Growth, broad base & low-rate taxes
Huzaima Bukhari, Dr. Ikramul Haq & Syed Muhammad Ijaz
“A comprehensive strategy has 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 Fayaz Ahmed Tarin has stressed upon 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 been repeatedly highlighting the need for higher growth and resource mobilisation through low-rate taxes on a broad-base. 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”. The Finance Minister expressed his determination to take alternative measures to reduce circular debt instead of tariff increases. He also emphasised that the “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”. He said that unless “the country moves to higher economic growth, nothing will 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”.
In this article, for the consideration of Finance Minister and his team, we are presenting a blueprint for restructuring of tax system to move towards growth even in the most difficult circumstances in the wake of third and deadly wave of Covid-19. It is pertinent to mention that a comprehensive presentation was shared with the Finance Minister before the meeting with Federation of Pakistan Chamber and Industry (FPCCI) on April 30, 2021 with Federal Board of Revenue (FBR). This was also attended by Special Adviser of Prime Minister on Revenue, Dr. Waqar Masood, Commerce Minister, Abdul Razak Dawood and few others.
Pakistan needs a simple Income Tax Act of 2021 [ITA, 2021]. The main features of ITA 2021 were discussed in Need for new income tax law—I, Business Recorder, March 13, 2020 and Need for new income tax law—II, Business Recorder, March 18, 2020. The draft of new income tax law was published in these columns way back in 2017 in three parts. Pakistan also needs 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 just a path, a means to achieve the end goal of creating a welfare society where respect for rule of law as nobody is above the law, enrichment of human capital, equal opportunities for all are as important as physical infrastructure:
Revenue enhancement: and
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 in numbers appearing in ATL and in Press release can be due to the fact that FBR takes total number of returns filed for tax year 2020 (irrespective of being within time/late or payment of ATL surcharge) whereas ATL shows only those who filed within due time or late but with payment of ATL surcharge. FBR must explain this difference publicly on its website as it gives a negative impression about data disclosure. 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 14% 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 due facilities. FBR’s officers and staff deserve the status more prestigious than Pakistan Administrative Services (PAS, erstwhile DMG) being prime agency for collecting tax for the federation and federating units but it is ignored by successive government.
FBR has not disclosed numbers of income tax filers in Year Book: 2019-20 or thereafter in any 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 and many pre-paid and post paid users are students or others dependent on parents or payments made by employers or foreign remittances received by them) using details of their calling patterns, bills, handset ownership status, assets, travel abroad, payment of utility bills, fees for children etc. The total collection of FBR under the head income tax in financial year 2019-20 was Rs. 1502 billion out of which withholding taxes were Rs. 1092 billion (69.5% of total collection), voluntary payments were Rs. 407 billion(25.9% of total collection) and collection out of current and arrear demand mere Rs. 61 billion (3.9% of total collection).
Dr. Waqar Masood, Special Assistant to the Prime Minister (Minister of State) on Revenue,in an interview revealed that out of total returns received at least 1.5 million declared zero or below taxable income! “Household and income expenditure survey shows 21m individuals with annual household income of Rs400,000 or more, which is in the taxable limit, we have 6.4 million NTN holders, which also shows a huge population of potential taxpayers, 5 million people are paying withholding taxes every year”, he added. In fact, 100 million unique mobile users are paying advance adjustable income tax of 12.5% but filers are only 2.9 million. It shows that the potential taxpayers are much more than the number given by Dr. Waqar Masood. FBR should disclose the total number of those filing nil or below taxable income or claiming refunds.
The total potential of income tax is Rs. 5 trillion if filers are increased 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 agricultural income tax is also collected from 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 for all kinds of income. All adults having mobiles 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.
A simple one-page return should be available in English and Urdu that can be filed through mobile application or online changing the existing format of FBR as discussed below. Those not taxable but paid any withholding tax should be given refunds.
Present sales 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 2018 by Pakistan Muslim League (Nawaz) to show higher tax collection growth of 16% to 20% by their economic wizard, Muhammad Ishaq Dar, now a fugitive, discussed in detail in FBR performance under the spotlight, Business Recorder, February 5, 2021.
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 were 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 those not chargeable under the Act e.g. educational institutions, including deeni madrassas (religious schools), hospitals/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 2 million. Present gap is of 1.9 million (2,000,000 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. 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 persons, additional 3% sales tax is levied. The electricity supplier is bound to deposit the amount so collected directly without adjusting any input tax. Thus, presently all retailers and even many not in this category but having commercial electricity connection are paying 8% or 10.5% sales tax, though not registered or if registered are filing returns without any payment.
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 persons, additional 3% sales tax is levied. The electricity supplier is bound to deposit the amount so collected directly without adjusting any input tax. Thus, presently all retailers and even many not in this category but having commercial electricity connection are paying 8% or 10.5% sales tax, though not registered or if registered are filing returns without any payment. The real challenge is how to bring retailers in tax net—all must be filing sales tax and income tax returns. We must have separate taxation provisions for SMEs having turnover up to Rs. 800 million by restoring omitted sections 113A and 113B of the Income Tax Ordinance, 2001 with modifications of low rate sales tax and income tax with condition of POS connectivity. Simple combined sales and income tax return to boost growth of SMEs and also get much higher tax we are getting now.
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 those not chargeable or not registered for want of enforcement capacity of FBR, safe estimate will be $100 billion. By applying HST of 5%, total collection from retail sector alone comes to $5 billion. (FBR collected total sales tax of Rs. 1597 billion in 2019-20 out of total tax collection of Rs. 3998 billion).
FBR can increase total sales tax collection on goods to Rs. 3 trillion by enrolling all persons, engaged in the sales and purchases of goods imported, exported, produced, manufactured or consumed import and supply of goods by restoring compulsory registration provision in the Sales Tax Act, 1990, whether 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 solutions 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) of the Sales Tax Act, 1990 should not apply if the person is covered in sub-section (9B) of the Act read with section 99B of the Income Tax Ordinance, 2001. In the Sales Tax Act, 1990 after subsection (9A) of section 3, the following new subsection shall be inserted:
“(9B) 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 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 provide.
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, sales tax shall be charged, levied, collected and paid at the rate of 5% on the value of taxable supplies as defined in the Sales Tax Act, 1990) on 15th of every month next following the month to which such tax period relates in the case of all qualifying persons fulfilling the conditions mentioned in subsection (5) of this section.
(2) The income tax on taxable income of the qualifying persons under the head business shall be as per rates provided in the First Schedule to the Ordinance with the condition that tax payable shall not exceed 15% on taxable income under the head business. In their case, section 113, 113C, section 169 and any other provision of treating minimum tax or presumptive tax to the extent of income under the head business shall not apply. Those paying 15% of tax on taxable income shall not be subject to audit. However, provisions of section 122 will applicable where definite information is available or any erroneous order is made causing loss of revenue.
(3) The provisions of withholding of tax under section 148, 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) of this section.
(5) For availing the benefits under this section, any person, 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 only after fulfilling this condition will be registered as the “qualifying person”. The names and registration numbers of all qualifying persons shall be added in the List, named, “Qualifying persons under section 99B of the Income Tax Ordinance, 2001” and it will be updated on daily basis on website of the Board. The withholding tax agents will not withhold (deduct or collect) their tax provided the name of the person is appearing in the list, “Qualifying persons under section 99B of the Income Tax Ordinance, 2001” at the time of withholding the tax.
(6) There will be no sales tax audit of the qualifying persons as in their case prescribed invoice will be generated by the system mention in this section or rules made thereunder.
(7) In exercise of powers under subsection (9B) 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 income tax and sales tax returns and making payment and other ancillary matters for the qualifying persons.
The following rules are issued in exercise of powers under subsection (9B) of section 3 of the Sales Tax Act, 1990 and section 99B of the Income Tax Ordinance, 2001.
Rules for qualifying person under section 99B of the Income Tax Ordinance, 2001
1. Registration of qualifying persons.—Anypersonwho applies and registered under section 99B(5) of the Ordinance as a qualifying person shall be included in the list of “Qualifying persons under section 99B of the Income Tax Ordinance, 2001”, available on the website of the Board.
2. Filing of monthly sales tax return etc (1) The qualifying person shall be sent pre-prepared monthly sales tax return on 5thday of every month in the prescribed manner provided in Annexure A to make payment on 15thday of every monthly next following the end of the month to which the tax period relates and submit the return by 18thday of every monthly with proof of payment online. In case of default all the provisions relating to recovery and imposition of default surcharge, penalty and prosecution provided in the Sales Tax Act, 1990 shall apply mutatis mutandis.
(2) The qualifying person shall file online income tax return in the format provided in Annexure B below. In case of default all the provisions relating to recovery and imposition of default surcharge, penalty and prosecution provided in the Income Tax Ordinance, 2001shall apply mutatis mutandis.
Annexure A & B [These will be prepared on the same lines as available in many countries and can be just submitted through digital signature (digital signature is a type of electronic signature with encrypted information that helps verify the authenticity of messages and documents].
FBR needs to redesign interface/screens/software and make these more interactive like popular tax filing software e.g. TurboTax and H&R Block. TurboTax provides graphics and interactive screens. If FBR wants to use any such software, first of all it should introduce standardised forms for income payments and deductions as they use in Canada, for example, T2, T4 forms. Simple one-page income tax return should only have five things: (i) name with CNIC/NTN number; (ii) occupation; (iii) annual gross receipts; (iv) properties/assets in his/her name; and (v) annual gross expenses including utility bills, leases, fees etc. Unless the income is “NIL” or the income is in exempt category, tax should be on fixed percentages, such as from 1% to 5%, on the annual gross receipts. An option should be given to the tax payer to either pay tax on the basis of fixed percentages or on profit and loss basis. If it is on profit and loss basis, then his/her return would be reviewed by the tax officer with all evidence. And all fixed percentages returns may be sent for audit to private chartered accountants depending on their capability. This would be a major step and it will help a lot in higher tax recovery. This will also avoid corruption.
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 via SMS. If the taxpayer confirms it by return SMS then it may be accepted as an authenticated return. Mobile Apps and internet application should also be available.
The above may 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 by the Cabinet and be made part of Finance Bill 2021. Through POS or other IT system, FBR will have knowledge of real time entries of inflows/outflows and inputs/outputs.
The above technological interventions and innovation as well as changes suggested in laws will help even in sending pre-prepared income tax and sales tax returns and taxpayers can accept through digital signature as such or make changes wherever due, if they want to portray the correctness of declared version. It will reduce cost of doing business while enhancing ease of doing business and ensuring documentation. The four objectives of growth, broadening of tax base, enhancement of revenue and documentation will be achieved without much hassle, removing cumbersome procedures and reducing cost and time of compliance.
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).