Need for new income tax law

Huzaima Bukhari & Dr. Ikramul Haq

When the government of General Pervez Musharraf decided to promulgate a new income tax law in 2000, we, amongst many others, opposed it strongly. The main objection was that his regime had no mandate to enact any such law. The rule, “No taxation without representation”, was stressed by us and others. This cardinal constitutional rule is embodied in Article 77 of the  Constitution of Islamic Republic of Pakistan but being usurper, the military dictator was least pushed about it. Strangely and disturbingly even the elected governments since the exit of Musharraf have been showing complete apathy towards enacting a new income tax law and other tax codes that conform to fundamental rights and public policy guidelines contained in the Constitution.  

During the Musharraf era, it was argued that the dictator lacked the mandate to enact Income Tax Ordinance, 2001 repealing Income Tax Ordinance, 1979, which was also promulgated by a military dictator, General Zia-ul-Haq. It was demanded that he should leave this work for the future elected government. Unfortunately, the law was promulgated and thereafter all elected parliaments, including the present one, have never bothered to review it.

We do not enact tax laws through consultative process, which is a prerequisite of democratic polity. Tragically, the repealed Income Tax Ordinance, 1979 was also promulgated by a military dictator, and the existing Income Tax Ordinance, 2001, is reminiscent of undemocratic rule of General Musharraf.

The Supreme Court of Pakistan aptly observed in CIT v Eli Lily (Pvt) Ltd [(2009) 100 Tax 81 (S.C. Pak)] as under:

“Since the creation of Pakistan we have not been able to frame any Income Tax Act duly debated in the Assembly. Both the Ordinances were promulgated during the Martial Law Regime otherwise the Constitution has prescribed a four month life of an Ordinance in case the Ordinance is not be placed before the Assembly and it shall be enacted as an Act then the Ordinance will automatically cease to exist. This aspect also reveals that the Constitution has cast duty upon the legislative body to frame the laws within the parameters prescribed under the scheme of the Constitution”.

The Income Tax Ordinance, 2001 is highly complex law and badly drafted. During the last 17 years [it was made effective from tax year 2003] and despite the fact that over 3000 amendments were made, it has generated enormous litigation. The Apex Court noted in (2009) 100 Tax 81 (S.C. Pak) noted:

“The fact that the Ordinance in question was issued and various amendments were incorporated before and even after the enforcement of the Ordinance 2001 raises the controversy that the Ordinance in question was promulgated without meticulous debate on the subject due to which taxpayers and concerned departments were compelled to agitate the issues in different courts”.

 We have been pointing out since its inception, various errors of drafting and concepts (see Law & Practice of Income Tax,Volume I, pp 1-14) but the Federal Board of Revenue (FBR) did not bother to consider these and ultimately lost revenue of billions of rupees when Supreme Court vindicated our viewpoint in (2009) 100 Tax 81 (S.C. Pak) as under:

“It appears that the Ordinance was drafted in post haste and the draftsman omitted to incorporate this important provision. This observation is supported from the fact that the Ordinance was subjected to speedy, successive and large scale amendments, particularly at its very inception”. It may be seen that section 238 provided that the Ordinance shall come into force on a date to be appointed by the Federal Government by notification in the official gazette. Accordingly, vide notification (SRO No. 381(I)/2002) dated 16.6.2002, the Ordinance came into force with effect from the first day of July 2002, but with more or less 1000 amendments inserted by the Finance Ordinance, 2002, as calculated by the learned counsel for the respondents…..Had the un-amended provision of subsection (1) of section 239 continued on the statute book, no difficulty would have arisen regarding the treatment of assessment orders passed in respect of the assessment year ending on 30^th June 2003. In such eventuality, the assessments up to the said period would have been governed under the repealed Ordinance, while the assessments of the post enforcement period of the Ordinance of 2001 would be governed under the latter Ordinance”.

In para 53 of (2009) 100 Tax 81 (S.C. Pak), the Supreme Court has categorically held:

There is a need to review the language, content and scope of the power to amend and further amend an assessment, the power to revise an assessment and the power to rectify mistakes envisaged in these sections so as to make it in line with the legislative intent of consolidating the law relating to income tax so as to make it easily comprehensible to the convenience of the taxpayers”.

This judgement was passed on June 22, 2009 and till today neither FBR nor the Parliament has implemented the command of the Supreme Court. The FBR has lost and is still losing cases involving substantial revenue because of conflicting and confused provisions of the Income Tax Ordinance, 2001, but tax bureaucrats are least pushed to request the Parliament to amend the law as suggested by the Apex Court or enact a new one that is more suitable to our conditions.

Time has come that the Parliamentary Standing Committee on Taxation & Finance of National Assembly initiates the process of drafting and adoption of a new income tax law rather than further amending the Income Tax Ordinance, 2001 that is simply impractical. Services of experts should be elicited for this task. We can never ensure tax culture unless tax laws are made simple and easy to comply.

 All citizens should be taxed fairly that is according to their ability (all the presumptive and minimum tax regimes, concessions and exemptions given in the existing law should be abolished). The taxpayers should be given rights through legislation (Taxpayers’ Bill of Rights) that taxes collected would be spent for public welfare and not for the luxuries of the elites—militro-judicial civil complex and politicians in power—and  that their cases shall be adjudicated expeditiously through an independent tax appellate system. Efforts are needed to have an income tax law: 

• ensuring taxation on the basis of ability to pay as enshrined in Article 3 of the Constitution;
• providing uniformity of tax treatment as far as possible for various categories of taxpayers;
• reducing dependence on withholding taxes;
• encouraging voluntary compliance through deterrent provisions;
• minimizing tax exemptions;
• reviewing the existing tax appellate system; replacing it with National Tax Court completely independent of FBR and Ministry of Law; and
• removing distortions and anomalies to make the law coherent and consistent;

New Approach

It is an inescapable conclusion that income tax law, as it exists, is a most undesirable piece of legislation. Direct tax system intends to achieve the twin aims of maximizing revenue as well as utilizing revenue for achieving socio-economic objectives. In actual practice, our tax system has failed to achieve either of these objectives. In fact, the complex regime of incentives and disincentives built into the direct tax law cannot but lead, per se, to difficulties in enforcement and to the opening of opportunities for tax-dodgers/evaders. At the operational levels, this has resulted in undue bureaucratization, corruption and harassment of the citizens. Undoubtedly, time has come to resolve these contradictions and to completely convert direct tax regime into simple tax law. The new approach should aim at generation of resources besides achieving some limited but important economic objectives like promotion of savings, encouragement of new investments and conservation of energy.

Equity in taxation

For any meaningful change, solutions have to be found for those issues that have been sidetracked for years. One problem that affects personal taxation significantly relates to presumptive taxes, minimum taxes, tax brackets, exemption limits, tax rates and fairness of the system of indexing for inflation. On the eve of each year’s budget exercise, these issues are raised but avoided rather than solved, by an appeasement policy of giving tax amnesty, asset-whitening schemes, more exemptions for the powerful segments, raising deductions, re-arranging tax brackets and making hanges in tax rates. The case for adjusting the structure of personal income tax to inflation, to retain the same levels for taxation and collections in real terms, should receive the first priority in any future tax reform to enhance the credibility of the system.

Broadening tax net

We, in Pakistan, have been running after small fry to broaden the tax net. For example, a widows or pensioners are subjected to 10% flat tax on income earned from Bahbood Certificates and pension accounts. They also pay advance adjustable income tax on mobile use even if income is below taxable limit. Such erratic taxation is highly lamentable. Salaried persons having no other source of income have to pay advance tax not only on salary but also when paying fee of their children and mobile bills. They have to file tax returns and then claim refund of excess payments made to FBR, which they seldom receive. This exercise generates tremendous infructuous, unproductive and wasteful workload without any significant gain to the revenue. It strengthens the feeling that the government, unable to tackle the hardened tax evaders (for example sharks in real estate speculative business and at stock exchanges), is unduly harsh on salary and wage earners. A feeling goes around that they are made to bear the major burden of taxes. The consequence is that ordinary people who generally think of themselves as honourable and honest end up in participating or advising others to practice evasion of taxes!

Administrative reforms

The administration of a tax system is highly complex. No doubt, a proper bureaucratic input is vital for making the system successful but it is equally necessary to take all the stakeholders on board and laws are made and implemented through consultation and consensus rather than by means of irrational policies and illogical measures. Unfortunately, this aspect of the problem, which deserves utmost priority, has been neglected for no ostensible reasons. All the tax reform committees and commissions have failed to consider this matter important enough to merit full-scale attention. Even if they recognised it as a problem they decided to leave it for the relevant quarters. The undeniable reality is that no agenda for rationalization or simplification of tax system can significantly improve tax compliance, unless there is a substantial improvement in public perception regarding the efficiency, technical competence, integrity and ability of the tax authorities to relentlessly pursue and punish tax evaders without any political and other interference.

There is always talk of giving “market” wages to officers, but nobody has even thought of improving the overall working conditions of tax departments and refining professional skills of tax collectors. If one goes to a tax office as a taxpayer only then one would feel the taste of inhuman and insulting treatment an ordinary citizen receives daily. Does it really need enormous money from lenders/donors to extend respect and courtesy to taxpayers, which they deserve? Does this issue relate to market wages or foreign funding or advice?

Tax reform is a continuing exercise

The exercise relating to tax reforms cannot be a time-bound affair and does not mean merely making changes in law. Reforms can be successful only if simultaneous analysis is made of the whole system, that is, tax structure, tax administration, state of economy, taxpayers’ attitude, revenue needs of the country and so many other allied aspects. Measures that are necessary to make a tax system successful relate to:

1. devising and running an efficient and truly independent justice system;
2. provision of expert legal advice for drafting of laws;
3. designing of tax forms and procedures;
4. improvements in the management of tax department;
5. a broad-based personnel policy;
6. training of tax administrators, especially for under-cover operations;  
7. educating taxpayers and making them realise that it is their moral duty to pay tax;
8. development of work ethics;
9. provision of healthy working conditions; and
10.  efficient appellate system for deciding tax cases within a year of their filing, and dispute resolution apparatus for settlement of the problems faced by taxpayers.

Relatively successful reforms in Indonesia, Jamaica, Malawi, etc, were carried out in three to four years’ time and these involved substantial preparation and transition arrangements including extensive consultations with all parties affected by tax reform.

In Pakistan, the five-year (2006-2011) foreign-funded Tax Administration Reform Programme (TARP) extended for one more year (2012) failed to achieve anything, rather it multiplied the problems of tax machinery as well as taxpayers. Tax reform programmes and strategy involve continuity in key decision-makings and major educational campaigns concurrent with the introduction of tax reform proposals to familiarise taxpayers with new requirements. In Pakistan, we merely made it a bureaucratic exercise that is always bound to fail. Now a new tax reform programme under the name of ‘Pakistan Raises Revenue (PRR)’ Project is accepted by the present government with the total cost of about US $1.6 billion, of which counterpart contribution is $1.2 billion and IDA financing is $400 million. In the past as well, World Bank and others gave a lot of money to Pakistan for reforms, yet things have changed only for the worse on fiscal/tax front. Pakistan Raises Revenue (PRR) Project is designed to “sustainably increase domestic revenue by broadening the tax base and making it easier for citizens and businesses to pay their taxes. This will make it possible for Pakistan to finance the investments in infrastructure, education and health needed for the country to accelerate and sustain growth”. But no serious study is unveiled for this!

For initiating a public debate, we have prepared a draft ‘Income Tax Act, 2020’ [text is long and can be obtained through email at info@aacp.com.pk]. It can serve as a starting point of debate in the Parliament. All concerned—members of House Standing Committees, tax administrators, trade and professional bodies, taxpayers, tax professionals and public at large—can examine this draft and suggest improvements as well as highlight its shortcomings and deficiencies. A meaningful public debate on this draft can pave the way for better income tax legislation in the country. However, it all depends on the attitude of the elected members, who hardly take any interest in enacting such laws that can make a difference in the lives of ordinary people.

We hope that some elected member may get inspired and opt to present it as a private member’s bill in the house before the next budget is announced if Government is not interest. It can generate meaningful debate in the Parliament as fair taxation is at the heart of establishing a true social democracy. FBR will certainly not like this draft as tax bureaucrats want complex laws and cumbersome procedures that give them unbridled powers and discretion—their strength and capacity to extort money (not tax but bribes) depends on complex and complicated laws. They resist any such change. It is now the duty of elected members of all parties and not of the ruling government alone to take initiative and enact income tax law law through consultative process.

Salient features of proposed Income Tax Act, 2020

I.          Integration of all components

There are four authorities responsible for enactment and implementation of taxes on income, Parliament, Federal Government, Federal Board of Revenue and the Inland Revenue Service. The role of each one of them should be clearly defined.

II.        No delegated powers

There should be no delegation of power to any administrative authority in fiscal law, except to make rules. The notorious SRO system should be disbanded completely as it is against Article 77 read with Article 162 of the Constitution.

III.       Tax rates should not be subject to annual Finance Bill

Income tax rates should be at least for 10 years so that people can make long term planning of their affairs. The base of income and the range of tax rates should be made adequately wider so that there is no need to change it every year. The progressivity of tax rates is essential to meet the constitutional requirement of ensuring economic justice and social disparities. Tax rates should also be rationalized in order to make them equitable for all classes of persons.

IV.       Tax on undisclosed income

The tax on undisclosed income must not be charged by clubbing it with the declared income. It should be taxed separately at a fixed rate after debate in Parliament. However, it is proposed to have a National Deposit Account in which any amount can be deposited without giving explanation for its source. No money should be allowed to be withdrawn from it for 3 years and it would not carry any interest either. Thereafter, on maturity date the whole amount minus tax payable would be returned. It will generate extra revenues for the government. 

V.        Distribution of income within a family

In respect of deductions, a minimum 20% of the income, if transferred to members of taxpayer’s family, must be exempted. It can be made taxable in the hands of the members of the family. This will provide for faster and equitable distribution of wealth amongst the members of the family and greater family stability in the society. All recipients would be bound to file returns, show receipt through banking channel and utilization for own benefit. If it is found that the payer in any way took an advantage of this provision he would be penalised by double the amount of tax he intended to avoid.

VI.       Penalty and prosecution

Penalty and prosecution provisions must continue and the income-tax authorities should be given wider powers to enforce these provisions of law. No degree of liberalization or reduction in the rates of tax can take away the lure of not paying taxes. Tax is like any other expenditure and every one would like to save as much as possible.

VII.     Payment of tax

The entire amount of tax should be made payable by the taxpayer either by deduction at source or by advance payment of tax before the end of the year. The base for deduction of tax at source may be made very wide but option must be given to the taxpayer to declare that his income is below taxable level to receive income without any deduction of tax. Penalty and prosecution provisions can be strengthened against giving a false declaration.

VIII.    National Tax Tribunal

There may be a National Tax Tribunal subordinate only to the Supreme Court. It should be the final authority as regards the interpretation of all federal tax laws. It should only refer important questions of law to the Supreme Court. This would relieve the High Courts of very heavy burden of tax cases.

IX.       Rules of interpretation

The Act should contain the rules for interpretation of the statutes. Much of tax litigation has arisen because of different rules of interpretation being applied by different authorities and by the same authorities at different times. The rules of interpretation of tax laws should be applied uniformly and decisively.

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The writers, lawyers and partners in Huzaima, Ikram & Ijaz, are Adjunct Faculty at Lahore University of Management Sciences (LUMS)