayers preferred to remain within the FTR due to its benefits and did not opt to ask FBR for refund due to their apprehensions of harassment by the tax collectors.
Nevertheless, it is widely accepted that FTR is an ad hoc measure that has ultimately to be discontinued once the essential pre-requisites for its withdrawal such as the desired level of documentation, increase in the capacity of FBR to tax actual incomes and the willingness of the taxpayers to pay their due taxes are in place.
Through the Finance Act 2019 the mechanism of FTR has been discontinued for some important categories of taxpayers mainly contractors, commercial importers, commission agents, suppliers of goods, those earning income from profit on debt or from running of CNG stations or renting of machinery and equipment.
However, the tax that is withheld from the persons previously under the FTR will not become adjustable against the tax worked out on the basis of their net profits which is the hallmark of the NTR.
Instead, this tax will become their minimum tax liability or in other words, if the tax on the basis of net profit is less than the withheld tax, the excess will not be refunded and if the tax so worked out is higher than the withheld amount the additional amount will have to be paid by the taxpayer. This important change having substantial implications for the taxpayers under the FTR has not received the attention that it deserved due to the simple fact that it will be implemented in the Tax Year 2020, the returns for which are still under the process of filing.
Once the taxpayers start filing their returns and the returns are processed by FBR, the unfair treatment that has been meted out to them will become apparent.
The worst of both the worlds
In the opinion of some tax experts, this change can be described as combining “the worst of both the worlds” for the taxpayers who have been taken out of the FTR. Their tax liability will be at least equal to what they were paying under the FTR and they will also be deprived of the benefits of the FTR.
They will have to follow all record-keeping requirements prescribed by law, will have to work out and declare their net profits and undergo tedious tax audits.
This will not only increase the cost of doing business but also leave them at the whims and mercy of the tax auditors taking away the certainty regarding their tax liability that they previously enjoyed under the FTR. They may have been willing to accept the withdrawal of FTR if they could visualize, at least theoretically, a possibility of reduction of their tax liability and refund of the excess tax paid.
Tax experts have also highlighted the gross discrimination and anomalies inherent in the new tax regime explained above. Taxpayers who are or were not under the FTR are required to pay minimum tax at the rate of 1.5% of their gross turnover. These are mainly the taxpayers whose business transactions are not with the organized sector and not subjected to collection of tax at source and hence far less documented.
Organized sector will get preferential treatment
It will be expected that persons operating in the organized sector and having a greater level of documentation will get preferential treatment from FBR as compared to those who are less documented but we are witnessing the exact opposite of this legitimate expectation.
This becomes obvious from the fact that the rate of minimum tax as a percentage of the gross turnover for the categories that have been taken out of FTR will be 8% to 10% for the contractors, 12% for commission agents and brokers, 15% for those having income from profit on debt, 5.5% for commercial importers, 4% to 4.5% on supply of goods, 10% for persons renting machinery and equipment and 4% for CNG stations.
This will mean that a taxpayer who supplies goods or executes a contract with an entity who is not required to deduct any tax on the payments made to the taxpayer, will be paying 1.5% of his gross turnover as minimum tax, whereas a taxpayer whose business receipts come from an entity that has been made withholding agent under the law, such as a government organization or a limited company will be required to pay much higher percentage of his gross receipts as minimum tax despite selling identical goods or performing identical contractual services.
The discrimination inherent in the above change of tax regime becomes even more glaring when it is realized that some categories have still been retained in the FTR. It is not understandable that if the change from FTR was so desirable why the exporters have still been kept in the FTR?
The discrimination becomes even more blatant when we see that the CNG stations have been removed from FTR and the tax withheld by Gas distribution companies and DISCOs from their monthly bills is now the minimum tax but petrol pump operators are still under FTR.
Through the Finance Act, 2020 tax-deductible on certain payments to non-resident persons has also been made the minimum tax. Experts have pointed out that Pakistan has tax treaties with almost all the countries to which the non-residents receiving payments from Pakistan belong. All tax treaties provide for taxation of these non-resident persons on the basis of net income and law provides that in case of a conflict between the domestic law and the tax treaty, the treaty overrides the domestic law.
Therefore, it will not be possible to make the tax withheld from the non-residents as the minimum tax and the change will be ineffective and will not yield the desired results and only cause unnecessary litigation with non-residents and a bad name for Pakistan.
Tax experts are therefore of the opinion that the change from FTR to the new regime must be withdrawn to prevent unnecessary hardships for the taxpayers or alternately if the FTR has to be discontinued at all costs then the tax withheld must be made adjustable instead of being the minimum tax. In case the tax withheld is more than the tax payable on the taxable income the excess may be made refundable.