Whilst the global economy is slowing down under the impact of the US subprime crisis, Pakistan has not remained immune from the suffering of the global turmoil. Pakistan's economic growth is declining sharply and according to International Monetary Fund, the economic growth is anticipated to be 2.5%. Liquidations, layoffs and job cuts are expected to continue. Currently, Pakistans economy is facing the threat of a prolonged recession. The situation is not merely for Pakistan only as according to a recent global survey, auditors report on 25% companies was not on going concern basis!
Under this economic scene, the Finance Bill for 2009-2010 is definitely a challenging task. However, intuitive economists are of the view that enhancing Pakistans competitiveness and regenerating the economic momentum should be the ultimate objective of the Finance Bill for 2009-2010.
Such an objective will gain the acceptance of the taxpayers, hence, the Government should ensure that the totality of governments treatment of its subject, its expenditures and its tax, is just. In achieving this, intuitive economists are of the view that the role of the government is to provide a favorable business environment to facilitate business development and free flow of capital, personnel and resources and to strengthen Pakistan as a preferred point of entry for investment flowing into the region.
Although Pakistans tax system is the most modern system after china in the region but its ranking is nowhere in fairness, simplicity or transparency and recent hoax of meeting the targets further deteriorated the principles of equity, certainty, convenience and efficiency [four cannons of Adam Smith] of our tax system.
In Pakistan, every citizen is experiencing the impact brought by the global economic downturn, every taxpayer is questioning the utilization of $35 billion in without proof war on terror while every businessman is questioning the reason of non-exploitation of natural resources in Sind, NWFP and Balochistan.
With the sluggish condition, every citizen considers that the government should play a leading role to stimulate the economy by tax and other relieves, promote a caring society, and encourage financially responsible behaviors through the tax incentives. Whilst I share the principle of fiscal prudence, every citizen considers that a package of measure is required to help relieve the citizens of Pakistan. This article is a crystal ball for the Finance Bill, 2009.
ECONOMICS – TURNING THREATS INTO OPPORTUNITIES
Inflation and Interest Rates
The theories relating to co-relation of inflation with interest rates has inherent limitations because these theories do not consider the concept of accretion of wealth in few hands. Consequently, although the money supply was high enough but was in few capitalist hands, hence, keeping the interest rates high only hampers the generation of economic activities.
It is worthwhile here to note that OECD has given instructions to its member countries to decrease interest rates in order to generate economic activities and surprisingly UKs economist are in a process to crack the impact of recession by reducing the interest rate even at less than a single digit.
It can effectively be argued that high interest rates are not co-related with inflation in excessive money supply economic environment and keeping the interest rates at current level or merely reducing it by 200 or 250 basis point would only defer the economic recovery of Pakistan. In the recent monetary policy statement, the discount rates were reduced by 100 basis points but contrary to that during the recent auction of treasury bills, the 3 to 6 months TB rates were very much indifferent from one-year TB rates.
One fails to understand the contradictions by State Bank of Pakistan! SBP must rely on strict control through prudential regulations and not through interest rates where most of the banks are operating in private sector. The existing TB rates are nothing but will increase the cost of deficit financing.
Balance of Payment
Firstly, it is really sad to state that role of EPB was an inactive body instead of a proactive body. EPB fails to identify the new exportable items and little has been done to promote cement etc. EPB fails to provide the exporter the data relating to competitive prices offered by neighboring countries and strategically making Pakistans export survive in competitive environment.
Secondly, custom department of the FBR was busy in merely unearthing the under invoicing and misapplication of correct duty rates instead of providing any data compiled after due brain storming session to identify imports of items which are already available in Pakistan, items which are luxurious in nature, etc. The core reason is that either there is no such department or if there is then they are not effectively trained on this count. Such a process of analysis could easily be undertaken after the computerization that has not been used effectively in the past.
Thirdly, the non-alignment of import, export and trade policy was another core reason. Fourthly, the speculation gain (Capital Gain) exemption even to non-residents has seriously affected the foreign currency reserves.
Last but not least, imported trading items are taxed at 2% Income Tax while locally manufactured items are taxed at 3.5%. Further, commercial importer is not only immune from Sales and Income Tax Audit but by implication from record keeping. What a pity! Further, it is imperative that unnecessary imports be reduced next to zero while the commercial imported trading items be brought under normal tax regime from final tax regime under Income Tax Ordinance, 2001 and Sales Tax Act, 1990.
These measures would not only help us in promoting local manufacturing but would also help us in reducing the gap of balance of payments. EPB should be re-organized for a pro-active role while an analysis wing of the custom department be set up which will ultimately help in formulating a policy. The policies of individual ministries and organization need to be aligned with overall objective, that is, monetary and fiscal policy at the cost of individual heuristic approach.
Unaligned Monetary and Fiscal Policies
The points discussed identify the key factors of current account deficit and reasons of loss in budgeted figures. It is high time that these policies be aligned by having effective interaction among concerned ministries and organization that is FBR, SBP, EPB, SECP etc instead of individual heuristic approach. Consequently, the fiscal laws and monetary / fiscal regulators efforts need to be coordinated.
Exploitation of Natural Resources
Sind, NWFP and Balochistan are the hub of natural resources Salt, Gold, Copper, coal oil and gas reserves whilst rice and wheat is shared generously by Punjab and Sind apart from industrial infrastructure duly management. All this is nothing but mutual sharing as in isolation every one is the net looser! For the past more than six decades, the Governments had not effectively and effectively discharged their development expenditure and are the hottest question in town now.
It is suggested that special provisions need to be introduced in direct and indirect tax codes whereby new exploitation of natural resources zones be set up in Sind, NWFP and Balochistan which need to be exempted from tax through the concession agreement subject to certain conditions. The prime condition need to be adherence of corporate social responsibility for instance hiring of unskilled local labor to the extent of at least 50%, development of one local school and one technical school of mining or exploration in the area within a time frame.
Regional Hub Ports
Karachi, Bin Qasim and Gawadar ports are the entrance points into the region. Unfortunately, these un-quantifiable natural resources had not been transformed into effective multinational regional hub points for creation of regional headquarters.
Currently, tax incentives for regional headquarters are provided by many jurisdictions including Singapore, Malaysia and the Philippines. In Singapore, a wide range of tax and other initiatives are in place to promote financial services including asset management services. These include tax exemptions and concession on trading and fee income made by financial services companies and fund management companies.
Tax incentive scheme is also available to encourage businesses to undertake high value added peripheral services to support financial institutions. All these measures are meant to encourage financial institutions to set up their operations in Singapore.
Given Pakistans geo strategic location coupled with natural ports, investors would be more willing to set up their regional headquarters in Pakistan in serving their investment in Central Asian Republics and Afghanistan subject to the provision of specific tax incentives for regional headquarters.
Attracting such new investments in regional headquarters would provide jobs and to maintain prosperity. Government should come up with to provide Pakistan the competitive edge by providing concessionary tax rates Half of existing tax rates for regional headquarters activities which are of substantial scale and are of the nature of investment, general and financial management and marketing with a broad geographic coverage of CARs.
Broadening Of Tax Base
Civic Sense has never been part of our primary and secondary school syllabus although, nowadays good private schools are teaching this as part of their syllabus. Similarly, Federal Board of Revenue need to start negotiation with Ministry of Education to incorporate basic income, sales and excise tax computations as part of the syllabus of Mathematics while a considerable part of economics syllabus need to be negotiated for incorporation of basic rationale of direct and indirect tax code with specific reference to the names of the laws. Further, Income and Sales Tax Practitioner certificate need to be given to only those graduates who have studied corporate and tax laws of Pakistan as part of their syllabus being two full-fledged subjects instead of a mere part.
In furtherance, a new member Member Broadening of Tax Base be devoted. The member needs to be equipped with appropriate work force and work in close liaison with DG Withholding Taxes. The prime responsibility of such member may include liaising with various chambers and local association of various segments of businesses association to identify inducement for tax registration. The issue of new registrants prior years tax issues may be dealt within the panorama of section 120A and 146B. However, it is also suggested that the salaries of such staff be compensated through potential tax recovery also in the shape of bonus on realization of tax. The scope of such member should include direct and indirect tax code.
It is strongly suggested that the withholding tax statements under section 165 of the Income Tax Ordinance, 2001 be analyzed carefully. The NTN number column needs to be checked with NTN database to identify potential new taxpayers. This would help in identifying non-filers of return of total income and sales tax returns. Further exercise should also be extended to PACCS database. Moreover, the sales tax registration numbers should be replaced with Taxpayer Identification numbers which will be one point of identification.
Equal Opportunity for Accountants
It is suggested that members of Association of Chartered Certified Accountants, Institute of Chartered Accountants of Pakistan and Institute of Cost and Management Accountants of Pakistan should be treated at par within the direct and indirect tax code, that is, Income Tax Ordinance, 2001, Sales Tax Act, 1990 and Federal Excise Act, 2005 because ACCA is offering Pakistan tax and corporate law as part of its syllabus while ICMAP has a long professional history. Sales Tax Act, 1990 read with Chapter IX of Sales Tax Rules, 2006 be aligned with Section 223(11) of the Income Tax Ordinance, 2001 read with rule 225 of the Income Tax Rules, 2002.
These include the provision related to outsourcing of audit, appointment of experts and alternate dispute resolution committees. Further, part III of ICMAP and Intermediate examination are eligible to apply for Income Tax Practitioners. It is suggested that students clearing Foundation examination of ACCA should also be treated at par and be allowed to apply for Income Tax Practitioner.
It is surprising to note that even an illiterate person can audit the accounts of a private limited company not being a subsidiary of a public limited company having paid up capital of less than three million. It is suggested that keeping an eye over the inflation since the introduction of this limit in 1999, the limit of three million be enhanced to three hundred million in case of limited companies. Further, the members of ACCA, ICMAP and ICAP members be specified as auditors for private limited companies having paid up capital upto 300 million, guarantee limited and partnership having more than 20 members.
FAVORABLE BUSINESS ENVIRONMENT
The budget need to introduce measure designed to provide support to Pakistani businesses and help stimulate the economy in what are recognized as very difficult times.
Transfer Pricing and Advance Pricing Agreements
The present rules relating to transfer pricing are provided in Income Tax Rules, 2002 that are not in line with specific transfer pricing legislation in developed countries. Given the global trend of tax reduction and the growth in popularity of use of international business vehicles which, if appropriately structured, pay little or no tax anywhere, there has been continuous drain of profit by way of transfer pricing out of Pakistan.
Moreover, international trade has inevitably called for the need of exchange of goods or services amongst group entities in different jurisdictions. Cross border activities are no longer confined to the transfer of goods and materials, but evolving in variety and sophistication.
Multinational companies engage in transfer of intellectual properties and provision of management and consultancy services, whilst financial institutions engage in projects with their international partners in fund raising, asset management and financial product trading.
All these activities involve allocation of income among parties different jurisdictions, and businesses are thus exposed to tax risks on transfer pricing either locally in Pakistan or in location where those entities operate. Consequently, double taxation may also arise in the absence of proper transfer pricing rules.
Lack of clear and unambiguous transfer pricing rules in Pakistan creates uncertainties in international and regional businesses in structuring their businesses or making commercial decisions. Businesses may also tend to allocate profits to jurisdictions with lower tax cost or to location they fear they may be challenged by tax authorities and thus depriving Pakistans fair share of revenue.
It is strongly suggested that the uncertainties surrounding the transfer pricing rules need to be eliminated by adopting the international practice in transfer pricing which includes allowing taxpayer to apply for Advance Transfer Pricing Agreement [APA] with the Inland Revenue department and other departments of FBR as Advance Ruling can not be equated with an APA.
Proper transfer pricing legislation can ensure the predictability of tax liabilities of taxpayers in their cross border transactions as well as they are not doubly taxed in Pakistan and other jurisdictions. Certainty in taxation of cross border activities is essential in promoting international trade and businesses while ensuring businesses that engage in cross border activities with related entities do pay their fair share of tax in Pakistan.
WHT Regime Rates and Refund
Old assesses and now the taxpayers dont know that two provisions of WHT imported from Income Tax Act, 1922 now spread over existing Income Tax Ordinance, 2001 to cater the taxability of transactions. Although the WHT provisions cover almost all major types of transactions but FBR failed to facilitate the business that are currently facing two major problems.
Firstly, the payer businesses normally add up the WHT rate on top of the value of invoices just to remain in businesses and in need of supply or service. Secondly, the taxpayer being prospective recipient of WHT payment receipt cannot oblige the payer of to provide him or her either WHT deduction certificate or Tax Payment receipt, as there is no redresser or penal provision to compel them. Consequently, the refunds are not always verified.
FBR must incorporate a modus operandi to curb this menace. A suggested modus operandi may include appearance of such grossing up either on the face of WHT payment receipt or statement under section 165 apart from redresser or penal provision for obtaining the WHT receipt. Please check my detailed article on WHT problems published earlier.
Final Tax Regime
One failed to understand the rationale behind the various tax rates prescribed for various provisions of WHT covered under Final Tax Regime [FTR] except services, supplies and contract. There is no comparison between the tax rates applicable on Commission Income, Prizes and Winnings and Income from Property with the tax rates prescribed under first schedule. Further, the transactions covered under Final Tax Regime need to be revisited.
Final Tax Regime and Double Taxation Treaties
Double Taxation Agreements [DTAs] provide certainty to investors in assessing their potential tax liabilities on economic activities and provide an added incentive for overseas companies to do business in Pakistan. However, recent inclusion of foreign insurance and re-insurance companies in Withholding Tax [WHT] and Final Tax Regime [FTR] has given rise to a new era of conflict.
Taxpayers are wondering DTAs are silent about FTR regime except to the extent of Royalty and Fee for Technical Services, hence, which shall prevail in the event of conflict between Income Tax Ordinance, 2001 and DTAs. Although section 107 of the ordinance specifically provides the fact that DTAs shall prevail in the event of conflict but is silent when the income is covered under Final Tax Regime. FBR must spell out over this issue for the sake of certainty in commercial decisions.
Group Loss Relief
Businesses incorporate new companies due to various commercial reasons such as limitation of liabilities or holding of accountability on operational activities etc. As such, many local as well as overseas investors establish separate operating companies under one or more holding companies. These group companies are effectively arms or division of a central unit.
FBR and SECP has already joined hands by introducing group loss relief rules so that losses of one company can offset the taxable profits of another company within the same group. Consequently, taxing group companies as a single entity by way of group loss relief will provide flexibility to investors to venture into new activities through separated business vehicles and yet enable segmented business results be consolidated not only for the accounting purposes but also for tax filing purposes.
However, it seems that the modus operandi of filing of return by such groups has skipped the attention of FBR. The question whether individual companies in a group will also be required to file their returns individually or in a consolidated format requires immediate attention and amendment in web portal form of return available at http://e.fbr.gov.pk.
Taxation of Corporate Restructuring
Section 97A of the Income Tax Ordinance, 2001 specifies the treatment in relation to Companies ordinance, 1984 and Banking Companies Ordinance, 1962. The ordinance itself is silent about the principles in debt restructuring, merger and spin-off.
Tax and Fair Value Accounting
Fair Values of some financial instruments are taken to the profit and loss account in accordance with the International Accounting Standards and recently the debate on the future of Fair Value Accounting is underway in International Accounting Standard Board. It is well settled and long accepted principle of Income Tax Law that only realized gain is taxed.
It is suggested that this principle be incorporated in the central concept part of Income Tax Ordinance, 2001 for the sake of certainty. Taxpayers think that tax assessment should not be driven entirely by accounting treatment when clearly a tax based on accounting treatment has produced undue tax hardship and when the gain being taxed is no more than a sum created by accounted entries.
Loss Carry Back
As cited above, IMF and World Bank have already cautioned that year 2009 would be a year of recession. During the last tax year the profits of the companies were enormous and current year is proving to be inverse. Any provision to carry back the loss will encourage businesses to reinvest its profits in new plant and equipment as the depreciation allowance may produce a tax loss in the year of investment or for providing liquidity for businesses.
Further, the carry back of loss will provide an incentive in the form of automatic tax refund for the preceding year. It is strongly suggested that tax loss of business be allowed to be carried back to set off against the assessable profits in the preceding year. However, this provision may be linked to non-issuance of refund during Tax Year 2008 and a declaration to carry back the loss is filed with the Tax Authorities.
The banking industry has expanded itself very rapidly in the urban areas while the rural areas were neglected. It is also a part of corporate social responsibility that branches need to be set up in rural areas, however, this would have serious implications over the profitability of banks who may not be ready to compromise over the shareholders value. It is suggested that the cost of setting up the branches in rural areas be allowed as tax deductible expenditure while the three years losses relating to branches set up in rural areas be allowed at one hundred and thirty five percent.
Further, the seventh schedule has not proved to be separatim legislation as in the case of fourth and fifth schedule and the very purpose remain unresolved. Special provision relating to banking industry in the main enactment like section 28, 29A, 30 and 31 of Income Tax Ordinance, 2001 were not specifically embodied in seventh schedule. Consequently, the certainty is still lacking!
Further, the non-alignment of SBP and FBR policies in relation to irrecoverable debt and issue of forced sale value has seriously affected the banking industry. These issues need to be resolved in consultation with banking industry for future purposes. Further, during this recessionary period the three percent limit prescribed in section 29A in respect of consumer loans requires a revisit.
In furtherance, it is interesting to note that UK revenue authorities have amended its stamp duty act to facilitate the Islamic Banking. It is high time that provincial governments do consult the Islamic Banks to eliminate the excessive collection of stamp duty on shariah compliant financial products as part of the provincial budget exercise.
This infant Islamic Insurance industry is no more a dream in the developed countries. It has expanded itself considerably and proved itself as alternate of conventional insurance business and according to current business statistics; it has left conventional insurance way before. It is suggested that a clause similar to clause 3 of seventh schedule be inserted in fourth schedule to avoid non-competitiveness of this infant industry in Pakistan.
Compensations, Additional Tax, Notional Interest and Refunds
The Federal Board of Revenue must emerge as standing with those revenue authorities that provides greater scope of tax payment deferrals where viable businesses are having difficulty in meeting tax payments due because of economic conditions. The recent trend of having conducting audits under section 177 and reluctance of Commissioners of Income Tax in not exercising deferral powers provided under section 137 in order to achieve their targets are nothing but adding fuel to fire.
It is suggested that compensation on refunds to small and medium sized businesses be issued at regular intervals as currently refunds of Rs50,000 or less are issued more rapidly. In furtherance, it is also suggested that the rate of compensation, benchmark of notional interest on interest free loan and additional tax be aligned with KIBOR. These steps will provide a sigh of relief during liquidity crises and help in generating economic activities.
Initial and First Year Allowance
Capital investment involves cash flows and is substantially high in the first year when the business is at its infancy stage. It is suggested that the rates of Initial Allowance need to be categorized. Further, the areas of First Year Allowance need to be increased during this economic era.
It is further suggested that 100% First Year Allowance be extended to environment friendly assets and replaced assets write off be allowed for tax purposes.
Agriculture Income Tax
It is high time that modus operandi of Provincial and Federal Sales Tax be adopted in respect of Provincial Agriculture Income Tax under the Income Tax Ordinance, 2001. The Income Tax Department of Federal Board of Revenue should be entrusted to convert this dream into reality. However, it is suggested that the gross revenue less collection charges based on time-spent basis must be transferred to provinces on monthly basis. In furtherance, given the cyclical nature of agriculture, it is suggested that agriculture income be taxed on two years average basis.
Taxation of Capital Gain
It is also high time that capital gain on sale of shares and real estate be taxed. The concept of bed and breakfasting need to be introduced whereby the speculation must be separated from capital gain through holding period in line with section 63 of the Income Tax Ordinance, 2001. Similarly, the sacred cow of real estate needs to be slaughtered now. However, it is suggested that inflation level adjustment instead of existing 25% limit need to be considered while providing for the modus operandi of taxation.
Sales and Excise Tax
It is strongly suggested that the rates of sales be brought within the range of 10 to 12 percent instead of existing range of 15% to 21% in order to align the rates with the rates prevailing in the region. It is suggested that concerned member of FBR must identify potential sectors other than textile, beverages, tobacco, cement, sugar, telecommunication, oil and gas exploration and imports not merely individual businesses. This could only be possible in close liaison with federal bearue of statistics and State Bank of Pakistan.
It is further suggested that a minimum of at least 0.5% or 1% sales tax be levied on agriculture produce to collect the data relating to supply chain. This could be done through the sales tax collection agents, which include government departments and purchaser of such produce.
It is further suggested that the issue of tax fraud in supply chain management and black listing require fresh thought in consultation with the business community. It is suggested that refunds need only to be blocked to the extent of black listed supplier or customer. It is worthwhile here to note that a similar provision exists in all developing countries and the decision of European Court of Justice is worth considering for any such negotiation and new modus operandi.
Currently, FBR is monitoring the collection of sales tax on services, which is promulgated through the Provincial Sales Tax Ordinances. It is suggested that FBR should identify new service sectors and extend the existing list of five items. The potential sectors may include professional services.
Moreover, it is suggested that input and output relating to sales and excise tax should be made adjustable by amending section 7 and omitting second schedule of the Federal Excise Act, 2005.
The existing law and order situation of the country has not only crippled the economy but has also increased the number of dependents. It is suggested that tax credit provision be introduced for children education, medical and support to parents. Our society is very much distinguishable in the world for taking care of our families and parents that needs further inducement and support from fiscal laws during this recessionary period.
The receipted expenses incurred for claiming tax credits would either be helpful in unearthing potential taxpayers or cross checking the data of existing taxpayer during audit under section 177 of the ordinance.
The above recommendations are meant for making Pakistan emerge as a first choice for regional hub. This may seem difficult in current crises but the measures suggested are only meant to convert the dream into reality. The special emphasis over exploitation of our natural resources and duly spending the earnings in the capacity building of that very province would make Pakistan prosperous. We forgot the lesson that almost 60 years before a more than 100-year ruler was unable to maintain its writ in NWFP and we are experiencing the same again.
The fiscal and monetary policies of the country need to be aligned and recession could only be cracked through reduction in interest rates substantially. State Bank of Pakistan should be vigilant through compliance and adherence of prudential regulation by the private banks instead of monitoring the interest rates.
Generation of economic activities need to be the prime goal which can only be achieved through vigilant eye on our imports. Currently, an imported item is taxed @2% while the locally manufactured item is taxed @3.5%. There must be some inducement to manufacturers.
The primary characteristics of our society may remain for a long time but caring attitude may further be promoted through parents support allowance and children education.
The writer is the Chairman of ACCAs Budget and Tax Committee [South] and member of Income Tax Bar Association Karachis CPE Committee and can be contacted at email@example.com. His articles used to appear in local and international journals. Accountancy may or may not agree with the opinions expressed in this article.