Focus on Narrow Base for Tax Collection Encourages Informalization of Economy: PBC

The Pakistan Business Council (PBC) has labeled tax policy in Pakistan as regressive in nature and one that penalizes growth and profits; it concentrates on a very narrow base for tax collection and encourages the informalization of the economy.

In its agenda document for the incoming government, PBC said the tax collection mechanism suffers due to a lack of technology and trained and motivated HR. The lack of transparency and accountability along with lacunas in the law has resulted in a demoralized tax collection machinery which is viewed with suspicion by the taxpayers.

It said Pakistan’s Tax to GDP ratio will remain more or less at the current rate unless there is political will and capacity/capability in the enforcement machinery to formalize the economy and broaden the tax base.

To ensure fiscal space through a broadening as well as a deepening of the tax base, PBC has highlighted a number of issues that need to be addressed:

Tax policy is short-term

Tax policy in Pakistan is inconsistent and subject to kneejerk reactions in the face of tax collection pressures. This discourages long-term investments in industry. As an example, entities operating in Special Economic Zones (SEZs) are exempt from all taxes on their income – they, however, have to pay a minimum turnover tax on their revenues.

Corporatization is discouraged

The corporate sector which by the nature of its structure needs to be transparent and compliant is at a disadvantage when it comes to other forms of business such as AOPs. The tax rate on AOPs is lower than that on corporates discouraging firms from corporatizing. It is important to have a minimum or no tax arbitrage when it comes to various forms of businesses

Tax policy discourages consolidation for scale

The formation of Groups and Holding Companies is a prerequisite for consolidation and growth of businesses. Pakistan in 2007 started down this path with a Holding Company law aimed at encouraging the formation of Groups & Holding Companies. However, by taxing intercorporate dividends since 2016 it has reduced the momentum of Group formation. A shareholder in a Holding Company may end up paying tax as high as 61 percent on profits.

Turnover, not profits are taxed

The minimum tax regime in Pakistan taxes turnover as opposed to profits, this discourages investments in large-capital-intensive projects where a tax loss is normal in the initial years of operations. Pending the development of FBR capability, as a first, the listed sectors be exempt from turnover tax as listed firms are well audited with multiple audits and transparent accounts.

High rates of corporate & personal income tax

Pakistan’s corporate tax rate of 29 percent is one of the highest in the region. In addition, to the high tax rate, there are contributions from income to the Workers Welfare Fund (WWF) at 2 percent & Workers Profit Participation Fund (WPFF) at the rate of 6 percent. In addition, successful firms are also subject to a Super Tax. In addition, personal income tax rates of up to 35 percent are leading to an exodus of Pakistan’s best professional talent.

PBC said the approach to formalization needs to be holistic rather than fragmented and cover the following:

Check the use of cash

With nearly a third of the money in circulation outside the banking system, 80 percent of the population is unbanked and 60 percent (80 million people) is not included in any financially transparent system, creating opportunities for financial inclusion, concurrent with disincentives for the use of cash should be major thrusts. These can be achieved through leveraging the growing penetration of smartphones and the greater use of Point of Sales (POS) terminals to create transactional transparency. The discontinuation of the Rs. 5,000 note and restrictions on the use of cash above a certain limit would also assist.

Address undocumented and under-valued parts of the economy

Real estate, retail & wholesale trade, gold, cash, prize bonds, foreign currency, etc., have become major avenues for generating and parking non-tax-paid business profits as well as income from illicit activities. Asset tagging and a more aggressive stance on avenues for generation as well as investing unaccounted money should thus be a priority. PBC estimates that Rs. 234 billion could be raised from taxation of retail/wholesale trade and Rs. 513 billion from the real estate sector. Public savings should be guided towards more productive venues, Pakistan’s savings and investment levels are about half those of its neighbors. The provinces have an opportunity to add Rs.380 billion to their revenue through the taxation of properties and Rs.372 billion from agriculture tax on large and medium-sized farmers.

High rates of taxes encourage evasion

An 18 percent GST rate in a poorly documented economy, together with relatively high import and excise duties provides an attractive incentive to evade, the spoils of which are then shared with a notoriously inefficient enforcement and collection machinery. Since provincial GST does not apply to goods, provinces where most of the evasion of federal taxes takes place, have no financial interest to stem it. Some measures like the requirement of Urdu language labelling on imported finished products need to be supplemented with raids on shops selling products not meeting this condition.

Under invoicing of imports

It is estimated that imports are under-invoiced by $5 billion annually. This hurts the national exchequer and creates an unfair playing field for the formal sector. Agreement to exchange data on the value of imports/exports through Electronic Data Interchange (EDI) with partner countries would help stem under-invoicing. It should at the very least be implemented with China.

Leakages in Afghan Transit Trade

The transit treaty with Afghanistan has been misused through the diversion of goods to Pakistan. As the treaty has expired, Pakistan can renegotiate in the current more regionally favorable environment, to put quantitative and qualitative restrictions on what can transit, insist on letters of credit, charge duty, and GST on imports which would only be refunded to the Afghan government on exit, track and monitor containers, strengthen inspection of empty containers returning and make physical controls along the border stronger.

Front-loaded and unrealistic tax targets

These force the inadequately resourced FBR & provincial revenue authorities to chase existing taxpayers and adopt harassment rather than objective assessment as the means to meet targets. Until the FBR & the provincial revenue authorities are radically restructured and their capacity to broaden the tax base through the use of technology addressed, the scope of broadening the tax base will remain limited. Tax collection targets should be set separately for those in and outside the tax base so that its achievement of growing the latter becomes more visible.

Widespread counterfeiting

Widespread counterfeiting particularly of food and drugs is a menace that affects the consumers as much as it hurts the government and the formal sector. Weak enforcement of Intellectual Property Rights also puts off foreign investment. One way to check counterfeiting of consumer products is to move the trials to consumer courts and to allow prosecution to be conducted by the lawyers of the hurt parties rather than public prosecutors.