NEED FOR TAX INTELLIGENCE SYSTEM

Dr. Ikramul Haq[1]

Pakistan for the last many years has been grappling with the problem of raising revenue to survive as viable economic entity. The ever-increasing fiscal deficit, coupled with mounting debt servicing, is posing a serious threat to country’s economic revival. The economic managers have failed miserably to increase the revenue. Paradoxically, their pre-occupation with more and more revenue collection have made them neglect the infrastructures required to administer these very taxes. They are caught in a dilemma; on the one hand there is mounting pressure from IMF and other foreign institutions to lower the fiscal deficit and on the other all attempts to increase revenue from the existing taxpayers is proving detrimental to the already ailing economy.

Pakistan needs to learn from the experience of many developing countries of the world that managed to raise revenue by improving the tax administrations. In 1992, Richard M. Bird and Milka Casanegra de Jantscher presented a marvelous book Improving Tax Administrations in Developing Countries (interestingly this was IMF publication based on a conference held in Spain in 1991). Since 1992 there has been growing awareness that more efforts are required to improving existing administration if a developing country is keen to explore new sources of revenue.

The old saying “tax policy is only as good as its administration” is outdated. Today’s consensus is that “tax administration is tax policy.[1] Anyone who has worked in a tax administration of a developing country (like me in Pakistan from 1984 to 1996) can vouch for that. Many well-intention laws have been laid to rest by inefficient (which also include indifferent, corrupt and incompetent) tax administrations. Pakistan is a classical example of it. The Central Board of Revenue, apex administrative body for federal taxes, is the most apt example of an indifferent (though highly oppressive and inefficient) tax administration in the entire Third World.

Taxation requires pragmatic thinking and is most effective when developed from the practical and possible agenda for building a sound tax administration, it is necessary to start its foundation from a Tax Intelligence System (TIS). The widest possible taxpayer base has to be identified for any tax to be equitably spread across the whole taxpayer population. Even a small tax at a lower rate spread over a wide taxpayer base will invariably yield more revenue than a higher tax on a narrow base. The levy of General Sales Tax (GST) at 15% (16.5% where non-registered persons are involved) in Pakistan has failed to bring the desired results as it is a higher tax on a narrow base. Had it been a 2 to 3% levy across the board, it could have been acceptable as well as successful in terms of yielding more revenue being a low rate tax spread on a wide taxpayer base.

How Pakistan can succeed to improve revenue collection when it has no information/intelligence system/unit to maintain the taxpayer roll? The efforts through National Document Survey to build a taxpayer roll are theoretically sound, but the strategy to implement them are totally illogical and not in conformity with the ground realities of Pakistan.

The software developed by Pakistan Revenue Automation Limited (PRAL) and a company owned by a son of an ex-chairman of CBR (we Pakistanis cannot live without nepotism?) to document the data collected during the survey is highly unreliable and prone to duplications/errors. I have strong fears that the database management through it will be an utter disaster as happened in the case of NADRA.

TIS is the area that should be given the first priority in improving tax administration. As far back as 1958, Professor Stanley S. Surrey of the Harvard Law School pointed out the advantages of building up a comprehensive taxpayer roll:

            The beginning of tax administration lies in seeing that the taxpayers are on the tax rolls. Unless the tax authorities know who are the individuals or units subject to the tax, the whole machinery of administration must necessarily function with incomplete coverage of the taxable area …. The important tasks are to select among the various sources only those which promise to be productive of names likely to be taxpayers under the tax in question (thus in some places telephone books may be very useful, while elsewhere these lists may contain only more non-taxpayers than taxpayers); to gather only so much information as can be efficiently processed; and to devise an efficient system for correlating the selected information in a continuously current form usable for enforcement purposes.

Note:    The CBR has realised the importance of preparing taxpayer roll in 2000! It confirms that we are at lease 40 years behind from the rest of the world in tax administration reforms

The CBR, responsible for the collection of federal taxes, has miserably failed to introduce any Tax Intelligent computerized system, despite the fact that it has a market-wage oriented company, PRAL, at its disposal, to monitor the economic activities of corporate/business sectors. TIS, a computer-based system, has been proved useful in a number of countries as it:-

—        monitors the “large taxpayers” that is all the companies registered in a tax jurisdiction.

—        identifies the most productive centers of information from which significant data can be extracted.

—        uses simple computer technology and can be set up quickly. [In Pakistan CBR and PRAL have made very effort to make it complicated and difficult to work]

—        avoids any tax specific and can be adopted to any type of tax.

—        easily extendable to all types of taxpayers.

Tax Intelligence System (TIS) is not a new idea. It was implemented even in the countries like Botswana in the 1980s and helped in its rapid increase of diamond revenue as well as proved extremely beneficial for other areas of the economy to expand simultaneously.[2] The Tax Intelligence System concentrates on third-party information that continuously originates from different areas of the government and quasi-governmental institutions to the tax department. The Tax Department of Botswana in 1983, on the advice of IMF, revived its investigation division and the Intelligence Unit that specialized in gathering information on corporate activity. Previously all information received was maintained manually in the form of registers, as is the case in Pakistan. The problem faced by the Tax Department of Botswana was the same as is now faced by the CBR; the flood of information it was trying to process was too great and the system became to slow, prone to errors. They found an efficient way to handle it through computerization. Did IMF forget its advice to Botswana in 1980s whiled dealing with Pakistan in 2000? We have better human resource in Information Technology (IT) and yet even could not achieve what a small African State managed as early as in 1985! It is indeed shameful and eye-opener for the CBR stalwarts and wizards sitting in the Ministry of Finance.

There is an urgent need to set up TIS in Pakistan to maximize the scope the revenue collection. Its salient features inter alia to cater for:

—        a computer network for intelligence work. It should be able to record and process a large volume of information.

—        it must increase dramatically the number of new persons that should be registered as active taxpayers and who start filing tax returns and paying taxes.

—        it must expose registered taxpayers who need to be investigated.

—        its impact should reflect in the increased amount of taxes collected.

However, it should be kept in mind that the introduction of computers ispo facto will not drastically change the way present system operates. The computer system merely imitates the manual system. In Pakistan, we are still keeping record manually. This is mainly due to the fact that the programmes developed “in house” by PRAL for computerization of record are either faulty or cannot be implemented by the field staff due to absence of their skill in this area. The CBR never thought to devise an integrated programme for computerization in the tax departments. The result is that registers are still maintained, in tax circles/ departments in shabby ways.

To exploit the capabilities of the computer network fully, a completely fresh conceptualization is required in CBR and preferably not by the tax officials, but by system analysts. The knowledge of the tax officials in respect of the user requirements is to be successfully fused with the skills of the computer programmers. Independent professional programmers should be contacted and given the task of building a relational database i.e. a database in which the data relationships could be established electronically. The tax officials should be left with the task of defining the scope of the project and the method of selecting, collecting and processing the data. The main purpose of the project should be of creating a database that could record and process significant information in respect of taxpayers, both existing and prospective. It is necessary to determine what is significant and to devise a selective basis for gathering data. This approach will make the work of the CBR proactive rather than reactive.

Significant information

The problem encountered by CBR is not how to gather information or the lack of it but its abundance. Information can be gathered from many sources, e.g. the telephone directory, the list of electricity consumes, the government gazette and endless other sources including Internet. The question is: How useful are these sources? The mere fact that a person has a telephone or pays electricity or has been issued with a trading licence does not in itself determine whether that person may eventually become a taxpayer. Information should be processed on the basis of its usefulness. The information collected through National Survey for Documentation of Economy in certain areas of selected cities can be useful if processed from this perspective. Otherwise it will remain bulk of paper trash without any useful purpose. Therefore, several factors, including the following, are to be considered in order to consider it as significant:

—        Information would be most useful it if related directly to expenditure or income.

—        If it related to the ownership of commercial property, like farms, commercial vehicles, etc., there has to be an expectation that these assets would eventually produce assessable income.

—        Information would be considered significant if the time lag is short between its receipt and the consequential registration of the new taxpayer. Statutory provisions placed time limits on the power of the assessing/tax officials to impose additional liabilities on taxpayers and this meant that old information soon loses its usefulness.

—        Information collected is also needed to have at least the following components:

            —        a name (and if possible the address) of a person;

            —        a description of the type of transaction i.e. whether purchase or sale or a record of the ownership of property;

            —        the date of the transaction;

            —        a description of the property or the service that was transacted e.g., house property, contract payments;

            —        a monetary value above a stipulated threshold, depending on the type of property or service.

The objective

The objectives in setting up the database should be:

—        to record the “significant” financial transactions that are entered into by companies during a tax year;

—        to consolidate into one record all the information from different sources relating to one taxpayer/person according to tax years;

—        to send a consolidated report to the field officer in the tax division at the end of the tax year or during the relevant period.

—        to provide quarterly and annual reports to senior managers (e.g. commissioners/collectors of the data recorded and processed;

—        to be flexible enough to provide special reports on an ad hoc basis.

The use of “exincome” flows

A concept of expenditure-income (“exincome”) flows (see Annexure A) should be developed to create a system that can collect and process information needed by field formations rather than work with what they passively received. The concept of flows of income, capital, goods, services, etc. within an economy is common in economic theory. It is the basis of the value added tax system, whereas in Pakistan we are implementing it without the support of reliable Tax Intelligence system. Goods and services are monitored as they flow from one person to another and one person’s expenditure becomes another’s income. This concept is at the core of building Tax Intelligence system (TIS).

For intelligence purposes whether the expenditure or income (exincome) of a revenue or capital nature is not significant. What is important is the ability to trace one person’s income from another’s expenditure or vice versa by identifying both sides of a financial transaction. These flows could be recorded by monitoring streams of activity like that which cascades from governmental capital expenditure down to private contractors, subcontractors, employees, wholesalers, importers and finally out of the country to foreign suppliers. Once the main flows of exincome in the economy are identified it is possible to select points at which the information relating to persons and their transactions in that flow could be gathered.

In Pakistan the major flows are relatively easy to map, as its main source of economic activity is “imports”. The flow of “imports” can be monitored through the computerization of all points of customs where “imports” are handled. Once the exincome stream reaches the contractors, it is a little more difficult to trace. It spreads out through many channels in a wide delta of economic activity. Tax Intelligence system should be able to track some sections of this flow by examining the records of government departments and other large institutions, for which statutory amendments are required in various laws, especially the Banking Laws protecting even criminal financial transactions.

From the Department of Customs and Excise, it is possible to monitor the imports of goods that enter the country and travel up this delta to wholesalers and retailers that service the large pool of householders and others that are active in the economy. Intangible imports such as management or professional services by offshore companies can also be traced independently through bank records wherever necessary.

Income flowing into the hands of employees can be recorded through the Tax Withholding System. Other centres of information like that of the Registrar of Motor Vehicles, the Registrar of Deeds, and various agricultural authorities and boards set up by government, can provide information to track rental, transport or agricultural exincome that are not part of the major flows. Information in respect of offshore transactions and suppliers could be accessed using double tax agreements where possible and appropriate.

One important feature of the Tax Intelligence System should be its recognition of exincome flows. Under the existing system, each piece of information received is followed up without checking whether the data is significant. This is a reactive approach that leads to an enormous amount of unsolicited, uncontrollable and unmanageable work. Once the main sources of exincome are identified the scarce resources of the CBR can be deployed fruitfully in areas that have the greatest chance of producing positive results. For example I have detected tax frauds by big multinational companies in Pakistan by using ‘transfer pricing’ mechanism that can yield tax worth billion of rupees. The CBR is only chasing small traders and has neither will nor expertise to unearth such sophisticated tax fraud cases. The IMF is also not very keen to help Pakistan to expose their favourite transnational companies (TNCs), which are inflicting colossal revenue loss to Pakistan. The IMF wizards are suggesting increase in POL prices to force our domestic industry to close or become uncompetitive in export markets. This is a conspiracy against Pakistan. I am willing to expose tax fraud committed by such TNCs and can also help to recover tax worth billion of rupees avoided by the beneficiaries of loan write offs. But is CBR and State willing to tax the big fish and plunderers of national wealth? They have been set “freed” on good promises of not becoming a threat to certain forces of status quo. Is tax measures are only for the poor and the helpless masses? Why the mighty people in civil-military bureaucracy and big absentee landlords have not been brought into tax net for their enormous tax-free incomes?

Data types

Under the proposed TIS two types of data is to be recognized:

—        Permanent or core data that describe the taxpayer and its activities, for example the name of the company and its business, the address, the type of business licence held etc.

—        Periodically recurrent data in respect of the transactions of a company and other classes of taxpayers in terms of income earned, assets acquired and expenditure or liability incurred.

This information, when correlated annually, can give a clearer picture as to whether the person should be registered as a taxpayer or be investigated for any tax fraud.

The functional design

The new database should have a very simple functional design. The system must be designed around the following two major files:

The core file

The core information regarding a company or a business extracted from the Registrar of Companies of Firms should be maintained in a database in which data are entered only once. Any subsequent changes need to be made through approved procedures. This database must contain permanent information such as the name, incorporation and tax numbers, and address of the company/ business.

The transaction file

The other file should be the transaction file, which captures the constant flow of information that comes in respect of the activities of the companies/business. The transaction file must relate to the company/business file through a business or an incorporation number. Details of all transactions that can be captured through generic fields common to all sources of information e.g. the monetary value, whether it is a purchase or sale, the date of the transaction, the type of property, and the exact description of the property. Each source of information from which this data emanates should be coded so that the transactions can be traced to the original source. For example, different codes can be used to distinguish information from the Registrar of Lands from that of the Registrar of Motor Vehicles.

The advantages of the system

The advantages of the TIS can be:

—        Simple to use. Once the major flows of exincome in the economy have been identified and the information centers/sources selected, then the main task is to see:

            —        that all the information is in fact transmitted from the different sources of information and is entered in the transaction file; and

            —        the company and business files are kept updated.

—        New sources of information can be easily added on to the system.

—        “Referencing” and cross-verification are done electronically.

—        Information can be recorded and processed quickly. One of the problems of CBR is that by the time information reaches the assessing/tax officer and is acted upon, the business has often closed down or the owners have sold up and left the country or the year of assessment has become statute barred. The speed of TIS can make it possible to track non-filers while they are still actively engaged in business.

—        Data capture errors are minimized. The fact that the core information is entered only once minimizes input errors, especially duplications; there are fewer chances for data corruption.

—        The system is developed for a network. More staff can be engaged to enter data simultaneously thus speeding up the process; unlike the manual system in which only one person could use a register or the master taxpayer index at any given time.

—        Officers can be trained to use the system in a relatively short period of time.

—        It increases the skill levels of officers and so their efficiency. Junior officers can attain high skill levels that no only enable them to track non-filers but also to identify taxpayers that merit investigation or audit.

—        A variety of reports can be obtained on a periodic as well as on a ad hoc basis to reflect the amount of data recorded and processed. Reports can also be obtained to monitor the extra tax collected as a result of the information that has been processed, e.g. the amount of tax that the new taxpayers will be paying in their first year of registration.

—        The cost of setting up the system is comparatively low while the cost benefit ratio is high. The entire development can be accomplished with local funds without requesting aid from donor agencies.

Conclusion

Carlos A. Silvani in his famous book Improving Tax Compliance in Improving Tax Administration in Developing Countries, edited by Richard M. Bird and Milka Casanegra de Jantscher, (1992) at page 274, has identified four key groups which cause shortfalls in tax administrations.

1.         Unregistered taxpayers — The gap between the potential taxpayers and the registered taxpayers.

2.         Stopfiling taxpayers — The difference between registered taxpayers and those who file returns.

3.         Tax evaders — The difference between the tax reported by the taxpayers and the potential tax according to the law.

4.         Delinquent taxpayers — The difference between the taxes assessed and the taxes paid.

The proposed Tax Intelligence System (TIS) can be used by CBR to alleviate some of the problems associated with revenue shortfalls in Pakistan due to above-mentioned reasons.

Unregistered taxpayers can easily be located and those most likely to become regular taxpayers can be selected and followed up. Stopfilers can be encouraged to file returns by issuing or threatening to issue fairly accurate estimated assessments on their income based on reliable information available in the database. Estimated assessments can often be wild “top of the hat” estimates that are not taken seriously by the taxpayers. If the estimates are too high the taxpayer is too overwhelmed to respond. If they too low the taxpayer would rather pay the tax than file returns. Near accurate estimates send a clear message to taxpayers that the Tax Department has reliable information on their activities and could take sterner action if the default continues. In Pakistan, our tax officials are doing just the opposite and the entire tax system is discredited.

Tax evaders can be quickly detected if investigation division is able to assess and collect large amounts of additional taxes by detecting:

—        companies and other persons engaged in land sale; and

—        companies that are overpricing imports.

TIS can come in useful when delinquent taxpayers do not pay their taxes. The availability of current up-to-date information can assist seizure of assets or income in extreme cases of default.

Investment in microcomputers is extremely cost effective. In the first year of operation the cost will be recovered. The increase in taxes from new taxpayers and from the new investigation cases will justified the initial investment. There is no doubt that recent innovations in microcomputers technology have made the goal of achieving reasonably effective tax administrations attainable in developing countries, like Pakistan. However a word of caution is necessary. Current and accurate third party information is a powerful tool in the hands of the tax administration, yet in the final analysis even the best of tools are only as effective as the person who uses them. Once computer systems are introduced, sufficient resources would be needed in training the officers who are expected to use them. The potential of new computer-based TIS can only be fully exploited when motivated and trained staff uses it. The CBR must, therefore, prepare an integrated system and not piecemeal efforts here and there, which are being done these days by so-called foreign consultants, retired IMF, World Bank people who have neither competence in taxation nor insight into our mundane realities to suggest any workable solutions.

Annex ‘A’:Exincome Flows

			Imports/supplies
				Double tax agreements

 

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[1] Stanley S. Surrey, “Tax Administration in underdeveloped countries”, University of Miami Law Review, xii (winter 1958) at 158-88. Stanley S. Surrey at that time was the professor of law and international programme in taxation, Harvard Law School.

[2] Botswana’s New Corporate Tax Intelligence System by K.L. De Silva, Bulletin (official Journal of the International Fiscal Association) Volume 53, Number 7, 1999 (page 302).

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Dr. Ikramul Haq, a leading international tax counsel, is a well-known author specialising in international tax, human rights, press, intellectual property, corporate and constitutional laws. He served for 12 years as Deputy Commissioner of Income Tax. He has written many books on various aspects of Pakistani law. He has been awarded Doctorate of Law for his research: Tax Reform in Quasi-Constitutional Perspective.