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Growth, broad base & low-rate taxes
Huzaima Bukhari, Dr. Ikramul Haq & Syed Muhammad Ijaz
“A comprehensive strategy had been formulated to shift the gear and move to higher economic growth. I do not believe in increase in taxes to increase revenue collection but those outside the tax net would be tapped. The chances for any harassment by FBR officials shall be eliminated for which change in audit procedures. 17 percent General Sales Tax rate is very high and a mechanism has been prepared for its reduction and the government was also working on a sales tax system for small businesses….”— Finance MinisterShaukat Tarin in his first testimony before the Standing Committee of the National Assembly on May 3, 2021.
Fiscal consolidation should be as growth-friendly as possible. In general, tax base-broadening reforms are identified as growth-oriented reforms. To the extent that they reduce distortions to economic decisions on work, saving, investment and consumption, they should increase output and improve social welfare—Choosing a Broad Base–Low Rate Approach to Taxation, OECD Tax Policy Studies No. 19
The newly-appointed Finance Minister, Shaukat Alam Ahmed Tarin has hinted for the path of growth and reforms that has been emphasised in these columns since the last two decades. It is very encouraging that we have a person now as head of economic team of the coalition Government of Pakistan Tehreek-i-Insaf (PTI) who has repeatedly highlighted the need for higher growth and resource mobilisation through low-rate taxes on the broad-based as well as correction in many other areas that are hindering growth. Mr. Shaukat Tarin while briefing the Standing Committee on Finance of National Assembly on May 3, 2021 said “the higher power tariff is leading to corruption and affecting economic growth. The conditions agreed to under the IMF programme were very harsh”. He showed determination to take alternative measures to reduce circular debt instead of tariff increases. He also emphasised that “tax net will be expanded instead of increase in taxes to achieve revenue targets”.
Mr. Shaukat Tarin revealed that the International Monetary Fund (IMF) “was being convinced to have a sympathetic view towards Pakistan after it had been hit by the third wave of coronavirus pandemic. Unless the country moved to higher economic growth, nothing would improve and if we continue with stabilisation that has been in place for over two years, neither revenue collection would go up, nor job opportunities would be available to people or productive capacity of the economy could improve, he explained”.
In this article, we are presenting for the consideration of Finance Minister and his team in Revenue & Finance Divisions, a blueprint [comprehensive presentation is shared with them before the meeting with Federation of Pakistan Chamber and Industry (FPCCI) on April 30, 2021 with Federal Board of Revenue, which was also attended by Special Adviser of Prime Minister on Revenue, Dr. Waqar Masood, Commerce Minister, Abdul Razak Dawood and few others] a complete roadmap for restructuring of tax system to move toward growth even in the most difficult circumstances in the wake of third and deadly wave of Covid-19.
Pakistan needs a simple Income Tax Act of 2021 [ITA, 2021, for which draft is already published in these columns] and single-digit Harmonised Sales Tax [HST] to tap the real tax potential and achieve the following four important objectives for long-term, sustainable, equitable and inclusive development. Most of the people, even economists, confuse “development” with “growth” that is a just a path, a means to achieve the end goal of creating a welfare society where respect for rule of law, nobody is above the law, enrichment of human capital, equal opportunities for all, is as important as physical infrastructure:
Growth;
Broad-base;
Revenue enhancement: and
Documentation
Income Tax base and its broadening
The number of “active” income tax return filers as per Active Taxpayers List (ATL) on FBR’s website [data updated every Monday], was 2,623,962 as on May 5, 2021 at the time of submitting this article. According to Press release of the FBR issued on May 1, 2021, it is mentioned: “Meanwhile, FBR’s efforts to broaden the tax base are expending apace. Early signs suggest such efforts are bearing fruits. As on 1-5-2021, income tax returns for tax year 2020 have reached 2.9 million compared to 2.6 million in tax year 2019, showing an increase of 12%. The tax deposited with returns was Rs.50.6 billion compared to only Rs.33.1 billion, showing an increase of 53%”.
The difference, according to spokesperson of FBR, “the total of returns filed for tax year 2020 (irrespective of being within time/late or payment of ATL surcharge) whereas ATL has those filed within due time or late but with payment of ATL surcharge. A difference will always be there obviously”.
However, it is a fact that the vast majority appearing in ATL shows no or negligible income just to avoid higher deduction of tax under Tenth Schedule to the Income Tax Ordinance, 2001 [“the Ordinance”].
FBR has performed extraordinarily in the most difficult circumstance and achieved above 50% growth rate in the first 10 months of the current fiscal year (FY) compared with the same period of last FY. It received kudos from the Prime Ministers and nation should be proud of the entire team in FBR Headquarters and in field formations. FBR should be given the due facilities and its officers and staff deserve the status more prestigious than Pakistan Administrative Services (PAS, erstwhile DMG) as prime agency of collection tax for the federation and federating units.
FBR has not disclosed numbers of income tax filers in Year Book: 2019-20 or thereafter in any quarterly statement or its website. According to the latest data available on the website of Pakistan Telecommunication Authority (PTA), the total number of cellular subscribers as on February 28, 2021 were 180 million (84% teledensity), out of which 95 million were 3G/4G subscribers (44.5% penetration), 2 million basic telephony users (1.3 teledensity) and 98 million broadband subscribers (45.6% penetration).
FBR should determine income tax base from the data of about 100 million unique mobile users (many have more than one number and many pre-paid and postpaid users are students or others dependent on parents or payments made by employers) using details of their calling patterns, bills, handset ownership status, assets, travel abroad, payment of utility bills, fees for children etc. All of them are paying advance adjustable income tax of 12.5% but the gap between persons subjected to withholding provisions like advance and adjustable income tax of 12.5% under section 236 of the Ordinance and filers is at least 7.2 million, if not more. Only 2.9 million returns received for tax year 2020.
The total potential of income tax is Rs. 5 trillion if filers are increase to 10 million (by compulsory registration of all as suggested in Simplification of taxes for growth—III, Business Recorder, April 2, 2021), all exemptions and tax credits are removed and agriculture income tax is also collected from the rich absentee landowners by FBR after resolutions by all the provinces under Article 144 of the Constitution of Islamic Republic of Pakistan [“the Constitution] for uniform laws and uniform rates as in the Federal Income Tax Act, 2021. All adults having mobile should be registered as taxpayers and sent text message with username and password (they can change password online) to update profile and file return, irrespective of level of income or no income. It will create National Tax Registry. The simple one-page return should be available in English and Urdu.
Present sale tax base and its broadening
Collection of sales tax at import stage in fiscal year 2019-20, was 54% of total net collection of Rs. 1596.8 billion. FBR’s Year Book: 2019-20 shows an extremely narrow sales tax base. The share of POL products alone at import stage is Rs. 231 billion of total net collection of Rs. 869 billion and under domestic net collection of Rs.720 million is Rs. 235 billion.
The total share of one item alone is Rs. 466 billion [29%]. These are official figures and details of sector-wise share in sales tax collection of top ten revenue spinners at import and domestic stage can be seen at page 18 & 19 of FBR’s Year Book: 2019-20 that exposes the claim of extraordinary performance (sic)! It also does not disclose the actual quantum of refunds blocked in income and sales tax since 2013 to show higher tax collection growth of 16% to 20%.
The World Bank in its report, Project Information Document (PID), updated on April 22, 2019, revealed that out of total 220,042 registered sales tax payers in fiscal year 2017-18 only 141,106 (64%) filed returns and 43,355 (only 20% of registered persons) paid any tax. Recent data show till March 2021 drastic decrease as total filers are about 186,000 and those who paid any tax were around 39,000.
According to ‘State of Industry Report 2020 byNational Electric Power Authority (NEPRA), the total commercial and industrial electricity connections as on June 30, 2020 are 3,716,285 and 370,640 respectively (total 4,086,925).
By excluding all not chargeable under the Act e.g. educational institutions, including deeni madrassas (religious schools), hospital/dispensaries, mosques, agricultural sector, service sector, retailers having annual bill of up to Rs. 1.2 million and cottage industries, the fair sales tax base out of 4 million commercial and industrial users comes to around 3 million. Present gap is of 2.8 million (3,000,000 minus 186,000 filers).
Sales tax coming through electricity bills as per FBR’sYear Book: 2019-20 is Rs. 91.8 billion. It was second highest after POL at Rs. 234.5 billion. The retailers pay 5% sales tax where the monthly bill amount does not exceed Rs. 20,000 and at the rate of 7.5% where the monthly bill exceeds this threshold. On unregistered additional 3% sales tax is levied. The electricity supplier is bound to deposit the amount so collected directly without adjusting any input tax.
According to Planet Retail estimates, Pakistan’s current retail market size is $152 billion. Even if we take negative effect of Covid-19 endemic and ignore entire sales for want of enforcement capacity, safe estimate will be $100 billion. By applying HST of 8%, total collection from retail sector alone comes to $8 billion. (FBR collected total sales tax of Rs. 1596 billion in 2019-20 out of total tax collection of Rs. 3998 billion). We can increase total sales tax collection on goods to Rs. 3 trillion by enrolling all the persons chargeable or not (for documentation purposes and part of National Tax Registry), to ensure compliance, documentation and reducing the rate as well as adopting the solution discussed below.
Solutions: legal provision for IT, 2021 & HST
To achieve growth, broaden the tax base, enhance revenues and implement documentation, the following changes in the Sales Tax Act, 1990 and section 99B of the Income Tax Ordinance, 2001 are proposed:
Section 3(9) & (9A) of the Sales Tax Act, 1990 should be omitted and following new subsection (9) should be inserted:
“(9) Notwithstanding anything to the contrary contained in the provisions of this Act or any other law for the time being in force, tax on persons mentioned in section 99B(2) shall be charged, levied, collected and paid as provided under rules issued under section 99B of the Income Tax Ordinance, 2001 at the rate of 5% of or at such a lower or higher rate as the National Parliament may specify by notification in official gazette.
Provided that provisions of subsection (7) of section 3 of this Act shall not be applicable, in case of persons covered under section 99B of the Income Tax Ordinance, 2001”.
In the Income Tax Ordinance, 2001, section 99B should be substituted as under:
99B. Special procedure for certain persons.–(1) “Notwithstanding anything contained in this Ordinance or any other law for the time being in force, harmonised, sales tax (HST) shall be charged, levied, collected and paid at the rate of 5% on the gross turnover (value of supply as defined in the Sales Tax Act, 1990) on 15th of every month next following the month to which such turnover relates in the case of all qualifying persons fulfilling the condition mention in subsection (5) of this section.
(2) The income tax on taxable income of the qualifying persons under the head business shall be 10%.
(3) The provisions of withholding of tax under section 147, Part “V” of Chapter X (except under section 149) and Chapter XII and provisions of Tenth Schedule shall not be applicable to persons covered under subsection(5)”.
(5) Any person to avail the benefit of this section, irrespective of any threshold or other criterion, shall have to connect with FBR’s Point of Sale (POS) system or other prescribed IT-related system and on fulfilling this condition will be registered as the “qualifying person”.
(6) There will be no audit of the qualifying persons as in their case invoice will be generated by FBR as well as pre-prepared sales tax return will be sent electronically.
(7) In exercise of powers under subsection (9) of section 3 of the Sales Tax Act, 1990 and section 99B of the Income Tax Ordinance, 2001, the Board may prescribe the rules and regulations for filing of returns and making payment and other ancillary matters for the qualifying persons.
Chapter—–
Rules for the qualifying persons under section 99B of the Income Tax Ordinance, 2001 read with section 3(9) of the Sales Tax Act, 1990.
Registration of qualifying persons.—The names and registration numbers of the qualifying persons shall be available online on the website of the Board under the title “Persons covered under section 99B and section 3(9) of the Sales Tax Act, 1990”.
Filing of monthly sales tax return etc (1) The qualifying person shall file monthly sales tax return in the prescribed manner entering the name and registration number of purchasers and make payment on monthly basis along with return on the 15th of every month next following the end of month to which such turnover (value of supply) relates.
(2) The qualifying person shall file the prescribed sales tax returns in the format provided in Annexure A below through irs portal and deposit the tax accordingly.
Filing of annual income tax return (1) The qualifying person shall file annual income tax return on the 30th September next following the tax year or within extended date as provided in the Ordinance in the prescribed manner provided in Annexure B below.
(2) The qualifying person shall file online income tax return in the format provided in Annexure B below.
Annexure A & B [These will be prepared on the same lines as available in many countries and can be just submitted through electronic signature (Digital signatures are a type of electronic signature with encrypted information that helps verify the authenticity of messages and documents)].
We need to redesign interface/screens/software and make these more interactive like popular tax filing software available in US and Canada e.g. TurboTax and H&R Block. TurboTax provides graphics and interactive screens. If we want to use any such software, first of all FBR introduce standardised forms for income payments and deductions as they use in Canada as an example, T2, T4 forms may be considered as good examples.
The second thing that FBR should do is use taxpayers as participants in cross controls. This means that when a designated tax withholding agent withholds tax, then the taxpayer should get an acknowledgement from FBR via SMS. If the taxpayer confirms that the tax has been correctly withheld via a return SMS, then it should become part of taxpayers return. At the end of the year the taxpayer would get a summarised tax return as a SMS. If the taxpayer confirms it by a SMS response then it may be accepted as an authenticated return. Mobile Apps and internet application would also be available.
The above should be finalised after taking feedback from all stakeholders, and the same then should be presented to the Finance Minister through Chairman of FBR for final approval. Through POS or other IT system, FBR will have real time entries of sales, the purchasers (all compulsorily registered appearing in Active Taxpayer Lists of Income Tax and Sales Taxes).
The technology will help even in sending prepared return and taxpayers can accept through electronic signature as such or make some changes, if they want to portray the correctness of declared version. It will reduce cost of doing business and enhance ease of doing business. The four objectives of growth, broadening of tax base, enhancement of revenue and documentation will be achieved without any hassle, removing cumbersome procedures etc. See illustrations below.
SMALL & MEDIUM CORPORATE TAX PAYERS
Illustration: commercial importer of finished goods
Imports Rs. 40,000,000
Customs duty @ 5%: A Rs. 2,000,000
Sales during the year Rs. 30,000,000
Sales tax @ 5%: B Rs. 1,500,000
LRIT Tax Return
Turnover: Rs. 30,000,000
Gross profit Rs. 6,000,000
Net profit Rs. 4,000,000
Income tax payable @20%: C Rs. 800,000
Total taxes paid A+B+C= 4,300,000
If same preposition is assumed for individual or AoP component C would be: Rs 550,000
Total in case of individual A+B+C= 4,050,000
Illustration: Wholesaler purchasing from commercial importer or manufacturer
Purchases. Rs. 40,000,000
Sales Tax @ 5%:A Rs. 2,000,000
Sales during the year Rs. 30,000,000
Sales tax @ 5%: B Rs. 1,500,000
LRIT Tax Return
Turnover: Rs. 30,000,000
Gross profit Rs. 6,000,000
Net profit Rs. 4,000,000
Income tax payable @20%: C Rs. 800,000
Total taxes paid A-B+C= 300,000
If same preposition is assumed for individual or AoP component C would be: Rs 550,000
Total in case of individual A+B+C= 50,000
Illustration: Importer cum Manufacturer
Imports Rs. 40,000,000
Customs duty @ 5%: A Rs. 2,000,000
Local purchases Rs. 20,000,000
Sales Tax @5%: B Rs. 1,000,000
Sales during the year Rs. 30,000,000
Sales tax @ 5%: C Rs. 1,500,000
LRIT Tax Return
Turnover: Rs. 30,000,000
Gross profit Rs. 6,000,000
Net profit Rs. 4,000,000
Income tax payable @20%: D Rs. 800,000
Total taxes paid A-B+C+D= 3,300,000
If same preposition is assumed for individual or AoP component C would be: Rs 550,000
Total in case of individual A-B+C+D= 3,050,000
Illustration: Professionals
Sales of services during the year Rs. 30,000,000
Sales tax @ 5%: A Rs. 1,500,000
LRIT Tax Return
Turnover: Rs. 30,000,000
Gross profit Rs. 6,000,000
Net profit Rs. 4,000,000
Income tax payable @slabs%: B Rs. 550,000
Total taxes paid A+B= 2,050,000
Illustration: Salaried Individuals
LRIT Tax Return
Salary: Rs. 4,000,000
Income tax payable @slabs%: A Rs. 550,000
Total taxes paid A = 550,000
Rates for Individuals and AOPs
Income up to Rs. 500,000 Nil
From 500,001 to 1,500,000 7.5%
From 1,500,001 to 3,000,000 Rs. 75,000 plus 15% on amount exceeding 1,500,000
From 3,000,001 to 6,000,000 Rs. 300,000 plus 25% on amount exceeding 3,000,000
6,000,001 and above Rs. 1050,000 plus 35% on amount exceeding 6,000,000
Presently FBR is getting taxes (A & B) at import stage it results in under-invoicing, misdeclarations etc., concealing of turnover, avoidance of sales tax and income tax. In this model, Government will get more tax, total documentation, growth in business due to paying taxes when sales are made and income is computed. The following rates and examples explain taxation under the proposed new tax model:
RATES OF TAXES
Rates for Individuals [Other than salaried individuals] and AOPs
Income up to Rs. 500,000 Nil
From 500,001 to 1,500,000 7.5%
From 1,500,001 to 3,000,000 Rs. 75,000 plus 15% on amount exceeding 1,500,000
From 3,000,001 to 6,000,000 Rs. 300,000 plus 25% on amount exceeding 3,000,000
6,000,001 and above Rs. 1050,000 plus 35% on amount exceeding 6,000,000
Rates for Salaried Individuals [Where salary exceeds 75% of the total income] and AOPs
Income up to Rs. 600,000 Nil
From 600,001 to 1,500,000 6%
From 1,500,001 to 3,000,000 Rs. 66,000 plus 15% on amount exceeding 1,500,000
From 3,000,001 to 6,000,000 Rs. 291,000 plus 25% on amount exceeding 3,000,000
6,000,001 and above Rs. 1041,000 plus 35% on amount exceeding 6,000,000
Rate for companies other than small companies 20%
Rate for Small Companies 18%
Companies- Manufacturer
Imports Rs. 500,000,000
Customs duty @ 5%: A Rs. 25,000,000
Local purchases Rs. 500,000,000
Sales Tax @8%: B Rs. 40,000,000
Sales during the year Rs. 900,000,000
Sales tax @ 8%: C Rs. 72,000,000
IT Tax Return
Turnover: Rs. 900,000,000
Gross profit Rs. 180,000,000
Net profit Rs. 120,000,000
Income tax payable @20%: D Rs. 24,000,000
Total taxes paid A-B+C+D= 81,000,000
If same preposition is assumed for an individual or an AoP component C would be: Rs 43,050,000
Total in case of individual A-B+C+D= 100,050,000
SMALL COMPANIES
Illustration: commercial importer of finished goods
Imports Rs. 40,000,000
Customs duty @ 5%: A Rs. 2,000,000
Sales during the year Rs. 30,000,000
Sales tax @ 8%: B Rs. 2,400,000
IT Tax Return
Turnover: Rs. 30,000,000
Gross profit Rs. 6,000,000
Net profit Rs. 4,000,000
Income tax payable @18%: C Rs. 720,000
Total taxes paid A+B+C= 5,120,000
If same preposition is assumed for individual or AoP component C would be: Rs 550,000
Total in case of individual A+B+C= 4,950,000
Small Company: Wholesaler purchasing from commercial importer or manufacturer
Purchases. Rs 40,000,000
Sales Tax @ 8%: A Rs. 3,200,000
Sales during the year Rs. 30,000,000
Sales tax @ 8%: B Rs. 2,400,000
IT Tax Return
Turnover: Rs. 30,000,000
Gross profit Rs. 6,000,000
Net profit Rs. 4,000,000
Income tax payable @18%: C Rs. 720,000
Total taxes paid A-B+C= (80,000)
If same preposition is assumed for individual or AoP component C would be: Rs 550,000
Total in case of individual A+B+C= (250,000)
Small Company: Importer cum Manufacturer
Imports Rs. 40,000,000
Customs duty @ 5%: A Rs. 2,000,000
Local purchases Rs. 20,000,000
Sales Tax @8%: B Rs. 1,600,000
Sales during the year Rs. 30,000,000
Sales tax @ 8%: C Rs. 2,400,000
IT Tax Return
Turnover: Rs. 30,000,000
Gross profit Rs. 6,000,000
Net profit Rs. 4,000,000
Income tax payable @18%: D Rs. 720,000
Total taxes paid A-B+C+D= 3,520,000
If same preposition is assumed for individual or AoP component C would be: Rs 550,000
Total in case of individual A-B+C+D= 3,350,000
Individual-non-Salaried: Professionals
IT Tax Return
Turnover: Rs. 30,000,000
Gross profit Rs. 6,000,000
Net profit Rs. 4,000,000
Income tax payable @slabs%: A Rs. 550,000
Total taxes paid A= 550,000
Salaried Individuals
IT Tax Return
Salary: Rs. 4,000,000
Income tax payable @slabs%: A Rs. 541,000
Total taxes paid A = 541,000
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The writers are lawyers and partners of Huzaima, Ikram & Ijaz. Huzaima and Ikram are adjunct faculty of Lahore University of Management Sciences (LUMS) and Syed Muhammad Ijaz is that of Beaconhouse National University (BNU).