Selection for and conduct of audit is not ex facie detrimental to the interest of taxpayer, however to exercise such powers; the discretion needs to be structured by framing rules and issuance of policies for ensuring consistency and certainty of procedures; transparency and fairness— Nestle Pakistan Limited etc. Versus Federal Board of Revenue [(2017) 115 TAX 84 (H.C. Lah.)]
Revenue authorities across the world grapple with how to effectively apply their scarce resources to the task of maximizing voluntary tax compliance. The challenge is in knowing where and how to most effectively apply those resources whilst maintaining coverage and visibility in the community— Selecting Cases for Audit–Getting It Right, Margaret E. Cot ton, Asia Pacific Tax Bulletin, International Bureau of Fiscal Documentation (IBFD)
An effective tax audit system is essential to maximize voluntary tax compliance. All the developed tax administrations possess sophisticated tax intelligence systems in place enabling them to enforce voluntary tax compliance. Duplicating a similar system for developing administrations is not optimum due to the lack of basic systems and skilled staff. Countries like Pakistan need a model that combines the best of a developed administration’s practices with the flexibility that allows it to be used regardless of the size of an administration and skill of staff.
The issue is not that of powers of Federal Board of Revenue (FBR) and/or Commissioner Inland Revenue (CIR) to concurrently select cases for audit, but finding out a pragmatic model for case selection for meaningful tax audit. Global comparison of tax audit provisions, procedures and practices with those adopted in Pakistan shows that FBR has never bothered to provide a transparent selection process based on any intelligible differentia to provide benchmarks that are intrinsically linked with risk areas.
It is important to highlight that in USA, UK, Euro zone, Scandinavia, Japan, Singapore and many other developed tax administrations, the main emphasis is on selecting cases for audit on the following two bases:
1. Benchmarks are provided for each year on websites before the filing of returns. Any case falling in any of the benchmarks is automatically selected for audit. There is neither any discretion nor any discrimination involved in the audit selection process. It makes the selection process universally acceptable and transparent.
2. Special audit is done in cases where any definite information is generated by computerized tax intelligence system or obtained through an independent source.
In Pakistan, FBR did not provide any transparent method for selection of cases for audit under any tax law. It has created distrust and taxpayers invariably contest audit selection in High Courts invoking Article 199 of the Constitution of Pakistan. In Nestle Pakistan Limited etc. v Federal Board of Revenue [(2017) 115 TAX 84 (H.C. Lah.)], Lahore High Court held that “FBR shall rectify the defects pointed out, hereinbefore, in the impugned Audit Policy 2015 and in the policies to be issued in future. Following directions shall be read and incorporated in the rules or policies:
n A taxpayer selected and audited in preceding tax year/period shall not be selected and audited without giving reasons for such selection. FBR shall enhance its capacity to audit a selected taxpayer for last five years to give respite from consecutive selections.
n Audit, being administrative proceedings, shall be completed on issuance of Audit Report. If audit is not completed within the given time frame, the selection shall be deemed to have been dropped. After issuance of Audit Report; adjudication proceedings shall be carried out by some other taxation officer to satisfy command of the Constitution under Article 10A.
n After selection for audit, any demand for increase in payable tax to drop audit proceedings is not only against the scope and spirit of audit but is in violation of the provisions relating to audit under the Federal Taxing Statutes as well.
n The audit shall be conducted in accordance with “Income Tax Manual Part V” and “Sales Tax Audit Hand Book” and such procedure for conduct of audit shall be incorporated in the Rules for Selection and Conduct of Audit.
n Remedy against any grievance, regarding selection or conduct of audit, under Section 7 of FBR Act, 2007 shall, henceforth, be read as part of every Audit Policy and its procedure is directed to be incorporated in the Rules for Selection and Conduct of Audit.
n The decision, directions and observations made in this judgment shall be followed while implementing the impugned Audit Policy 2015 and future audit policies”.
The Lahore High Court in its order Federal Board of Revenue v Chenone Stores Ltd and Others 2018 117 Tax 17 (H.C.Lah) has once again cautioned the FBR that:
- We are in agreement with the observation in Chenone Stores’ judgment that ‘even though the Commissioner may be the best person in the system to identify a tax default, he cannot enjoy unguided discretion’.
- It has already been declared in Media Network’s Case [(2006) 94 TAX 293(S.C. Pak)] that Commissioner shall give criteria/reasons in the notice for selection.
- Following the laid down law, first proviso to the Section 177(1) requires that reasons shall be given by the Commissioner before calling the record for audit. Yet in our opinion, his discretion to call for record to conduct audit need to be structured for avoiding its potential misuse. This discretion should not be used to call a taxpayer consecutively to meet budgetary targets of collecting tax. In subsection (7) of the Section 177, though the legislature has authorized audit of a taxpayer in the next and following tax years but only where there are reasonable grounds for doing so. These reasonable grounds need to be confronted, in addition to the reasons for selection required under the first proviso.
- Commissioner can call for last six years record for audit, as is deducible from the second proviso, therefore, collective reading would show that the Legislature deprecates, as a rule, selection or calling for record of a taxpayer every year. Calling for record in the next or following year should be in exceptional circumstances on very sound reasons.
- Commissioner’s discretionary power to select cases for audit must be structured. Structuring of discretion, liable to be misused, has been ordained by Supreme Court of Pakistan in Amanullah Khanand others v. The Federal Government of Pakistan through Secretary, Ministry of Finance, Islamabad and others (PLD 1990 SC 1092), Government of NWFP through Secretary and 3 others v. Majee Flour Mills (Private) Limited (1997 SCMR 1804), and Muhammad Amin Muhammad BashirLimited v. Government of Pakistan through Secretary Ministry of Finance, Central Secretariat, Islamabad and others (2015 SCMR 630).
FBR needs to adopt a rational audit strategy representing a new direction for its compliance effort. FBR must conduct research and planning to work out a new approach that could focus on high-risk areas of non-compliance. The audit policy of apex revenue authority must aim at new and enhanced efforts on several priority areas, including:
- High-risk, high-income taxpayers.
- Abusive schemes and promoter investigations.
- High-income non-filers.
- Unreported income.
- The National Tax Research Programme.