Case for abandonment of a bad law
Dr. Ikramul Haq
Dr. Ikramul Haq, a leading international tax counsel, is a well-known author specialising in international tax, press, intellectual property, corporate and constitutional law. Dr. Ikram is Chief Partner of Lahore Law Associates (fax: +92 42 6365584, e-mail: irm@brain.net.pk; website: http://www.paktax.com.pk). He is a member of the visiting faculty of the Lahore Institute of Tax Education (LITE). He studied literature, journalism and law, for his Masters and Doctorate degrees. He has written many books on various aspects of Pakistani law and global narcotics trade, some of which are co-authored with his wife, Mrs. Huzaima Bukhari.
The Income Tax Ordinance, 2001, promulgated on the dictates of foreign donors on 13 September 2001, is a bad law by all standards. There is a consensus between the official and non-official quarters [which is a rare phenomenon] that it needs to be abandoned. It is agreed that even if its enforcement is inevitable then it must be thoroughly amended before it becomes operational on 1st July 2002. It is a unique piece of legislation that requires changes on a mammoth scale even prior to its operation! The Central Board of Revenue (CBR), after lot of criticism and public demand, has finally appointed one of its ex-chairmen to prepare a “compendium of amendments” that will be inserted vide Finance Ordinance, 2002 [expected to be announced in the 2nd or 3rd week of June, 2002] to make it workable.
Time and again it has been suggested that this Ordinance should be repealed and repromulgated, if necessary at all. The proposed changes can easily be incorporated in the existing Income Tax Ordinance, 1979, which has now a time-tested 22 years of existence. There is no need to promulgate and enforce a new Income Tax Law having only cosmetic changes here and there [with new jargon alone and in fact nothing new in substance]. Alternately, if it had become inevitable for the government to enforce the new law (as a prerequisite to obtain foreign aid and make Pakistan subservient to foreign donors), then the better choice is to repromulgate it as the Income Tax Ordinance, 2002 instead of inserting innumerable amendments in a law that has yet to take effect. The amendments proposed so far by the stakeholders and approved by the CBR and Ministry of Finance can be made public. The best way to make the new law workable would be to elicit public response on proposed amendments and after taking these into consideration, new Income Tax Ordinance, 2002 can be promulgated with effect from 1st July, 2002. It would save CBR from embarrassment and the public inconvenience in inserting a number of amendments in an existing law.
The present strategy to “improve” (sic) the new Income Tax Law through closed door bureaucratic process is not only against the principles of good governance and transparency, but also going to make it a law unacceptable to the taxpayers in general and the traders in particular. The Karachi traders (Alliance of Market Associations) in their meeting on 6 May 2002 demanded the CBR “to withdraw the new Income Tax Ordinance and restore the previous law with amendments proposed by different bodies”.
According to Business Recorder (May 7, 2002), the traders’ Alliance of Karachi, representing various markets of the city, unanimously adopted a resolution rejecting the new Income Tax Ordinance. They said that the traders were fighting against the highhandedness of the Sales Tax staff for the last many years and now unreasonable conditions of maintaining substantial accounts had been imposed under the new Income Tax Law, effective from 1st July, 2002. The traders’ Alliance alleged that the CBR was adopting coercive policies to meet budgetary targets rather to improve voluntary tax compliance through reforms. They are of the opinion that the present business scenario, complex laws and unstable tax policies would not help the government to meet its targets. They revealed the startling facts that out of Karachi’s 1,75,000 taxpayers, 1,00,000 had gone out of tax net. “It shows that the government claims for searching new taxpayers also fell flat, hence, the government is forced to reduce its sales tax target every quarter”, they added.
This reaction of the traders’ alliance should be an eye-opener for the CBR policy-makers. Their tax policies are forcing the businessmen to shift their capital elsewhere where no such tax harassment exists. The argument that such businessmen are not loyal to Pakistan is fallacious. Is our tax machinery loyalty to Pakistan? They are forcing the people to leave the country. They are harassing businessmen for self-aggrandisement. They are creating an atmosphere of terror and yet the traders are blamed for tax avoidance and evasion. Can these acts stated to be in the interest of the State? Since they filled the ballot boxes for the referendum, their loyalty with the State is bona fide? The government will have to realise that present tax apparatus needs to be overhauled (not by hiring local consultants on market wages or paying huge amounts to foreign “experts” out of loan secured from foreign donors) but by taking the taxpayers into confidence. There is an urgent need for education and facilitation of taxpayers instead of coercive measures.
The new income tax law has following disastrous anti-business provisions that going to create more hardships for the growth of industry and dissuade both local and foreign investors:
- Extension of withholding obligations to non-residents’ permanent establishment (PE) & determination of Pakistani-source income on PE basis
The non-resident companies having permanent establishment (PE) in Pakistan are now required to comply with withholding tax obligations in the same manner as in the case of resident companies. This is an ill-conceived departure as nowhere in the world such obligations are imposed on foreign investors. Interestingly the concept of PE has also been unnecessarily included in the new Ordinance as this term is a subject matter of international tax treaties and for domestic tax laws the expression “business connection” is more appropriate. The expression PE should not be part of domestic tax law and the century old concept of “business connection “ as elaborated by the courts should alone be retained. The concept of PE for determination of Pakistani-source income in the hands of non-residents is totally uncalled for and will create a lot of problems for the tax collectors as well as taxpayers. The concept of PE is exclusively for the double taxation treaties and it is alien to domestic tax laws.
The new provisions relating to PE attempt to tax direct sales from outside Pakistan through a PE, which is against the established international principles. Such a provision will further dissuade foreign investors, and needs immediate attention of the Board of Investment. It appears that one arm of the Government is working against the other. One wants to attract foreign investors and the other wants to dissuade them. It is an established international practice that the States do not tax any transaction involving sales that are not effected through any “business connection” vis-à-vis their territorial jurisdiction. It is beyond one’s imagination how in Pakistan we want to tax something that has nothing to do with Pakistani-source. This is an unprecedented move that would have disastrous consequences for business and trade.
- Curtailment of depreciation and recouping the same on export
Under the Income Tax Law since its inception in the sub-continent in 1886, full year depreciation was allowable even if an asset is used for part of the year. Under the new law the depreciation allowance has been restricted to the number of months the asset is used during the accounting year. Depreciation is an allowance that should not be restricted on prorata basis of the use of the asset in an accounting year. Nowhere in the world such a restriction is imposed under international accounting practices.
Previously, initial depreciation was never recouped on export of an asset used in Pakistan in certain cases. Under the new Ordinance, the whole depreciation allowed, including initial would be recouped. These two departures are anti-business measures that would seriously affect the industry in general and allowability of depreciation charge on machinery (such as drilling rigs) temporarily imported in Pakistan in particular.
- Recovery of “Advance Tax” as tax due
The new law provides for recovery of advance tax as tax due, meaning by that the same would be recovered by passing an order where the taxpayer opts not to pay it and rather go for additional tax for default. The apex court held in (2001) 83 TAX 119 (S.C.Pak) that recovery of advance tax by passing an order is ab initio void and the Department can only levy additional tax for its nonpayment. If a taxpayer is facing a liquidity crunch why he should borrow and pay advance tax, as he has option to pay “cost of funds”[additional tax] to the Department. This amendment is irrational, aimed at nullifying the principles set by the apex court and very damaging for businesses, especially when the companies and firms are to pay this tax on turnover basis rather than on their actual incomes. Our tax masters want to hang the taxpayer twice. There is no justification of double jeopardy which even otherwise is against constitutional principles.
- Confiscatory taxation in the case of employees.
The new law taxes notional benefits provided to employees in utter disregard of the established principles of equity and reasonableness. If the predominant business activity of the employer is to lend money, interest free or concessional loans given by him to the employees will not constitute any benefit as companies engaged in air carriage business give free air tickets to their employees. The misconceived notion that in such cases benefit is passed on to the employees has resulted in taxation to the extent of confiscation in the case of bank employees. They will have to pay from their own pockets if the new formula of taxation is applied in their case.
In the case of hi-tech industries like software development, the human resource is the actual capital investment, so employees are naturally the real profit earners. Such companies, which include many multinationals, compensate their highly qualified employees by giving them stock options and other free of cost benefits. The non-taxation of such benefits is necessary for attracting highly qualified people to work in Pakistan and to discourage them from going abroad. The new law has done diametrically the opposite. It will discourage the growth of hi-tech industry by forcing brain drain from Pakistan. It is strange that anti human resource provisions have been added totally in contradiction to the policies of the present government of human resource development.
The CBR is asking even the petty businessmen to start maintaining substantial books of accounts with effect from 1st July 2002. This process should have been done in phases and not at one go, without giving ample time to the businessmen. The promulgation of draft rules through Statuary Regulatory Order (SRO) No.168(I)/2002 on 26 March 2002, introducing changes in book-keeping in the in existing Income Tax Rules, 1982, to be effective from 1st July 2002, is yet another move by the CBR in the wrong direction. These enhanced requirements of book-keeping are going to create a number of new obligations for the businessmen, who have already developed repulsion towards so-called “documentation” by the CBR. They always see with doubt any such move considering it detrimental to their business environment. The businessmen over the period of time have inculcated antagonism against the tax collectors, the causes of which are deeply rooted in bad faith between the tax machinery and taxpayers. There is no cavil about the fact that tax collection and culture cannot be improved without proper documentation, but first of all the stakeholders need to be educated, facilitated for the process of change and taken into confidence. The CBR stalwarts want to do it unilaterally that would result in antagonism with the taxpayers and difficulties in implementing even well-meaning policies. These rules have the following flaws:
- Mandatory requirement of keeping books of accounts for all businessmen and professionals, who earn even marginal taxable income, is absurd, unjustified, expensive and impractical. It will give leverage to tax collectors to harass these small taxpayers by checking their books of account and taking their case out of Universal Self Assessment Scheme. Can you force a taxi driver or a panwala to keep books of accounts?
- Prescribing peculiar books and documents is against the established principles of international accounting, as International Accounting Standards only explain principles and not any specific manner in which accounts are to be kept. According to judicial principles, every person has a right of keeping the accounts in a manner that is best suitable to him and the only condition is that the profits and gains should be deducible from these as per established norms and practices of accountancy. The CBR has violated these judicial pronouncements in the draft rules.
- In the case of corporate entities there are certain statutory requirements under the relevant laws to maintain certain books and documents. The CBR has tried to bypass them or posed more obligations on these corporate bodies, which could have easily been avoided by asking them to adhere to requirements already available in their case.
The CBR is bound to implement these draft rules, as this is one of the conditions of IMF’s first year Pakistan’s Poverty Reduction and Growth Facility (PRGF) Programme with the Structural Performance Criteria (SPC) that requires the CBR to: “Publish rules and regulations including for record keeping under the universal self-assessment scheme for income tax to become effective July 1, 2002. Timing (March 31, 2002). The proposed rules intend to lay down new requirements for every taxpayer doing business for the maintenance of documents/record-keeping with effect from July 1 2002 are thus on the command of foreign masters. While acting on the dictates of the IMF, it was not a condition also to act illogically, irrationally and without applying mind. How CBR thought of making book-keeping necessary even for the small shopkeepers in town and villages, who file returns declaring tax between Rs. 50 to 500 is simply inconceivable.
It is strange that on the one hand the CBR has substantially burdened business houses and other taxpayers with plethora of record-keeping and documentation and on the other, reasonable time has not been allowed to them to adopt the new rules. The CBR wizards think that by just promulgating rules they will achieve everything. Time and again voices have been raised against this rather callous attitude of the CBR of neither consulting the stakeholders before imposing new tax obligations nor giving them sufficient time to fulfil them.
The other shocking aspect of this exercise is that Income Tax Rules 1982 have been amended with effect from 1st July 2002, whereas from the said date the new income tax law is going to take effect and these rules are going to be redundant. The CBR has yet not promulgated new Income Tax Rules in conformity with the new Income Tax Ordinance promulgated on 13 September 2001 [following the suit of terrorists at the World Trade Centre in New York, the CBR dismantled a time-tested 22 years old Income Tax Ordinance, 1979] and instead, the old rules, which are in the process of being repealed, are proposed to be substantially amended. This shows a confused thinking on the part of CBR. If they do want to implement new Income Tax Law then they should stop making any amendments in the existing rules but should rather concentrate on framing new rules as very little time is left for the commencement of the new financial year.
In a recent seminar, Member (Coordination), CBR, made some amusing [for some shocking] remarks that if the new rules under the Income Tax Ordinance 2001 could not be promulgated by 1st July 2002, then the existing Income tax Rules, 1982, framed under the Income Tax Ordinance, 1979, would remain in force. One would like to know what is the impediment in the way of CBR to frame and promulgate new rules. Those who have read the new Law certainly know the existing rules would not be compatible with it and a lot of contradictions and dichotomies are going to surface, if the same are retained vis-à-vis implementation of Income Tax Ordinance, 2001 drafted by an Australian expert. At present, the CBR has 12 members [5 on market wages!] and nearly 700 qualified (sic) staff at the Headquarters in Islamabad and yet it is finding difficult to frame new Income Tax Rules. Does one still need some tangible proof to declare this august body inefficient?
The government wants the new Income Tax Ordinance, 2001 to be enforced in one go, without debate and proper procedure. They are not even waiting for the new rules to be drafted in conformity with this law. CBR wizards should realise by now that the less workable a law is, the more problematic it is to enforce. People do not obey the law that they don’t believe in. The Government finds it difficult to enforce laws that only a handful of people understand. Laws that people do not obey and the governments are unable to enforce are of no use to a society. If a law is bad enough (which the new Income Tax Law certainly is) even its proponents might be willing to abandon it in favour of an existing different law (the existing Income Tax Ordinance, 1979) that seems more legitimate to the people. There is a consensus amongst all the concerned that the existing law of income tax is fairly legitimate, yet for reasons best known to the government it is being preferred over a bad and unworkable law.