SMEs, EODB & tax reforms

Huzaima Bukhari & Dr. Ikramul Haq

“The small and medium enterprises (SME) sector contributes 30% to the national gross domestic product (GDP) and it comprises 90% of all enterprises in the country. 80 percent of non-agricultural jobs are being provided by the SME sector, however, the sector get only 7.5% of all financing in the country—Hammad Azhar, Minister for Economic Affairs  

The observations by Federal Minister for Economic Affairs, Hammad Azhar, regarding pivotal position of small and medium enterprises (SME) sector in economy and non-availability of finance (only 7.5%) to it, as well as difficulties faced on tax and other fronts, need serious consideration by the Government of Pakistan Tehreek-i-Insaf (PTI), State Bank of Pakistan (SBP), Federal Board of Revenue (FBR) and other concerned departments/agencies. While mentioning that Pakistan’s ease of doing business (EODB) ranking jumped by 28 places in the World Bank’s doing business index, Mr. Hammad Azhar expressed a hope that by the next year it would further improve. The Minister was addressing a two-day seminar, titled “Pakistan Innovating Finance Forum”, organised by Karandaaz and the Asian Development Bank (ADB) on November 26-27, 2019.

Mr. Hammad Azhar claimed that “since the index gauged the performance till April, there was hope that the ranking would improve equally or even more rapidly next year because of a number of reforms undertaken in the area of taxation and other related sectors in the budget for fiscal year 2019-20”.

It may be recalled that Pakistan carried out six reforms that helped improving its ranking from 136 to 108, according to the World Bank’s annual flagship report, ‘Ease of Doing Business 2020’, released on October 24, 2019. According to the World Bank (WB) Country Director for Pakistan, Illango Patchamuthu, this rise was significant and made possible “by collective and coordinated actions of the federal government and provincial governments of Sindh and Punjab over the past year”. In Punjab, the improvement was largely because of the work done by the last government of the Pakistan Muslim League [Nawaz] that computerized huge land record. This fact is intentionally not acknowledged by the PTI ministers, including Hammad Azhar.

It may be highlighted that Pakistan’s ranking on enforcing contracts remained unchanged at 156 and dropped on getting credit by seven spots to 119. Similarly, on protecting minority rights, its ranking slipped by 2 points to 28 and dropped on resolving insolvency by 5 spots to 58. It was admitted by Abdul Razak Dawood, Advisor to Prime Minister for Commerce, Textile, Industry and Production, and Investment of Pakistan, that there were still a lot of areas where Pakistan needs improvement. He added: “We still have to end superfluous rules and procedures”. He said that there was a need “to bring Balochistan and Khyber Pakhtunkhwa provinces in the fold of the EODB aimed at bringing improvement there before attracting new investments”.

Pakistan made biggest gain on the indicator of starting a business where its ranking improved by 58 spots to 72. The earlier ranking was 130. On the index of construction permits, the position improved from 116 to 112—a big gain of 54 points within a year. Similarly, on the indicator of registering a property, the ranking was improved by 10 points to 151. Karachi made property registration faster by making it easier to execute and register a deed at the Office of the Sub-Registrar. Lahore made registering property easier by increasing the transparency of the land administration system.

Improvement in index ranking is just one aspect of an overall business environment that does not fully guarantee the foreign investment. For that there is need for consistency in economic and taxation policies and economic political stability in Pakistan.

The Minister for Economic Affairs candidly admitted that the share of credit received by the SME sector reduced from 15% to only 7.5%. He, however, expressed the determination of the Government of PTI “to increase the SME share up to 17% by 2023”. He said that the Government of PTI had already engaged the Small and Medium Enterprises Development Authority (SMEDA) “for framing a new policy, which would address the challenges faced by the SME sector”. The Minister did not mention the fact that for the last seven months, SMEDA is working without Chief Executive Officer (CEO). On the one hand PTI Government calls SME sector as backbone of the economy and on the other callously running the SMEDA without CEO. At the beginning of this month, the President of Union of Small and Medium Enterprises reminded Abdul Razak Dawood that “we have been badly affected by the slow pace of work by the Ministry of Industries and Production”.

While Prime Minister in meetings with his economic team emphasises the growth of SME sector and says “it is on top of my agenda”, he is unaware of realities on grounds. He has no empirical study to assess the likely impact of China Pakistan Economic Corridor (CPEC) on the SME sector and how to best utilise it. The PTI has yet not announced the much awaited and promised SME Policy despite lapse of many months thus challenging faced by the sector remain unaddressed.

The best advice in the two-day event came from the United Nations Secretary General’s Special Advocate for Inclusive Finance for Development, Queen Maxima of the Netherlands, who emphasised that “financial inclusion was pivotal for the development of Pakistan, which would create more opportunities for the people”. She added: “Women and the poor segment of Pakistan have great potential to reap benefits of financial inclusion and digitization in the country”. She told the audience that a 2017 survey showed that Pakistan had made remarkable improvement as its financial inclusion had expanded from 13% in 2014 to 21% in 2017. Queen Maxima pointed out that the UN administration had welcomed Pakistan government’s efforts for expanding financial inclusion. She also welcomed Pakistan government’s efforts to formulate a revised policy to achieve goals of financial inclusion by 2023.

Later, the Queen Maxima witnessed a signing ceremony for a micropayment gateway. Economic Affairs Minister, Hammad Azhar, State Bank Governor, Reza Baqir, Syed Ali Mahmood of Pakistan Bill Melinda Gates Foundation and a representative of British aid-agency DFID were present on the occasion. The agreement on micro-payment gateway was signed between the SBP and Karandaaz, according to which a new system would help in resolving the complexities of financial transfers and reduce the time and cost of cash transfers.

It is worthwhile to mention that on the index of paying taxes under WB ‘Ease of Doing Business 2020’, Pakistan’s ranking improved by 12 points to 161. But it was still the poorest ranking that Pakistan obtained on any indicator. It exposes the tall claims of FBR and provincial tax agencies of undertaking reforms towards ease of doing business. Pakistan have made some efforts for paying taxes easier by introducing online payment modules for value-added tax and corporate income tax, and less costly by reducing the corporate income tax rate—it is still higher and must be 20%. In budget 2019-20, the PTI Government capped it at 29% though promise by PMLN was one percent reduction every year.

The country also got a jump of 31 positions on the rank of trading across border where its standing improved from 142 to 111. Pakistan made trading across borders easier by enhancing the integration of various agencies in the Web-Based One Customs (WEBOC) electronic system and coordinating joint physical inspections at the port.

While speaking on the event, the Chairman of FBR, Syed Muhammad Shabbar Zaidi, said: “The basic reason behind the small share in financial credit for the SME sector was that a large portion of the sector was not documented and was reluctant to come under the tax system”. He confessed that there was a trust gap between the government and the SME sector, adding that the SMEs had a mindset that “if I am an SME, then I must not be under the tax net”. He was not right in levelling this accusation. The fact is that the entire SME sector is paying advance income tax through electricity and mobile bills and number is as high three million. This shows the shallow understanding of Chairman FBR about SME sector paying taxes at source. Majority of businesses in SME sector earn below taxable income yet they are subjected to withholding taxes and since they do not file tax returns as procedure is cumbersome [ for them we must introduce single-page return in English, Urdu and regional languages], this becomes final liability—a heavy cost to run the business. The Chairman FBR has not disclose what plans he has to create a tax-friendly environment for the SME sector.

Mr. Shabbar Zaidi, Dr. Abdul Hafeez Shaik and their team members in FBR must remember that taxation, besides providing resources to governments to run their affairs, should serve as a catalyst for industrial expansion and economic growth in which SME sector plays the key role.

In Pakistan the ill-directed, illogical, regressive and unfair tax policies, laws, regulations and procedures are causing a dampening effect on the industrial and business growth and hurting the SME sector especially after heavy interest rate under tight monetary policy of State Bank of Pakistan. The sole stress on meeting revenue targets, without evaluating its impact on the SME sector and on overall economy, has badly crippled our trade and industry. Since we have started submitting completely before the dictates of the foreign donors, things have deteriorated instead of improving. It is impossible to enhance revenues with stagnation in economy, and over-taxing an ailing economy is a recipe for disaster. Had the successive governments concentrated on economic growth and industrial expansion, there would have been consequential significant rise in taxes.

The biggest challenges faced by us are facilitating SMEs through simplification of tax codes/rules/procedure and creating ease of doing business as well as reducing cost of doing business. However, the federal and provincial tax authorities are working in totally opposite direction. On this issue alone we have written dozens of articles as to hoe achieve the twin goals of ease of doing business and cost of doing business. We not only need simplification of tax codes, rules and procedures but at operation level, a user-friendly, competent, firm, transparent and efficient tax apparatus.

Though the World Bank, DFID, and other donors gave a lot of money in the past to Pakistan, yet things have changed only for the worse. Now a new loan of US$ 400 is given by World Bank for what is called Pakistan Raises Revenue (PRR)  programme 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”. The lion’s share of this huge money will go in the pockets of so-called foreign experts who have no idea of our mundane realities, rest will be wasted by untrained workforce we have in all tax agencies at federal and provincial levels.

There is yet no research-based study available with World Bank for improving tax administrations at all levels and growth-oriented tax reform agenda. The World Bank in Pakistan Revenue Mobilisation Project has not shown any indication of taxing the rich though noted as under:

Pakistan’s tax revenue potential would reach 26 percent of GDP, if tax compliance were to be raised to 75 percent, which is a realistic level of compliance for LMICs. This means that the country’s tax authorities are currently capturing only half of this revenue potential, i.e. the gap between actual and potential receipts is 50 percent. The size of the tax gap varies by tax instrument and by sector. The tax gap in the services sector is larger than in the manufacturing sector (67 percent vs. 46 percent respectively) and it is larger for the GST/GSTS than for income tax (65 percent vs. 57 percent respectively). 

Our studies have been intentionally ignored and preference is given to foreign experts (sic) who borrowed many of our ideas, e.g. single national tax agency and harmonised sales tax on goods and service etc, without acknowledging that is height of intellectual dishonesty! The following are some of our studies/articles—a few articles coauthored with Dr. Muhammad Babar Chohan, Additional Commissioner, FBR, holding PhD in Economic Planning from Massey University, New Zealand:

Towards Flat, Low-rate, Broad and Predictable Taxes [PRIME Institute, Islamabad, 2016], Essential reforms, Business Recorder, March 29, 2019, Challenges for budget-makers, Business Recorder, March 22, 2019, Optimising tax collection, Business Recorder, March 15, 2019, Fixing the ailing tax system, Business Recorder, March 1, 2019, Country needs massive reforms, Business Recorder, January 25, 2019, Time up for fiscal integration, Business Recorder, December 21 & 23, 2018, Tax policy for investment, Business Recorder, December 14, 2018, Productive tax reforms , Business Recorder, October 27, 2018, Overcoming fragmented tax system, Business Recorder, October 19, 2018, PTI & revival of economy, Business Recorder, October 12, 2018, Bridging the tax gap, Business Recorder, October 5 & 7, 2018, Case for All-Pakistan Unified Tax Service: PTI & innovative tax reforms, Business Recorder, August 31, 2018, Overcoming debt burden, Business Recorder, August 27, 2018 and PTI and tax reforms, Business Recorder, August 17, 2018.

The PTI Government instead of considering and debating our studies and suggestions and many others presented by local experts, improving capacity to detect tax evaders through a Tax Intelligence System, decided to impose more tax obligations on withholding agents.  Everyone knows that fault lies with the people who are implementing laws. If we want to improve tax compliance, pragmatic reforms are the need in all areas and at all levels. Successful models of various countries should be studied, debated and adapted after making necessary changes to suit our peculiar conditions.

The only way to facilitate SMEs, check massive evasion in customs, income tax and sales tax is implementing an integrated Tax Intelligence System and complete automation, which are capable of recording, storing and cross-matching all inflows and outflows. All in-bound and out-bound containers should be scanned/x-rayed to check evasion of customs duties and taxes payable at source. However, no reform agenda can succeed unless tax administrations are restructured, well-equipped, well-paid and staff is highly-qualified and properly trained. All tax administration should be insulated from outside pressures.

After restructuring the FBR and other tax apparatuses at all levels, the nation must debate to implement simple, fair and efficient tax systems. To start with FBR, the existing complex tax codes, rules and procedures should be replaced to facilitate SMEs and big businesses. The following points needs to be debated to reach a consensus for an effective voluntary tax compliance regime with strong deterrence to punish the avoiders and evaders and not squeezing the existing honest taxpayers:

1. Simple and fair tax system containing:
   1. 10% tax on individuals for all kinds of incomes with alternate minimum tax of 2% on net wealth exceeding Rs. 20 million
   1. 20% tax on companies and other entities
   1. 8% harmonised sales tax (HST) on all goods and services, except exporters with 0% rate
   1. 5% customs duty on all items, exporters to get refund once export proceeds are realised by State Bank
   1. Reconstruction of National Tax Tribunal [Draft law on National Tax Tribunal Business Recorder, November 3, 2017.]
   1. Establishment of single tax agency to collect taxes at all levels [A case for National Tax Authority, Business Recorder, November 30, 2018]
2. Action Plan for collection of Rs. 8 trillion [Productive tax reforms, Business Recorder, October 27, 2018]
3. Expeditious disposal of tax cases
4. Making FBR an effective and professional institution [Case for All-Pakistan Unified Tax Service: PTI & innovative tax reforms, Business Recorder, August 31, 2018]
5. Amending section 6 of Federal Board of Revenue Act, 2005 to make Policy Board an effective body
6. Filing of returns/assessments of all the persons who have taxable income
7. Registered companies as per SECP’s record are over 90, 000 whereas income tax returns are filed by less than 50%. All companies that have not filed returns should be issued notices and assessments should be finalised
8. Retrieval of tax loss by taking action against the beneficiaries of loan-write offs under the law [Explanation to section 18(1)(d) of the Income Tax Ordinance, 2001]
9. Recouping of sales tax losses due to under-invoicing and under-reporting
10. Recouping of tax losses on account of transfer pricing
11. Scanning and X-raying of each and every incoming and outgoing container
12. Recouping of loss of customs duty by tracking down under-invoicing through data/information matching. Once this is done the IRS should recover evaded sales tax and income tax.
13. Crackdown on smuggled goods.

To achieve the above goals and objectives, especially brining SMEs in tax net, we need major information technology and human resource improvements in all tax administrations. Tax reforms are meaningless without an effective tax administration that can counter tax avoidance and evasion but at the same time help and facilitate the taxpayers.  

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The writers, lawyers and authors, are Adjunct Faculty at Lahore University of Management Sciences (LUMS)