Thursday, 28 April 2011 18:18
TEXT: The following Proposals for the Federal Budget 2011-12 have been prepared by Taxation Committee of Institute of Chartered Accountants of Pakistan (ICAP) for the consideration of legislators, and policy-makers at Ministry of Finance and FBR:
1 TAX POLICY
1.1 RATE OF CORPORATE TAX AND REGIONAL COMPARISON
As a measure of policy, the rate of Corporate Tax has been substantially reduced over the decade. This is a correct policy. Rate of income tax for all corporate entities is now 35 percent, which requires reconsideration after taking into account the following factors:
1.1.1 Regional comparison with the economies having characteristics similar to Pakistan The present Corporate Tax rate of 35 percent is the highest in the entire region.
China, which provides reasonable opportunities for the establishment of manufacturing sector, operates with the rate of tax of around 15 to 20 percent. This is effectively a disincentive for locating their manufacturing base in Pakistan for multinational groups.
India, Bangladesh, Malaysia and Thailand have also brought down their corporate rate of tax to around 30 percent.
There are, even, cases where the rate has been brought down to 25 to 28 percent. This level is by and large in line with almost all the OECD member countries where the rate of corporate tax is around 28 percent.
UAE presents another extreme where there is, effectively, nil corporate tax.
The rate of corporate tax throughout the developed world has been brought down below 30 per cent. Pakistan is a place where income is taxed at a substantially higher rate than the rate applicable to head office of a multinational group. This is considered a bad omen for tax planning.
1.1.2 The effect of presumptive taxation system on the general corporate taxation
In Pakistan taxation system has introduced the concept of presumptive taxation. Prevalence of such system distorts the comparative taxation of such businesses which are organised and generally fall under the normal taxation system.
1.1 Effect of a lower tax rate for other entities
In Pakistan a reduced Corporate Tax rate of 25% is applicable for small companies and Association of Persons and for Individuals at slabs with maximum rate of 25%. This differential is discouraging expansion of companies and conversion of businesses from association of persons and individual to an organized and documented corporate structure.
1.1.4 Cost of doing business
Corporate sector being a withholding agent has to incur a huge cost to maintain and submit the details of the tax collected or deducted at source. Further the corporate sector also has to bear the extra burden of the amount of tax collected or deducted at source towards the cost of purchases and expenditures.
The rate of corporate tax for Public and Private Companies in Pakistan should be gradually reduced to bring it at par with other competitive economies and to provide incentive for formation of organized and documented sector.
1.2 TAX CREDIT FOR ENLISTMENT ON A STOCK EXCHANGE IN PAKISTAN-SECTION 65C
One time tax credit equal to 5% of the tax payable is available to company in the year in which it is listed on any registered Stock Exchange in Pakistan. The amount of this tax credit equal to 5% of the tax payable (effective tax rate stands reduced to 33.25% from 35%) and that too for only one year is too small to attract listing of companies on a Stock Exchange.
The amount of this tax credit needs to be raised to at least 15% of the tax payable, which will mean an effective tax rate of 30% instead of 35%. Moreover, the tax credit should be for at least the first five years of enlistment.
1.3 NON-SALARIED PERSON TAX RATE
Discrimination of salaried and non-salaried persons by providing for separate tax rates is against the norms of personal taxation. This clearly indicates that the law itself admits that non-salaried persons understate their income.
It is very odd that:
A salaried person attracts the maximum tax rate of 20% where the income exceeds Rs 4,550,000 as compared to a non-salaried person who attracts the maximum tax rate of 25% where the income exceeds Rs 1,500,000; A salaried person is allowed a marginal relief where the income marginally exceeds from a particular slab of income and tax thereon whereas a non-salaried person is not allowed any such relief.
Huge gap in maximum tax rate should be narrowed by expanding the non-salaried tax bands so that the maximum tax rate of 25% starts at least from income above Rs 3,000,000. Non-salaried persons should also be allowed to claim marginal relief where the income marginally exceeds from a particular slab of income and thereon.
1.4 PERSONAL TAXATION - RATE AND BASIS OF CALCULATION
The general rate of personal taxation has been brought down over the years, however, on account of abolition of exemption for non-taxable perquisites the effective rate has remained almost the same. Even in the past there were very few cases where effective rate exceeded the maximum rate of 20 per cent.
All the progressive tax regimes provide possibilities for tax planning for personal taxation if the same is in line with the overall economic priorities of the government. Such opportunities are provided by way of: availability of investment allowance for equity investment; and tax credit for interest on house mortgage, etc.
However, this needs to be rationalised by providing for following further incentives: 1.4.1 Tax Credit for Certain Personal Expenses
In Pakistan, there is a need to incorporate planning mechanism that simultaneously encourages documentation and assist in bringing untaxed services sector into tax net. This requires introduction of 'tax credit' against personal taxation on submission of evidences of expenses incurred on:
-- education of children
Such a credit will provide incentive for the user of such services in obtaining evidences for payments. That will in turn induce the recipient to be within the documented sector. Like other measures, this system had also been introduced in the past however, due to procedural difficulties and lack of will by the tax executives, positive results could not be achieved.
Tax Credit for personal expenditure on medical and education of children should be introduced with the only condition of submission of evidence of payment with full particulars of the payee.
1.4.2 Tax Credit for Life Insurance Premiums
A tax relief on Life Insurance Policies Premiums was allowed in the past to help the industry and the economy grow.
This was also permitted under Section 39 of the Income Tax Ordinance 1979 but was later withdrawn through Finance Act 1991.
Most saving instruments such as mutual funds, bank deposits are designed for short-term savings. Life insurance and pension plans are the only segments of financial services that address the needs of individuals in the long-term. Successive governments have applied different forms of tax-incentives to promote savings but there has been no significant support in tax policy to actively encourage long-term savings.
It is pertinent to mention that tax incentives are available on other financial savings instruments such as contributions to Mutual Funds and Voluntary Pension System. Therefore, similar incentives are also needed on Life insurance / Takaful business.
Tax incentive on Life Insurance premiums and contributions towards Takaful will strengthen the Life insurance and Takaful business thereby increasing insurance penetration, which is lowest in the region, and actively encourage long-term savings that would promote economic development of the country.
Tax Credit for Life Insurance Premiums paid and contributions towards Takaful should be introduced to promote long-term savings.
1.5 ASSOCIATION OF PERSONS
Through Finance Act, 2010, tax at a flat rate of 25% without any "zero" tax threshold was introduced w.e.f. tax year 2010 for an association of persons as against the incremental slab rates with "zero" tax threshold of Rs 100,000 earlier applicable. This will serve as an incentive to convert an association
of persons to a corporate structure.
In fact, the incentive to convert an association of persons to a corporate structure is further strengthened in terms of effective tax rate since a 'small company' is entitled to deduct Directors Remuneration/Salary in determining the taxable income and reducing effective tax rate on taxable income before such deduction, whereas an 'association of persons' is not entitled to deduct the Partners/Members Remuneration/Salary and will be subject to an effective tax rate of 25%.
However, small and medium sized association of persons which for many other reasons could not convert to a corporate structure and association of persons of professionals like engineers, architects, lawyers, chartered accountants, doctors, etc which by their governing statute are not permitted to carry on the profession in a corporate structure are hard hit by this abrupt increase of flat rate of tax of 25% on taxable income as is evident from the following table:
Income Tax Payable Increase
(Rupees) After Amount
(Rupees) Before (Rupees) Amendment Percentage
Amendment (Rupees) (Rupees)
100,000 Nil 25,000 25,000 Infinite
110,000 550 27,500 26,950 4,900%
125,000 1,250 31,250 30,000 2,400%
150,000 3,000 37,500 34,500 1,150%
175,000 5,250 43,750 38,500 733%
200,000 8,000 50,000 42,000 525%
300,000 15,000 75,000 60,000 400%
400,000 30,000 100,000 70,000 233%
500,000 50,000 125,000 75,000 150%
600,000 75,000 150,000 75,000 100%
800,000 120,000 200,000 80,000 67%
1,000,000 175,000 250,000 75,000 43%
Rationalising of this abrupt increase in tax rate by introduction of incremental tax rates to cater for small and medium sized association of persons; Re-introduction of the concept of no tax on the association of persons of professionals by restoring the amendments and omissions made in section 92 and 93 through Finance Act, 2007 to cater for the association of persons of professionals which by their governing statute are not permitted to carry on the profession in a corporate structure; Alternatively, Salary paid to the members of association of persons of professionals should be made tax deductible expenditure by making suitable amendments in section 21(j).
1.6 SMALL COMPANY
The benefits of a small company are available to only those companies which are incorporated on or after July, 01, 2005. This has placed small companies formed earlier at a disadvantageous position to meet the tax differential of 10%.
The concept of 'Small Company' was introduced in 2005 with a reduced rate of tax and exemption from being a withholding agent under section 153 of the Income Tax Ordinance, 2001 as applicable to the non-corporate sector, in order to provide an incentive for businesses conducted in the status of 'individual' and 'association of persons' to convert themselves into corporate structure and be a part of organised and documented sector without any tax burden.
Later, the exemption from being a withholding agent in case of small company was withdrawn and on the other hand associations of persons / individual with turnover exceeding fifty million rupees were also made a withholding agent under section 153.
The incentive for converting an association of persons to a corporate structure has been further strengthened with the introduction flat rate of tax of 25% on taxable income of an association of persons without any deduction on account of partners/members remuneration as against an effective lower tax rate available to a small company by way of deduction of directors remuneration.
At present the only disadvantage for converting an association of persons to a corporate structure is the threshold of the turnover of 50 million available to an association of persons for the purposes of withholding tax under section 153.
Recommendations: The benefit of small company be extended to companies incorporated before July 01, 2005; and Small Company to be brought at par with an association of persons and individuals by providing the threshold of turnover of Rs 50 million for the purposes of withholding agent under section 153.
1.7 MINIMUM TAX (TAX ON TURNOVER) - SECTION 113 Through Finance Act, 2010 the rate of minimum tax under section 113, was raised from 0.50% to 1.00% and made applicable on certain individuals and association of persons in addition to a company. The rate of this minimum tax is very high and results in financial hardships to the taxpayer especially in the current scenario where there are frequent power outages and deteriorating law and order situation in the country as a result there businesses are struggling to operate even at break-even point.
-- Minimum tax rate should be reduced to 0.5%.
-- Please see our alternate proposal under para 2.7
1.8 PRESUMPTIVE TAXATION Presumptive Taxation Regime (PTR) introduced in 1990 is another dogma that needs a serious policy review for a sustainable growth in tax base.
There is unanimity of the view that policy framework for PTR was in principle, introduced to cater for certain negative aspects of Pakistani tax culture. These aspects were:
Effectively no tax contribution by certain sector which resulted in the view that at least a minimum presumptive sum be taxed; and Withholding taxation with normal taxation necessarily requires refund, if the tax liability determined on net income basis is less than tax withheld. There were serious abuses of refund provision. Accordingly, checks to that effect were introduced by way of PTR.
Nevertheless, this was not a sustainable model. It was a 'stop-gap' arrangement. There was a need to incorporate and institute provisions which would check aforesaid abuses. Over a period of two decades (1990 to 2010) concrete measures have not been adopted to curb the abuses that lead to introduction of PTR. Accordingly, PTR has continued and in certain cases it is being promoted.
An effective tax system can only work where there are identical tax procedures and processes for the same kind or nature of business activities. Furthermore, there has to be no discrimination in incidence by one sector over the other. PTR disturbs both these aspects. There is a need to review PTR in that context.
As a transitional measure, for all corporate taxpayers current final tax regime should be converted into minimum tax.
1.10 TAXATION OF INCOME OF CERTAIN RETAILERS - SECTION 113B
Through Finance Act, 2010 the rate of tax on retailers being an individual or an association of persons having turnover upto Rs 5 million was raised from 0.50% to 1.00% by amendment in Division IA of Part I of First Schedule.
However, under section 113B, the rate of tax on retailers having turnover of more than Rs 5 million and registered under the special procedure for payment of sales tax continues to be 0.5% on turnover upto Rs 10 million and 0.75% for the turnover in excess of Rs 10 million.
Recommendation: In Section 113B in the table in column 3 against serial number 1 the figure "0.5" should be substituted by "1.00" and against serial number 2 the figure "0.75" should be substituted by "1.25".
TAX ON CAPITAL GAINS (SECURITIES) - IN CASE OF NON-RESIDENT PERSONS
There is a need to rationalise the regime for taxability of capital gains in case of a non-resident person. Tax on capital gain should be calculated after allowing indexation for devaluation of Pakistani Rupee, if any. Similar treatment is also provided in section 48 'Mode of computation' of Indian
Income Tax Act 1961, as follows:
"The Income chargeable under the head "Capital gains" shall be computed, by deducting from the full value of the consideration received or accruing as a result of the transfer of the capital asset the following amounts, namely: expenditure incurred wholly and exclusively in connection with such transfer;
(ii) the cost of acquisition of the asset and the cost of any improvement thereto:
Provided that in the case of an assessee, who is a non-resident, capital gains arising from the transfer of a capital asset being shares in, or debentures of, an Indian company shall be computed by converting the cost of acquisition, expenditure incurred wholly and exclusively in connection with such transfer and the full value of the consideration received or accruing as a result of the transfer of the capital asset into the shares or debentures, and the capital gains so computed in such foreign currency shall be reconverted into Indian currency, so however, that the aforesaid manner of computation of capital gains shall be application in respect of capital gains accruing or arising from every reinvestment thereafter in, and sale of, shares in, or debentures of, an India company."
In case of a non-resident, tax on capital gain should be calculated after allowing indexation for devaluation of Pakistani Rupee, if any.
1.11 PERQUISITES - SECTION 13(7) AND EXEMPTION OF PERQUISITES - CLAUSE (53A) OF PART I OF SECOND SCHEDULE
1.11.1 Taxation of Notional Income:
Under sub-section (7) of section 13 of the Income Tax Ordinance, 2001 the difference between the Benchmark Rate and the actual rate of interest charged (where actual rate of interest is less than the Benchmark Rate) by the employers on concessionary loans provided to the employees is treated as perquisite chargeable to tax.
This is not a significant source of revenue for the Government on the one hand and very rigid piece of legislation on the salaried taxpayer on the other hand who are hard hit by the present economic situation. The taxation of this notional income is highly unjust since it taxes the notional income of the salaried person which is against the basic principle of taxation since this notional income will never ever be received by the taxpayer. Similar notional income in the hands of employees of airline, transport, educational institutions, restaurants, hospitals, clinics etc are already exempt under clause (53A) of Part I of Second Schedule.
The taxation of marginal income on loans obtained from the employer below Benchmark rate should be exempted by making necessary amendments in clause (53A) of the Part I of the Second Schedule and by deleting sub-section (7) of Section 13; or
Alternatively a minimum threshold of the loan amount should be specified on which the provisions of Section 13(7) would be attracted eg loans exceeding the limit of Rs 2.5 million.
1.11.2 Exemption of mortgage loans (Alternate to above)
The rationale underlying this proposal is that:
(a) Only mortgage loans will be exempted from the applicability of Section 13(7) of the Ordinance whereas all other concessionary loans like auto loans, personal loans will continue to be taxed on the difference between the actual and the benchmark rate;
(b)It will boast the housing industry since in today's economic situation and the presence of speculators in the property market it is next to impossible for a salaried employee to own a house on commercial mark up rates. Once this industry takes off there will be provision of cheap houses and there will be increase in tax revenue from housing and allied sector;
(c)it will contribute in enhancing the national economic activity by extending affordable loans and advances to middle class income group of society;
(d)It will remove detrimental financial ramifications due to incremental rate of interest on notional income for all other salaried persons, who are already facing a tough challenge to survive within their paltry resources- all legally declared and tax paid;
(e)The FBR is also cognisant of this fact by stating in Clause (53A) that "any other perquisite or benefit for which the employer does not have to bear any marginal cost; and the Circular Letter 4(8)IT-J/91 dated June 30, 1991 issued by then CBR opines that "...it is not desirable to tax such notional income." The same principle should be applied in this situation.
Alternatively at least the mortgage loans be exempted from the operation of section 13(7) of the Income Tax Ordinance, 2001.
1.11.3 Bench Mark Rate
The Bench mark rate, in terms of sub-section (7) of Section 13 started from 5% in tax year 2003 and is presently 13% [will become 14% w.e.f July 1, 2011]. There is no logic behind such irrational / arbitrary increase in benchmark rate by 1% every year.
The Benchmark rate should be fixed now as already increased from 5% to 13%.
1.12 FOREIGN LOSSES - SECTION 104(2)
According to section 104(2) 'the foreign losses' are to be carried forward to the following tax year and set off against the foreign source of income chargeable to tax under that head in that year. As a result foreign loss sustained by resident taxpayer is not adjustable against the local income, which is un-realistic and against the concept of taxing global income.
In the repealed Income Tax Ordinance, 1979 there was no such restriction and foreign losses sustained by a resident could be set off against local income.
The restriction of set off of foreign losses against subsequent foreign income needs to be removed.
1.13 INCENTIVES TO EVADE TAXES
Improvement of tax base essentially requires abolition of any discrimination between taxpayer with adequate penalties for the delinquents but in Pakistan the situation is on the contrary. There are two policy features favouring the delinquents:
Whitening the untaxed money by abusing the various provisions of the law such as 'inward foreign remittance' By virtue of clause (a) of sub-section (4) of Section 111 of the Income Tax Ordinance, 2001 a taxpayer does not have to offer explanation about the nature and source of any amount of foreign exchange remitted from outside Pakistan through normal banking channels.
The above-mentioned sub-section though promotes inflow of foreign exchange remittances towards the country; however, the same provision is being largely misused to incorporate the untaxed income. Moreover, the provision is also refraining persons from being enrolled included in the tax net and making true and fair declaration of income.
It will be appreciated that why would some one like to pay tax at the rate of 20% to 25% when this permanent route of amnesty is available at a cost of around 2%.
Regular and persistent system of official whitening of money by way of 'Tax Amnesty Schemes'
Such schemes provide complete amnesty for all defaulted liabilities on payment of a very nominal sum. In the case of indirect taxes, there are almost regular amnesty schemes for delinquents. This places the taxpayer community in an embarrassing position.
The existence of section 120A on the statute book, granting a perpetual power to the Federal Board of Revenue to make such schemes, is a best remedy available and temptation for delinquent taxpayers and discouragement for compliant taxpayers.
These policies encourage the unorganised sector to continue with the present set-up. In this situation, the documented and organised sector suffers both in financial terms as well as culturally for the reason that such measures reflect a sign that system will continue to prevail and there is no need
for a positive shift.
Section 111(4)(a) of the Income Tax Ordinance, 2001 should be abolished;
Section 120A of the Income Tax Ordinance, 2001 should be deleted; and
Policy decision be taken that in future, no Tax Amnesty Schemes shall be offered.
1.14 PAYMENTS FOR GOODS AND SERVICES - SECTION 153(6)
Rendering of or providing of services subject to deduction of tax at source by the non-corporate
sector has been excluded from the ambit of final tax and instead tax deducted at source has been made the minimum tax.
The initiative of restricting the presumptive tax/final tax regime is in line with the earlier recommendations of the Institute and is appreciated.
However, the concept of 'minimum tax' is against the norms of taxation of income and indirectly tantamount to the continuation of presumptive tax regime. This concept to secure the revenue, to start with, is understandable but also needs to be progressively phased out.
Professional service providers, who by their governing statutes are not allowed to get themselves incorporated, is a class of taxpayer for consideration for exclusion from the 'minimum tax' concept.
Like corporate sector, professional service providers, who by their governing statutes are not allowed to get themselves incorporated, should also be excluded from the ambit of 'minimum tax' concept.
1.15 INCOME FROM PROPERTY - SECTION 15, 155 AND 169 AND CLAUSE (a) OF DIVISION VI OF PART I OF FIRST SCHEDULE
1.15.1 Exclusion from fixed tax regime
The Institute is of a firm view that presumptive/final/fixed tax regimes are distortion to our taxation system.
Income from property is another area for active consideration of bringing back to the normal tax regime (ie, prior to the amendments made through Finance Act, 2006 & 2010) and to start with organised and documented corporate sector is a best fit.
Income from property of the corporate sector should be excluded from the
presumptive/final/fixed tax regimes.
1.15.2 Exemption threshold - Section 15(7) and Division VI of Part I of First Schedule
Income from property with a gross rent not exceeding Rs 150,000 is not chargeable to tax under section 15(7) in the hands of an individual or an association of persons where such taxpayer does not derive taxable income under any other head.
This threshold of Rs 150,000 was fixed when the "zero" tax rate threshold for individuals and association of persons was Rs 100,000 after giving 50% margin for expenses against the gross rent. Through Finance Act, 2010 the "Zero" tax rate threshold for individuals was increased to Rs 300,000 and for the associations of persons such threshold was abolished. However, in sub-section (7) of section 15 the corresponding change was not made which is an inadvertent anomaly.
In clause (i) of sub-section (7) of section 15 the words "or association of persons" should be omitted; In clause (ii) of sub-section (7) of section 15 the figures "150,000" should be substituted with the figures "450,000"; In clause (a) of Division VI of Part I of First Schedule the words "and association of persons" should be omitted; and
In clause (b) of Division VI of Part I of First Schedule after the word "company" the words "and association of persons" should be inserted. 1.15.3 "Zero" tax rate threshold - Division VI of Part I of First Schedule The existing rate card for Income from property under clause (a) of Division VI of Part I of First Schedule (applicable to an individual and association of persons) and section 15(7) are contradictory.
According to section 15(7), the exemption is available if the property income (gross rent) does not exceed Rs 150,000 and the taxpayer has no other taxable income under any other head. Contrary to this under clause (a) of Division VI of Part I of First Schedule the exemption by way of "zero" tax rate is available even if the: property income exceeds Rs 150,000; or taxpayer has taxable income under any other head and income from property (irrespective of the quantum of property income).
The rate card under clause (a) of Division VI of Part I of First Schedule be substituted as under (subject to recommendation under the preceding Sub-Para):
S. No Gross amount of rent Rate of tax
where the taxpayer has Where the taxpayer has
no other taxable income taxable income under
under any other head any other head
(1) Where the gross amount of rent Nil 5 per cent of the gross
does not exceed Rs 150,000 amount
(2) Where the gross amount of rent 5 per cent of the gross Rs 7,500 plus 5 per cent
exceeds Rs 150,000 but does not amount exceeding Rs 150,000 of the gross amount
exceed Rs 400,000 exceeding Rs 150,000
(3) Where the gross amount of rent Rs 12,500 plus 7.5 per cent Rs 20,000 plus 7.5 per
exceeds Rs 400,000 but does not of the gross amount cent of the gross amount
exceed Rs 1,000,000 exceeding Rs 400,000 exceeding Rs 400,000
(4) Where the gross amount of rent Rs 57,500 plus 10 per cent Rs 65,000 plus 10 per cent
exceeds Rs 1,000,000 of the gross amount of the gross amount
exceeding Rs 1,000,000 exceeding Rs 1,000,000
1.16 EXEMPTION TO MUTUAL FUNDS - CLAUSE 99 OF PART - I OF SECOND SCHEDULE
Clause 99 of Part I of Second Schedule exempts mutual funds' income provided 90% or more of its accounting income for the year is distributed. For this purpose, the accounting profit shall be reduced by capital gains, whether realised or unrealised.
This results in a situation where the unrealised income booked in the accounts on account of measurement of the investment on mark-to-market basis (in compliance with IAS 39 and IAS 40) results in recording of unrealised gains / losses in the accounts and ultimately distributed to the unit holders.
This provision has in fact restricted the growth of mutual funds and has resulted in decrease in dividend payout by mutual funds over the period. We believe that any accounting income which is not realised should not be considered for distribution.
To avail this exemption, the mutual funds resorted to short term investments in share market while other avenues of investment remained untapped.
To amend clause 99 of Part - I of Second Schedule by adding the highlighted words as follows:
"Any income derived by a mutual fund or ........, if not less than ninety percent of its accounting income of that year, as reduced by realised capital gain and adjustments made on account of application of International Accounting Standards 39 and 40, is distributed amongst the unit or certificate holders or shareholders as the case may be:"
The proposed amendment is in line with Clause (g) of Rule 1 of the Seventh Schedule.
1.17 INTER-CORPORATE DIVIDENDS-CLAUSE (103A) OF PART-I OF SECOND SCHEDULE
Group taxation necessarily requires elimination of inter-corporate dividend taxation. This matter has been taken care of in the present law. However, it appears that like other positive measures this issue is not being properly implemented. Since the insertion of clause 103A in Part I of the Second
Schedule virtually no group structure has practically evolved inspite of dire need and desire for the same by many existing and emerging business groups. This has happened on account of problems relating to inter-corporate dividend. In practical sense, no industrial group will endeavour to switch
to holding company structure unless there is a clear position with regard to no taxation on inter-corporate dividend.
In order to remove this anomaly in the taxation of dividend in the hands of the company, it has been recommended by the Institute in the past as well that dividend received by resident companies be exempted from tax as this is dual taxation in the hands of the holding company and then the ultimate
Exemption granted to inter-company dividends under clause 103A of Part I of the Second Schedule should be expanded to inter-corporate dividends received by all resident companies instead of the present exemption to only group companies entitled to group taxation under section 59AA.
1.18 LIMIT OF EMPLOYER'S CONTRIBUTION TO PROVIDENT FUND - CLAUSE (3) PART I OF SIXTH SCHEDULE
Through Finance Act 2008, the employer's contribution in the recognised provident fund in excess of Rupees one hundred thousand (Rs 100,000) is deemed to be Income of the employee. This matter has importance since employer contribution though a constructive receipt is not an actual receipt as the same is not at disposal of an employee and therefore tax incidence should not be levied at the point of time of contribution. It is suggested that ceiling of rupees one hundred thousand may be withdrawn as in many case this is the only long term benefit.
Further taxation of salary income is permitted by section 12 on receipt basis only, therefore in the event that there is an excess contribution to an employee above Rs 100,000 how would that be taxed in the hands of an employee as he would not be receiving that contribution rather the contribution will be credited to the Fund who will pay to an employee when he retires or resigns from service.
Further, the employer's contribution can be withheld by the employer in the case if employee is charged with misconduct. Due to such eventuality, it is only at the time of retirement or resignation that one can say with certainty that the employer's contribution would be received by the employee. Recommendation: Due to multiple complications, the ceiling of Rs 100,000 should be withdrawn.
1.19 EXPORT OF SERVICES Exports whether of goods or services are the back bone of any economy and particular of developing economies. Pakistan is no exception to this fact and our policy thrust is to enhance the exports to its optimum levels.
Export of goods and export of services are for all practical purposes more or less the same. In both cases all the related activities of producing the goods and generating of services originate from Pakistan and earn valuable foreign exchange for the country.
Currently, only Information Technology related services are recognised by providing exemption of income from export of such services. However, there are a number of other services in particular professional services by Architects, Engineers, Chartered Accountants, etc also needs to be recognised for promoting export of such services.
Recommendation: To promote, encourage and incentives export of services, it is proposed that this should be brought at par with export of goods.
1.20 COMPENSATION TO WITHHOLDING AGENTS
Federal Board of Revenue has been availing the services of withholding agents free of charge for quite a long time. These withholding agents have been incurring heavy expenditure in the form of changes in their systems, hiring and training of their staff, storage for retention of withholding Tax records and similar operating expenses.
Withholding agents should be allowed to retain 10% of the amount of tax collected as service charges on the principle of natural justice.
1.21 EXEMPTION OF INCOME RECEIVED FROM ANNUITY OR ANNUITIES
Exemption of income received from annuity or annuities issued by a Life Insurance Companies registered under section 3 of the Insurance Ordinance were available through clause (21) of Part-I of second Schedule to the Income Tax Ordinance, 2001 which was withdrawn by Finance Act, 2008.
Pension received by an employee from its employer is exempt under clause (8), (9) and (12) of the Part-I of the Second Schedule to the Income Tax Ordinance, 2011. However, income received from an annuity, which is a kind of pension benefit remains chargeable to tax.
Logically, like pension income received from an annuity should also be exempt from tax to safe guard the interest of senior citizens after reaching the retirement age.
Income received from annuity upto Rs 120,000 per annum after 60 years of age should be exempted from tax.
2. DOCUMENTATION, RESOURCE MOBILIZATION AND INCREASE OF TAX BASE
Un-documented, cash and parallel economy is a menace to our entire taxation system. The major chunk of the state revenue is generated by few sectors of the businesses owned by National and Multi-National companies and corporations. The transport, wholesale, retail and professional services
sector of the business has a very low contribution in the tax revenue as compared to their share in GDP.
Our direct tax laws need a major shift to curb this situation. Following are the examples of our existing laws that do not support documentation and resultantly the increase in tax base and resource mobilisation:
Final tax regime;
Fixed tax or separate block of income;
A very extensive withholding tax regime coupled with final tax, which has converted direct tax into indirect tax; Another very significant area for major shift is facilitation of compliant taxpayers and penalisation of non-compliant taxpayers. All our direct tax laws are day by day burdening the existing and compliant taxpayers. No measures are being taken to enforce the tax laws on the non-compliant
With this background following measures are recommended.
2.2 FINAL TAX, FIXED TAX AND SEPARATE BLOCK TAX REGIMES
In the last two years steps have been taken to reduce the scope of final tax, fixed tax and separate block tax regimes but a lot more needs to be done by abolishing and replacing the same with minimum tax concepts to start with. This will ensure documentation and payment of tax at the applicable rate on the consolidated taxable income instead of breaking in different regimes.
Income from property
The concept of taxing income from property as a separate block of taxable income should be done
away. Deductions against the gross rent should be admissible only if actually incurred and that too subject to an overall threshold of 50% of the gross rent.
Income from business - Commercial Imports
Commercial imports should be excluded from the final tax regime and the tax collected at import stage should be converted into a minimum tax to start with.
Income from business - Sale of goods and execution of contracts
Sale of goods and execution of contracts should be excluded from the final tax regime and the tax
deducted at source should be converted into a minimum tax to start with.
2.3 TAX CREDIT TO REGISTERED PERSONS - SECTION 65A
To provide incentive for documentation of economy and increase in the tax base, in 2009 tax credit to those manufacturers registered under the Sales Tax Act, 1990, making 90% of their sales to persons registered under the Sales Tax Act, 1990 and also provide details of such sales to the department was introduced. This needs to be extended beyond the manufacturers in particular the entire wholesale chain.
This tax credit should be extended to all persons registered under the Sales Tax Act, 1990.
The proposed change will not affect the tax liability of incomes falling under the presumptive tax regime, as tax credits are not admissible to such persons under section 169.
2.4 CASH WITHDRAWAL FROM BANK - SECTION 231A; AND ADVANCE TAX ON TRANSACTIONS
IN BANK - SECTION 231AA
Un-documented, cash and parallel economy is a menace to our tax revenues. In order to overcome this situation the cash transactions needs to be penalised with a pinch of tax. On the other side the existing taxpayers in respect of their declared bank accounts are facing unnecessary burden on one hand and delayed refunds, if any, on the other hand. However this burden may be lessen
by increasing the exemption limit.
The rate of withholding tax on cash withdrawal should be increased from current 0.3% to 0.5%; and The exemption limit of Rs 25,000 on the other hand should be increased to Rs 50,000.
2.5 WITHHOLDING TAX ON INDUSTRIAL AND COMMERCIAL CONSUMERS OF GAS AND ELECTRCITY
The withholding tax regime has been very effective in increasing the tax base in the country. The existing scheme covers almost all the segments of the economy.
At present a very large number of taxpayers comprising of small and medium sized industries and the entire wholesale and retail chain are not contributing to the tax revenue in the ratio of their contribution to the GDP. This situation will be further deteriorated with the increased 'zero' tax rate threshold increased from Rs 100,000 to Rs 300,000, which needs to be taken care of by taking appropriate actions well in time ie:
2.5.1 Imposition of withholding tax on industrial and commercial consumers of natural gas Currently, natural gas consumption by CNG Stations is subject to withholding tax only.
A large number of industrial and commercial consumers of natural gas are not paying any tax or paying a very little amount as compared to the volume of business on the basis of their consumption of natural gas. It will be appropriate to bring this sector of economy to contribute to the national exchequer by way of a withholding tax.
Withholding tax at the rate of at least 5% and 10% on natural gas consumption by industrial and commercial consumers respectively should be introduced with a maximum capping of tax amount of Rs 10,000 per month to take care of cash flow problems of large scale consumers.
2.5.2Increase in the rate of withholding tax on commercial consumers of electricity. The current rate of withholding tax on electricity consumption by commercial consumers with bill amount upto Rs 20,000 per month ranges from 6% to 23% whereas for bill amount exceeding Rs 20,000 it is 10%. This needs to be increased and rationalised for the reasons stated above.
The rate of withholding tax on electricity consumption by commercial consumers should be fixed at a flat rate of 25% of electricity consumption with a maximum capping of tax amount of Rs 10,000 per month to take care of cash flow problems of large scale consumers.
2.6 INCREASE IN THE RATE OF WITHHOLDING TAX ON PASSENGER TRANSPORT VEHICLES
PLYING FOR HIRE AND OTHER PRIVATE MOTOR CARS - SECTION 234 AND PARA (2) AND
PARA (3) OF DIVISION III OF PART IV OF FIRST SCHEDULE
The current rate of advance tax collected along with the motor vehicle tax does not commensurate with the current margin of profit in case of passenger transport vehicles plying for hire and other operating cost of private cars. Further the reason for non compliance of the provision of clause (vi)
of sub-section (1) of Section 114 is also due to the fact that the current advance tax rates are very nominal. In our society in order to improve compliance with tax laws and increasing the tax base the rate of advance tax should have a pinching effect in proportion to the income or cost of operating.
The current rate of advance tax under Para (2) and (3) of Division III of Part IV of First Schedule should be at least be doubled.
2.7 INCREASE OF TAX BASE BY WAY OF INCENTIVE TO THE COMPLIANT TAX PAYERS
Currently there is nothing in the Income tax to promote tax culture and provide incentives to compliant tax payers. There is a need to introduce appropriate measures to reward compliant tax payers.
It is proposed to introduce a concept of furnishing annual sales summary along with NTN or CNIC of the customers with an incentive of reduced rate of minimum tax of 0.50% instead of 1.00%.
2.8 DEALERS/AGENTS OF AGRICULTURAL PRODUCE
The Federal Board of Revenue has recently introduced an amendment in SRO 363 whereby the exemption available to the supplier of agricultural produce from provision of section 153 has been withdrawn and limited to actual grower/producer of agricultural products. We welcome this step as it will bring into the ambit of taxation a very large segment of the economy which were taxable under the provisions of Income Tax Ordinance but were out of the net on excuse of agricultural income. Under the Income Tax Ordinance, the exemption to agricultural income is restricted to the actual producer and grower of the land and not to the intermediaries who make the real income
in the process. However, we feel that this change will only bring into net all those intermediaries who are making supplies to withholding tax agents. The persons who do business through market (mandis) will remain outside the net.
All business of agricultural produces both cash corps, fruits and vegetables are conducted through various 'mandis' spread across the country which are managed through marketing committees.
These marketing committees are governed under Provincial Act, eg Punjab Agricultural Marketing Ordinance 1978. Under this Act, in order to deal with the agricultural produces, they need to be registered as a working commission agent with the market committee under a formal licence which is renewed on annual basis. All Provincial Governments have reliable data available through marketing committees which can be used for taxation of their important segment and bring them into the tax net.
However, since the entire system works on cash basis, therefore, it would be difficult to start with taxation of real income and it would be more advisable to tax them on some fixed tax regime.
The market commission agent registered with market committees may be subject to fixed tax (excluding income subject to collection of tax at source under section 153) depending upon their category; we suggest the following fixed rates for each category:
Category - A Rs 10,000 per annum
Category - B Rs 7,500 per annum
Category - C Rs 5,000 per annum
The marketing committee should be made the withholding tax agent for collection of the above tax alongwith the annual fees and be required to submit annual statement to the tax department.
3.PROCEDURES AND MISCELLANEOUS
3.1 APPEAL TO COMMISSIONER (APPEALS) - SECTION 127
The Commissioner (Appeals) has the vested power to stay recovery of demand until decision of appeal as per the ratio decided by the honourable Supreme Court of Pakistan but this power has not been explicitly provided in the statute. Although this does not bar the Commissioner (Appeals) to grant stay but practical difficulties arise due to absence of explicit powers in this regard. Also sections 131 (5) & 133 (7) specifically deal with stay of recovery proceedings by the Appellate Tribunal and High Court.
Therefore there is a need to rationalise the powers of Commissioner (Appeals) in line with the findings of the Supreme Court in general, and powers of Appellate Tribunal and High Court in particular.
A new sub section be introduced to enlarge the powers of the Commissioner ( Appeals ) to be able to stay recovery proceedings where appeal is filed before him on the same lines as provided in sections 131 (5) & 133 (7).
3.2 PROCEDURE IN APPEAL - SECTION 128(4)
The power to set aside the assessment order in an appeal before the Commissioner (Appeals) contained in section 129(1)(a) was withdrawn through Finance Act, 2005. With this change the powers vested in the Commissioner (Appeals), under section 128(4) to cause further inquiry before disposing of an appeal to be made by the Commissioner, has attained a significant importance, in order to enable the Commissioner (Appeals) to give clear cut findings on the matters arising in the appeal before him.
Restricting, the further enquiry to be made by the Commissioner alone against whose order an appeal has been preferred by the taxpayer is not fair and judicious, because the results of such inquiry will naturally be biased and tilt to support the order, the Commissioner has originally made (order under appeal).
The powers of the Commissioner (Appeals), under section 128(4) to cause further inquiry by the Commissioner should be enlarged enabling the Commissioner (Appeals) to cause further inquiry by an expert or seek an expert opinion.
Consequently, section 222 of the Income Tax Ordinance, 2001 should also be amended, enabling the Commissioner (Appeals) as well to appoint an expert.
3.3 APPOINTMENT OF THE APPELLATE TRIBUNAL
3.3.1 Section 130(4)
Chartered Accountants in Practice can be of great value as Accountant Member of the Appellate Tribunal. This was recognised in the repealed Income Tax Ordinance, 1979 whereby the Federal Government could appoint Chartered Accountants with at least ten years of experience in practice as Accountant Member of the Appellate Tribunal, till June
Section 130(4) should be amended in order to provide for the appointment of Chartered Accountants with at least five years of experience in practice as Accountant Member of the Appellate Tribunal.
3.3.2 Section 130(8AS) and 130(8AA)
Through Finance Act, 2009, the Chairman of the Appellate Tribunal has been empowered to constitute as many benches consisting of a single member of the Appellate Tribunal, as deem necessary and such benches can hear cases involving tax or penalty upto Rs 5,000,000, as the Federal Government may specify.
In the absence of any concept of inter-tribunal appeal against the order of a bench comprising of a single member (as in case of High Court), the scope of cases (limit of cases involving tax or penalty upto Rs 5,000,000) that can be assigned to a bench comprising of a single member is exceptionally high, particularly in view of the fact that the Appellate Tribunal is the last fact finding authority under the Ordinance.
The monetary limit of Rs 5,000,000 should be brought down to Rs 500,000.
3.4 ALTERNATIVE DISPUTE RESOLUTION - SECTION 134A(1)
Through Finance Act, 2009, the scope of cases which could be referred for Alternative Dispute Resolution (ADR) was restricted such that the cases where:
Prosecution proceedings have been initiated; or Interpretation of question of law is involved having effect on other identical cases;
cannot be referred for Alternative Dispute Resolution.
The Rules regarding Alternative Dispute Resolution already provides that "Any such resolution shall not be used as precedent, except as provided in the agreement".
Accordingly restricting the scope of cases that could be referred for Alternative Dispute Resolution is not justified.
The position prior to the amendment made through Finance Act, 2009 should be restored.
3.5 AUDIT - SECTION 177
By Finance Act, 2010, section 177 has been amended by giving vast unconditional discretionary powers to the Commissioner at the field formation level without any restrictions to call for the records etc and conduct audit of the income tax affairs of any person or class of persons.
The law in the present form:
Does not regulate the selection of any person or classes of person for audit; and Gives un-conditional wide discretionary powers to the field officer.
This is against the norms of taxation and subject to misuse and harassment of the taxpayers. It is imperative that such power needs to be regulated for its judicious use in a manner that reduces the discretion and at the same time facilitates the smooth operation of audit.
Specific rules be first introduced in the Income Tax Rules, 2002 to regulate the selection of any person or classes of person for tax audit;
Section 177 should be then amended to provide for selection of any person or classes of person for conduct of tax audit under the prescribed rules (as suggested above) and only then call for the records etc.
3.6 REVAMPING OF INCOME TAX RULES
It has been observed that most of the Income Tax Rules are not aligned to Income Tax Ordinance 2001.
Income Tax Rules need to be revamped to avoid confusions.
4. REMOVAL OF IRRITANTS
4.1 DEDUCTIONS NOT ALLOWED - SECTION 21(l)
Section 21(l) provides for deductions not allowed for transactions exceeding Rs 10,000 paid otherwise than crossed cheque etc. Such provision is the need of the time to curb non-documentation and to increase the tax base. At the same time this section does not apply to certain transactions specified in second proviso.
The agro based industries are facing problem while making payments for purchase of agricultural produce directly from the growers/farmers, who either do not maintain any bank account or are not willing to accept crossed cheque etc.
Exemption from payment through crossed cheque etc should be provided in respect of transactions for purchase of agricultural produce directly from the growers/farmers.
4.2 GROUP TAXATION - SECTION 59B
Section 59B seeks to provide group relief in the form of adjustment of losses between holding and subsidiary or subsidiary to subsidiary if they fulfil the minimum holding criteria. The required holding is 55% if one of the companies in the group is a listed company and 75% if none of the companies in the group is listed company. The law further prescribes certain conditions that the group companies have to fulfill in case they avail the facility of group relief. The conditions are set out in sub section (2) of section 59(B). One of the conditions under sub-section 2(c) of section 59(B) is as follows:
"holding company, being a private limited company with seventy-five percent of ownership of share capital gets itself listed within three years from the year in which loss is claimed."
The Institute is of the view that requiring holding company to get itself listed within three years from the year in which loss is claimed should be removed and instead there should be a condition that at least one company within the group should get itself listed. This would bring the condition in line with the other condition of minimum holding discussed above where a higher holding is only required if none of the companies in a group is a listed company. Further the requirement to list the holding company is against the principle of group formation and consolidation as in our view no group would like to keep its investments in a listed company due to the risk of hostile take-overs etc as in such an event the group may loose control on its entire entities within the group.
It is therefore suggested that sub-section (2)(c) of section 59B be substituted as follows:
"At least one of the companies of the groups shall get itself listed within three years from the year in which loss is claimed if all companies of the groups including the holding companies are private limited companies."
4.3 COLLECTION OF TAX IN THE CASE OF PRIVATE COMPANIES AND ASSOCIATIONS OF
PERSONS - SECTION 139
It is without any doubt that corporate sector is better regulated and documented as compared to an association of persons or individual status of doing business. However, there are a number of provisions in the Income Tax Ordinance, 2001, that do not support the formation of corporate sector which in turns implies non-formation of regulated and documented sector.
One of such provision is section 139 of the Income Tax Ordinance, 2001 placing un-limited liability on the directors/shareholders of a Private Limited Company, which is against the basic concept of formation of limited liability business entity.
Section 139 should be suitably amended to exclude the directors and shareholders of a Private Limited Company from the discharge of tax liability of the Company.
It may be mentioned over here that in case of fraud by the director(s), the Companies Ordinance, 1984 does not protect them for discharge of any liability of the Company.
4.4 IMPORTS - SECTION 148
Manufacturers importing raw material for their own use are at present subject to collection of tax at source at the rate of 3% as against the standard rate of 5% applicable on imports. As a result, large scale manufacturers, whose major raw materials are imported goods, are facing cash flow problems due to abnormal delays in getting the refunds, if any.
Earlier, this problem was taken care by granting exemption certificates or substantially reducing rate of withholding tax. The menace of exemption certificates and its misuse has been controlled by removing sub-section 4A but on the other hand, the problems faced by large scale manufacturers
were not taken care of.
Substantially reduced rate of withholding tax, for large scale manufacturers not exceeding 25% of the standard rate of withholding tax on imports be introduced.
4.5 DUE DATE FOR PAYMENT OF TAX - SECTION 137
Finance Act, 2008 had unreasonably decreased the numbers of days specified for making payment into Government treasury to 15 days.
This curtailment of time resulted into:
Culture of creating unfair demands and unjustified liabilities by the assessing officers; and Short sighted approach adopted by field formations in meeting their tax collection targets, is hampering business confidence building measures adopted by the Pakistan Government during last decade.
The original time of 30 days should be restored to remove the hardship faced by the business community and taxpayers.
4.6 PAYMENT FOR GOODS AND SERVICES - SECTION 153(1)(c)
The term 'execution of contract' is unique in Pakistan as this term does not exist in any regional or international fiscal laws. The term 'execution of contract' under section 153(1)(c) is open ended (except for specific exclusion of sale of goods and rendering or providing of services) as every
transaction is an execution of a contract under the Contract Act eg sale and purchase of immovable property, right to use an intangible, etc, which do not necessarily have any element of profit.
The term 'execution of contract' for the purposes of section 153 be defined.
4.7 COMPUTATION OF EXPORT PROFITS AND TAX ATTRIBUTABLE TO EXPORT SALES - RULE
231 Rule 231(1) of the Income Tax Rules, 2002 reads as under:
"Where a taxpayer exports any goods manufactured in Pakistan, the taxpayer's profits attributable to export sales of such goods shall be computed in the manner, namely:-
(a) where a taxpayer maintains separate accounts of the business of export of goods manufactured in Pakistan, the profits of the export business shall be taken to be such amount as may be determined by the Commissioner in accordance with the provisions of Ordinance on the basis of such accounts; or "
The words 'separate accounts' (underlined above), are subject to different interpretations. One view is separate books of accounts in respect of business of export of goods manufactured in Pakistan and the second view is books of accounts of the taxpayer maintained in a manner from which the
profits attributable to the business of export of goods manufactured in Pakistan can be separately determinable.
The Institute subscribes the second view as stated above.
The rule 231(1)(a) be substituted as under:
"(a) where a taxpayer maintains books of account from which the profits of the business of export of goods manufactured in Pakistan are separately determinable, the profits of the
export business shall be taken to be such amount as may be determined by the Commissioner
in accordance with the provisions of Ordinance on the basis of such books of account;
4.8 INTEREST INCOME OF NON-RESIDENT INVESTOR FROM GOVERNMENT SECURITIES/BONDS
Presently, the interest yields in Pakistan on Government securities - Bonds / Treasury Bills are significantly higher than that prevalent elsewhere; more notably in Europe and US.
Based on the assessment of the economists there is a strong likelihood that this trend will continue in the near future - at least for a couple of years due to slow economic recovery in western economies.
The higher rate of return in Pakistan's security market can mitigates the negative consequences of currency devaluation, inflation and associated risks. Owing to this, much interest is now being shown by foreign banks and institutional investors to invest in Pakistan.
The present tax regime [Clause (5A) of Part II of the Second Schedule to the Income Tax Ordinance, 2001 (Ordinance)] applies withholding tax of 10% on the Interest income of non-residents from Securities, provided they have no Permanent Establishment (PE) in Pakistan. The WHT is an advance tax, adjustable against the final tax liability. The investors are, however, obliged to file an annual tax return along with the details of such income and calculate final tax on the net income at the corporate tax rate of 35%, unless the investor is a tax treaty country resident, whereby a lower tax rate can be applied as final tax liability on the gross interest (generally 10% - 15%).
The foreign investors generally shy away due to local tax compliance requirements, such as assessments by way of Audit, etc, and disputes with tax authorities over WHT/final tax liability, which lingers on for a considerable period of time. This is a detrimental factor for roping the non-resident investors for investment in Pakistan's Government Securities.
In order to further capitalise this opportunity, strengthening our security market as well as the inflow of foreign exchange into Pakistan, it is advisable that such WHT is treated as full and final discharge of tax liability, as this would create a healthy and hassle free system for the investors without any uncertainties as to the final tax liability.
Similar provisions were introduced last year for capital gains derived by investors in shares and other instruments listed on the stock exchanges.
This is basically an economic measure to strengthen our security market and increase our foreign exchange reserves. Such tax concession would be further stimulated.
In order to encourage the foreign exchange inflows into Pakistan, such interest payments to non-resident persons should be brought under the final tax regime whereby tax deducted at 10% under section 152 read with Clause (5A) of Part II of Second Schedule to the Income Tax Ordinance, 2001 should be declared full and final discharge of tax liability without filing
any Return of Income.
Further, capital gains arising on disposal of Government Securities before the maturity should also be subject to final tax say at 10% by way of withholding tax and without filing Return of Income.
In view of the exchange rate fluctuations, the Government may also consider to further reduce the rate of withholding tax from existing 10% to say 3% or 5%.
5. TECHNICAL AND EDITORIAL
5.1 PROFIT ON DEBT, FINANCIAL COSTS AND LEASE PAYMENTS - SECTION 28(1)(g)
Through Finance Act, 2009 a technical correction was made to replace 'Small Business Finance Corporation (hereinafter referred to as "the Corporation")" with 'Small and Medium Enterprises Bank (hereinafter referred to as "the SME Bank")'. However, the corresponding amendment to replace the word 'Corporation' with 'SME Bank' was not done in the later part of the said section.
The word 'Corporation' in section 28(1)(g) be substituted by the words 'SME Bank'.
5.2CAPITAL GAINS (SECURITIES)
Capital Gains arising on the disposal of "Securities" (shares of a public company, vouchers of Pakistan Telecommunication Corporation, Modaraba Certificates or instruments of redeemable capital and derivative products ) have been brought in the ambit of chargeable capital gains under the Income Tax Ordinance, 2001 and for this purpose section 37 was amended, Section 37A and Division VII in Part-I of the 1st Schedule was inserted and clause (110) of Part-I of 2nd Schedule was omitted through Finance Act, 2010.
A cumulative reading of the aforesaid amendment, insertion and omission has resulted into the following anomalies:
5.2.1 Chargeability of capital gains arising from disposal of securities under section 37 and 37A
5.2.2 Sub-section (1) of Section 37 does not exclude the capital gains dealt separately under section 37A. Resultantly, capital gains arising on disposal of shares of public companies etc held for less than twelve months are inadvertently chargeable to tax both under section
37 and 37A.
Taxability of capital gains arising on disposal of securities held for a period of exactly twelve (12) months and six (6) months
Sub-section (1) of section 37A reads as under:
"The capital gain arising on or after the first day of July 2010, from the disposal of securities held for a period of less than a year, shall be chargeable to tax at the rates specified in Division VII of Part I of the First Schedule;
Provided that this sub-section shall not apply if the securities are held for a period of more than a year:"
Division VII of Part-I of the 1st Schedule reads as under:
"The rate of tax to be paid under section 37A shall be as follows:
S.No Period Tax Year Tax Year Rate of Tax
1 Where holding period of a 2011 10.00%
security is less than six months.
2 Where holding period of a
security is more than six months 2011 7.50%
but less than twelve months.
3 Where holding period of a 0.00%
security is more than one year.
From the above it will be observed that the capital gains arising on the disposal of the "Securities" held for the period of exactly twelve (12) months is not covered under section 37A as well as Division VII of Part-I of the 1st Schedule.
Similarly, no rate of tax has been prescribed in Division VII of Part-I of the 1st Schedule for capital gains arising on the disposal of the "Securities" held for the period of exactly six (6) months.
5.2.3 Determination and computation of capital gains arising on disposal of securities held for a period of less than a year Section 37A is silent as to how the capital gains arising on disposal of "Securities" held for a period of less than a year shall be determined and computed.
Provisions similar to Sub-section (2), (4) and (4A) of Section 37 are missing in Section 37A and nor these sub-sections have been crossed referenced in Sections 37A for determination and computation of capital gains arising on the disposal of "Securities" held for a period of less than a year.
Taxability of capital gains arising on disposal of securities held for a period of exactly twelve months and more than a year Section 37 applies to all capital gains arising on disposal of "Capital Assets" which includes the "Securities" as well. However, the capital gains arising on disposal of "Securities" held for a period of less than a year stands presumably excluded from Section 37 by virtue of specific provisions under Section 37A.
Accordingly, capital gains arising on disposal of "Securities" held for a period of one year or more being not covered under Section 37A, in the absence of any exclusion from Section 37 continue to be chargeable under Section 37 (earlier this was covered by exemption granted under clause (110) of Part-I of 2nd Schedule).
It appears that instead of granting exemption to the capital gains arising on disposal of "Securities" held for a period of one year or more by making a specific provision in the Part-I of 2nd Schedule an alternate route has been adopted through First Proviso to Sub-Section (1) of Section 37A and S. No (3) of the Table in Division VII of Part-I of the 1st Schedule. However, this alternate route adopted is of not a valid legislation and the capital gains arising on disposal of "Securities" held for a period of one year or more are chargeable to tax under Section 37 for the following reasons:
5.2.4 Sub-Section (1) of Section 37A applies to capital gain arising from the disposal of securities held for a period of less than a year and therefore the First Proviso to Section 37A providing for that Sub-Section (1) of Section 37A shall not apply if the securities are held for a period of more than a year is a self contradiction, redundant and irrelevant.
Similarly, the "Zero" rate of tax provided at S. No 3 of Table in Division VII of Part-I of the 1st Schedule for capital gains arising on disposal of "Securities" held for a period of more than a year, is also a self contradiction, redundant and irrelevant since this Division is subservient to Sub-Section (1) of Section 37A which does not apply to "Securities" held for a period of more than a year.
The manner in which the long term capital gains have been ousted from sub-section (1) of section 37A and from sub-section (3) of section 37 suggests that these gains are not totally ousted from taxation instead the Capital Gain arising from the disposal of shares of public companies, etc held for twelve months or more are chargeable to tax at the standard rate (35% for company, 25% for an association of persons and 7.5% to 25% for an individual), where as short term gains have been made chargeable to tax at the rate of 8% to 10%.
5.2.5 Set-off of capital losses against capital gains arising on disposal of securities held for a period of less than twelve months
Sub-Section (5) of Section 37A reads as under:
"Notwithstanding anything contained in this Ordinance, where a person sustains a loss on disposal of securities in a tax year, the loss shall be set off only against the gain of the person from any other securities chargeable to tax under this section and no loss shall be carried forward to the subsequent tax year."
A plain reading of the Sub-Section reveals that loss on disposal of "Securities" in a tax year,
irrespective of the disposal period (ie, held for less than six months, six months, more than six months and less than twelve months, twelve months or more than twelve months) can be adjusted against the capital gains on disposal of any other "Securities" chargeable to tax under section 37A (ie gains arising on disposal of "Securities" held for a period of less than twelve months).
The capital gains arising on disposal of "Securities" for the purposes of taxability is divided into following categories:
Disposal after holding for Basis of Taxation Rate of Tax
Less than six months U/S 37A Separate Block 10.00%
Six months U/S 37A Separate Block Not provided*
More than six months but
Less than twelve months U/S 37A Separate Block 7.50%
Twelve months U/S 37 Taxable Income* Not provided**
More than twelve months U/S 37 Taxable Income*
U/S 37A Separate Block** 0.00%
In view of anomalies stated above.
FBR's view based on first proviso to section 37A(1) and S. No 3 of Table in Division VII of Part-I of the 1st Schedule. The mode of taxation and the rate of tax of each of the above five categories of capital gains is different. However, this sub-section is silent as to the whether capital loss on disposal of "Securities" under each of the categories stated above can be adjusted against the capital gains of that category alone, or capital loss under one category can be adjusted against the other category.
5.2.6 Capital gains arising on disposal of securities by taxpayers engaged in Insurance Business. The foregoing anomalies pointed out in respect of taxation of capital gains arising on disposal of securities chargeable under section 37 and 37A are also attracted in case of taxpayers engaged in Insurance Business under Rule (6B) and (6C) of the fourth schedule.
5.2.7 Rate of tax on capital gains arising on disposal of securities by taxpayers engaged in Insurance Business. The existing rates of tax on capital gains arising on disposal of securities as per Rule 6B of the Fourth Schedule to the Income Tax Ordinance, 2001 are higher than the rates of tax prescribed under Division VII of Part I of the First Schedule for taxpayers other than those engaged in the Insurance Business as under:
Tax Year Under Under Rule
Division VII 6B of the 4th
of Part I of Schedule
Where the holding period of a
security is less than six months 2011 10.00% 10.00%
2012 10.00% 12.50%
2013 12.50% 15.00%
2014 15.00% 17.50%
2015 17.50% 17.50%
Where the holding period of a 2011 7.50% 8.00%
security is more than six months but 2012 8.00% 8.50%
less than twelve months 2013 8.50% 9.00%
2014 9.00% 9.50%
2015 9.50% 10.00%
There appears to be no reason for this discrimination for the taxpayers engaged in the Insurance Business.
Removal of the foregoing anomalies by making appropriate amendments in the law.
5.3 EXEMPTION OF INCOME OF INTERNATIONAL DONOR/DEVELOPMENT AGENCIES
All the aid agreements entered into with the international donor/development agencies such as the United Nations (UNO, UNICEF, UNCTAD, WFP, UNCHCR, UNDP) US AID, Japan International Co-operation Agency (JICA), Department for International Development (DFID UK), Asian Development Bank etc contains a covenant whereby the amounts given under the grant or aid would not be
utilized for the purposes of paying direct taxes in the recipient (donee) countries.
In the absence of any specific provision in the Income Tax Ordinance, 2001 there is always an ambiguity and doubt on the taxability of income, if any, of such donor agencies and in particular with reference to withholding taxes.
Appropriate amendments should be made in the Ordinance to specifically exempt such international donor/development agencies from the application of income tax laws.
5.4 LIMITATION ON SET OFF AND CARRY FORWARD OF LOSSES - Section 59A
In subsections (1), (2) and (3) of section 59A, there is reference of sub-section (2) & (3) of section 92 and section 93 where as the above sub-sections and section 93 had been omitted by Finance Act, 2007.
The provisions of section 59A should be amended in light with change brought by Finance Act, 2007.
5.5 GEOGRAPHICAL SOURCE OF INCOME - AFTER-TAX PROFIT OF A BRANCH OF A FOREIGN
COMPANY - SECTION 101
By virtue of insertion and amendment of section 2(19)(f) through Finance Act 2008 and 2009, the remittance of after-tax profits of a branch of a foreign company operating in Pakistan has been included in the definition of dividend. However, the corresponding amendment in section 101 has not been made accordingly.
The corresponding amendment be made in section 101(6) to remove this anomaly.
5.6 MINIMUM TAX - SECTIONS 113(3)(a) and 113(3)(c)
Section 113(3) defines the turnover:
in clause (a) and (c) the term used is 'gross receipts', which is misleading and in common parlance refers to actual realisation and does not cater for the business accounts maintained under the mercantile/accrual method of accounting; and in clause (a) the amount of Sales Tax and Federal Excise Duty has been specifically excluded from the turnover being the collection of tax on behalf of the Government. However, in case of petroleum products, a major chunk of the turnover comprising of "Petroleum Levies" is not excluded form the turnover for the purposes of section 113 which is an anomaly and
unnecessary burden on taxpayers dealing in such products.
The words 'gross receipts' should be substituted by 'gross sales' in clause (a) and (c) of section113(3) ; and
The words and comma "Petroleum Levies," should be inserted before the words "Sales Tax" in clause (a) of section 113(3).
5.7 FILING OF WEALTH STATEMENT - SECTION 116(4)
Filing of wealth statement along with its reconciliation is obligatory on every person (other than a company) who is required to file the statement of final tax, where the final tax amounts to Rs 35,000 or more.
Inadvertently, the obligation of filing wealth statement has also been placed on an Association of Persons. Wealth statement is only in respect of an individual and therefore placing this obligation on an Association of Persons is not appropriate.
The words 'Every person (other than a company)' should be substituted by 'An individual'.
Alternatively, if the intention is filing of wealth statement of members of an association of persons than the entire section needs to be suitably re-drafted.
5.8 APPEAL TO THE COMMISSIONER (APPEALS) - SECTION 127
Section 127 (1) of the Income Tax Ordinance, 2001, provides for orders against which an appeal lies with the Commissioner (Appeals). For this purpose, specific sections have been referred to in this section.
As a result dispute arises as to whether an appeal lies before the Commissioner (Appeals) against orders under the sections that are not specifically mentioned in section 127(1) eg orders under section 123, 124 etc.
Originally, this section provided for all orders of the Commissioner under the Ordinance against which an appeal lies with the Commissioner (Appeals), just like the existing section 131(1) [orders against which an appeal lies before the Income Tax Appellate Tribunal].
In order to remove, the ambiguity in section 127(1) of the Income Tax Ordinance 2001, it should be substituted as under:
"Any person dissatisfied with any order passed by a Commissioner (other than the Commissioner (Appeals)) or an Officer of Inland Revenue under the Ordinance other than an order against which a specific remedy is provided under the Ordinance, may prefer an appeal to the Commissioner (Appeals) against such order".
5.9 DECISION IN APPEAL BY THE COMMISSIONER (APPEALS) -SECTION 129
5.9.1 Through Finance Act, 2009 a time limit of 120 days from the date of filing of appeal has been specified for the Commissioner (Appeals) for disposal of appeals. However, this period of 120 days can be extended by another 60 days, for reasons to be recorded in writing by the Commissioner (Appeals).
5.9.2 On the other hand, the provisions regarding notice by a taxpayer to the Commissioner (Appeals) for disposal of an appeal remains unchanged to 4 months from the date of filing of appeal, which does not cater for the extended 60 days time limit available with the Commissioner (Appeals).
The ambiguity needs to be appropriately redressed.
In section 129(4) the time limit has been stated in days, whereas in the corresponding sections 129(5) to 129(7), these are stated in months
In order to bring uniformity, in section 129(5) to 129(7) the time limits be stated in days instead of months.
5.10 APPOINTMENT OF THE APPELLATE TRIBUNAL - SECTION 130(8A) AND 130(8AA)
In these new sections added through Finance Act, 2009, the word 'Chairman' has been used instead of 'Chairperson' as used in the corresponding sections.
The word 'Chairman' should be substituted by the word 'Chairperson'.
5.11 ADVANCE INCOME TAX - SECTION 147(6A)(b)
5.11.1 Advance tax on taxable income - Section 147(1)
Two types of advance tax payment are now envisaged, ie, advance tax against taxable income (Section 147(1)) and advance tax against certain capital gains (Section 147(5B)).
Sections 147(1) does not operate to the exclusion of section 147(5B), which is erroneous.
Appropriate amendment of section 147(1) to exclude certain capital gains against, which advance tax is payable under section 147(5B).
5.11.2 Advance tax on taxable income - Section 147(4B)
Section 147(4B) provides for the formula of calculating the amount of quarterly advance tax payable by an individual.
Under section 147(1)(c), salary income subject to deduction of tax at source under section 149 is excluded for the purposes of payment of advance tax and similarly in the component "B" of the formula given in section 147(4B) tax deducted under section 149 can not be deducted from the each quarterly instalment.
Accordingly, the advance tax payable should have been the proportionate tax attributable on taxable income as reduced by income from salary. Contrary to this the component "A" of the formula given in section 147(4B) requires to pay advance tax equal to the tax assessed for the latest tax year which is inclusive of tax on income from salary as well.
In component "A" of the formula given under section 147(4B), the words "tax assessed" should be substituted by the words "proportionate tax attributable on taxable income excluding income from salary assessed".
5.11.3 Advance tax on taxable income - Section 147(6A)(b)
Under clause (b) of section 147(6A), a company is entitled to 'make adjustment for the amount (if any) already paid'. The words 'make adjustment for the amount (if any) already paid' are ambiguous.
The words "make adjustment for the amount (if any) already paid" should be substituted with the words "make adjustment of tax already paid for which a tax credit is allowed under section 168".
5.12 IMPORTS (COLLECTION OF TAX AT SOURCE) - SECTION 148(8)
Through Finance Act, 2009, tax collected at source on import of 'packing material' has been made minimum tax. A plain reading of the amended section reveals that 'packing material' imported by any one is subject to minimum tax. However, contrary to the provisions of the law, Para 32.2 of Circular No 3 of 2009 states that by virtue of this amendment the import of packing material by manufacturers of edible oil, will be subject to minimum tax. The amendment made last year is against the intent as explained in Para 32.2 of Circular No 3 of 2009. Accordingly, section 148(8) of the Ordinance needs to be suitably amended to reflect the true intent to avoid any misconception.
In section 148(8) after the word 'oil' a semicolon should be inserted and after the word 'material' the words 'imported by the manufacturers of cooking oil or vegetable ghee or both' be inserted.
5.13 PAYMENTS TO NON-RESIDENTS - SECTION 152(3)(a)
This clause excludes payments to non-residents from the operation of section 152(2), which are otherwise covered under other provisions of the Income Tax Ordinance, 2001. Specific provision also exists for payment to non-resident media persons under section 153A of the Income Ordinance. However, the same is not mentioned in this sub-section.
In section 152(3)(a) after the figure and comma '153,' the figure, alphabet and comma '153A,' be inserted.
5.15 EXPORTS (DEDUCTION/COLLECTION OF TAX AT SOURCE) - SECTION 154(3C) AND FIRST SCHEDULE - PART III - DIVISION IV
The Collector of Customs has been empowered to collect tax at source from the gross value of goods at the time of clearing of goods exported [section 154(3C)] in addition to an authorised dealer in foreign exchange at the time of realisation of foreign exchange proceeds on account of export of goods by an exporter [section 154(1)].
A plain reading of the section 154(1) and 154(3C) reveals that the tax on export of goods will be collected twice, once at the time of clearing of goods and again at the time of realisation of export proceeds of such goods. Although, this is not the intent of law as explained in Para 36 of Circular No 3 of 2009 that sub-section 154(3C) applies only on clearing goods for export made without form "E". However, the sub-section inserted is silent as to what has been explained in Circular No 3 of 2009.
In section 154(3C), after the word 'exported' the words "without Form 'E'" or the words 'through land routes' be inserted.
5.14 CERTIFICATE OF COLLECTION OR DEDUCTION OF TAX AT SOURCE
5.15.1 Section 164(1)
A withholding agent collecting or deducting tax at source is also required to provide the copies of tax deposit form (challan) of the tax duly deposited on behalf of the person from whom it is collected or deducted or "any other equivalent document".
The Ordinance and the Rules are silent as to what is meant by 'any other equivalent document'. This will be open to different interpretations and continuity of the problem of allowing credit of tax or refund of tax collected or deducted at source, particularly in case of utility bills, book transfers by government departments / banks in respect of profit on debt
and cash withdrawal, etc.
The term "any other equivalent document" should be defined in section 164(1).
5.15.2 Section 164(2)
The sub-section on one hand requires submission of the tax deposit form (challan) in respect of tax collected or deducted at source along with the return and on the other hand states that the certificate of tax collected or deducted in the prescribed form shall be treated as sufficient evidence thereof, which is a contradiction.
The contradiction in section 164(2) needs to be removed.
5.16 CREDIT FOR TAX COLLECTED OR DEDUCTED AT SOURCE - SECTION 168(3)
This section deals with the tax collected or deducted for which credit is not allowed since the tax collected or deducted is a final tax. As per Finance Bill 2009, tax collected on import of goods was excluded from the ambit of final tax and made 'minimum tax' and accordingly, the corresponding amendment in this sub-section was also proposed. However, as per Finance Act 2009, the tax collected on import of goods continues to remain a final tax and as such the amendment in this section (omission of 'sub-section (7) of section 148'), which effectively means that credit of tax collected on import of goods will be allowed is an editorial mistake/error.
In section 168(3) after the word 'under' the words, brackets, numbers and commas 'sub-section (7) of section 148,' be reinserted.
5.17 PROSECUTION FOR NON-COMPLIANCE WITH CERTAIN STATUTORY OBLIGATIONS -
SECTION 191 Under sub-section
(1) non-compliance of statutory obligations results in prosecution proceedings which may result into a fine or imprisonment for one year or both and under sub-section (2) a further fine or imprisonment for two years or both if the compliance is not made within the time allowed by the court.
Sub-section (2) dealing with a further fine or imprisonment or both, after the amendment made through Finance Act, 2009, provides for a maximum limit of fine of Rs 50,000 while sub-section (1) continues to remain open ended as to the quantum of fine.
In section 191(1) after the word 'fine' the words 'not exceeding fifty thousand rupees' be added.
5.18 POWER TO COMPOUND OFFENCES - SECTION 202 AND CONDONATION OF TIME LIMIT - SECTION 214A
In these sections the words 'Director General' have been used but there is no authority known as'Director General' under the Ordinance.
The words 'Director General' should be replaced by the words 'Chief Commissioner' in the above sections.
5.19 DEFAULT SURCHARGE - SECTION 205
The rate of default surcharge in sub-section 1, 1A, 1B and 3 of section 205 is given at KIBOR plus three percent per quarter.
KIBOR rate is an annual rate to which adding 3% per quarter is superfluous. It may be noted that in the corresponding provisions of the Sales Tax Act the correct words ie "KIBOR plus three percent per annum" have been used.
Further, there is some confusion in the interpretation of the period for calculation of default surcharge under sub-section (1B). Currently the calculation of default surcharge starts from 1st day of April, which is not correct as the last date of instalment would be different in case of special income year.
In sub-section 1, 1A, 1B and 3 of section 205 the words "per quarter" should be substituted by "per annum" In sub-section (1B) the period of default should start from the due date of the last instalment to the due date of filing of return.
5.20 ELECTRICITY CONSUMPTION (COLLECTION OF TAX AT SOURCE) - SECTION 235(4)
In case of non-company taxpayer, tax collected along with electricity bills is a minimum tax where the monthly bill amount does not exceed Rs 30,000 and adjustable tax where the monthly bill amount exceeds Rs 30,000. As a result such tax collected during the year is partly minimum tax and partly adjustable tax depending upon the each month bill amount. Accordingly, each and every bill for a month has to be seen to establish which is the 'minimum tax" and which is the 'adjustable tax'. It is not a simple job, both for the taxpayer and the department, and it becomes more difficult where more than one electricity connection is involved.
In section 235(4) instead of threshold of Rs 30,000 of each electricity bill amount an annual threshold of Rs 360,000 on total expenditure of electricity should be prescribed for the purposes of determining whether the annual tax collected is minimum tax or adjustable tax.
5.21 RATES OF TAX FOR INDIVIDUALS - CLAUSE (1) OF DIVISION I OF PART I OF FIRST SCHEDULE
In the First Schedule - Part I - Division I - Clause 1, the words "to which sub-section (1) of section 92 applies" are redundant after omission of the words "or association of persons" through Finance
In Clause (1) of Division I of Part I of First Schedule the words "to which sub-section (1) of section 92 applies" should be omitted.
5.22 "ZERO" TAX THRESHOLD FOR WOMEN TAXPAYER - FIRST PROVISO TO CLAUSE (1) OF DIVISION I OF PART I OF FIRST SCHEDULE
Through Finance Act, 2010 the "zero" tax rate threshold for non-salaried and salaried individual was raised from Rs 100,000 to Rs 300,000 by substitution of Table under clause (1) and (1A) of Division I of Part I of First Schedule.
The enhanced "zero" tax rate threshold available to a salaried women taxpayer under First Proviso to Clause (1A) of the said Division was also omitted. Inadvertently, the corresponding First Proviso to Clause (1) of the said Division for a non-salaried women taxpayer was not omitted.
The First Proviso to Clause (1) of Division I of Part I of First Schedule should also be omitted.
5.23 EXEMPTION OF INCOME OF WORKERS' PROFIT PARTICIPATION FUND - CLAUSE (66) OF PART - I OF SECOND SCHEDULE
Exemption of the income of the WPP Fund is exempt under the WPP Fund Act which was accepted under the Ordinance by virtue of Proviso to section 54 of the Ordinance as it stood before an amendment brought in through the Finance Act, 2008. However, through the Finance Act, 2008 the proviso to section 54 of the Ordinance was omitted.
As a result exemption provided to the income of the WPP Fund under the WPP Act lost its applicability, which appears contrary to the entire Scheme.
The WPP Fund itself is not an entity engaged in any profit earning activity for the reason that the sums available to it are either to be paid to the workers or deposited with the Government. It is for this reason that the relevant Act provided exemption to a WPP Fund and such exemption was also protected under the Income tax law.
The amendment in section 54 of the Ordinance as discussed above jeopardised a number of entities which were exempt from Income-tax under various statutes other than the Income tax law. Accordingly, certain sub-clauses were inserted in Clause (66) of Part I of the Second Schedule to the Ordinance granting exemption from Income Tax to entities which were enjoying such exemption under respective statutes after the proviso to section 54 of the Ordinance was withdrawn. However, due to an oversight the exemption of income of WPP Fund could not find its place in Clause (66) of Part - I of the Second Schedule.
In view of the above it is imperative that a corresponding amendment should be made giving exemption to the income of WPP Fund established under the WPPF Act. Accordingly, it is proposed that the following sub-clause be reinserted in Clause (66) above after sub-clause (xxiii) - "(xxvi) Workers Participation Fund established under the Companies Profits (Workers Participation) Act, 1968."
5.24 MINIMUM TAX - SECTIONS 148(8), 153(6) AND 235(4)
The above sections read as under:
Section 148(8) - The tax collected from a person
under this section on the import of
edible oil and packing material for
a tax year shall be minimum tax.
Section 153(6) - Provided that tax deducted under
sub-clause (b) of sub-section (1) of
section 153 shall be minimum tax
Section 235(4) - in the case of a taxpayer other than
a company, tax collected upto bill
amount of thirty thousand rupees
per month shall be treated as minimum
tax on the income of such persons
and no refund shall be allowed
The first two sections do not clearly indicate whether this minimum tax is on the overall income [ie taxable income (normal income), income subject to final taxation and income subject to fixed tax as a separate block of income] or the proportionate tax attributable on such incomes.
On the other hand in section 235(4) the words used are 'minimum tax on the income of such persons', which read with the definition of income in section 2(63), clearly means that this is the minimum tax on the overall income [ie taxable income (normal income), income subject to final taxation and income subject to fixed tax as a separate block of income].
For the sake of simplicity and uniformity, the aforesaid minimum taxes should be on the overall taxable income excluding income subject to final tax and fixed tax and in order to remove the ambiguity, sections 148(8) and 153(6) needs to be appropriately amended.
5.25 RULE FOR TAXABILITY OF FEE FOR TECHNICAL SERVICES OF NON-RESIDENTS - RULE 19
Rule 19 is in contradiction to scheme of taxation laid down in section 6. Proviso to Rule 19(1)(c) provides option to non-resident person to elect for presumptive tax regime, whereas it is not permissible under section 6. Thus, this Rule overrides the sanctity of the Ordinance. A similar proviso in Rule 18 already stands deleted by SRO 590(1)/2004.
The option should be withdrawn. Alternatively, option should be provided in section 6 with a time limit of 90 days for filing of option.
6. LABOUR LEVIES
During the first tenure of the present government in 70's, labour levies were introduced to let the labourers share the benefit in the profits of the companies. Nevertheless, over the last three decades, such levies have been abused in such a manner that this social benefit has become a tool for exploitation in the form of high tax rate. In Pakistan, the effective corporate tax rate is 35 percent plus 2 percent Workers' Welfare Fund (WWF) and 5 percent Workers' Profit Participation Fund (WPPF). This effectively makes the rate equal to 42 percent which may be one of the highest corporate tax rates in the world. There is a need to immediately review the same.
Consolidation of all labour levies with a rate of 2 to 3 percent in line with regional standards.
6.2 WORKERS' WELFARE FUND [WWF]
Every business establishment is required to pay a 2 percent WWF at higher of returned income or accounting profit. This is a straight levy. The amount is collected along with the income tax.
This levy effectively places the profitable organised sector at serious disadvantage viz-à-viz unorganised sectors which are prone to under declaration of income.
The amount collected is apparently handed over to the Ministry of Labour to be utilised for the welfare of the workers. We are not aware of any instance where labourers employed have directly or indirectly been benefited by any scheme undertaken out of such funds. This places serious question on the continuity of this levy. For effective use of WWF it is advised that the employers be allowed to retain certain portion of the contribution enabling them to make investments for welfare of workers.
Workers Welfare Fund is levied under Workers Welfare Ordinance 1971 on all industrial establishments operating in Pakistan. Upto 30th June 2008 it was levied as 2% of the total income as determined under the Income Tax Ordinance 2001. Certain changes were introduced in the Finance Act 2006 to amend the concept of total income. In order to implement the above change, further amendments were made in Section 4 of the above Ordinance by Finance Act 2008. The above amendments have changed the total scheme of Workers Welfare Fund and the burden of Industrial Establishment on account of Workers Welfare Fund has increased manifold.
Further, the scope of this levy has been extended to almost all entities by inclusion of establishments covered under the Shops and Establishment Act, 1969 in the definition of Industrial Establishment in the Workers Welfare Ordinance, 1971. Historically, this levy was restricted to 'Establishments'
where industrial labour/workers were involved. The amendment made has extended this levy to almost all establishments and has substantially increased the quantum of such levy as well.
Effect of Changes:
The concept of total income was changed and the same was defined to mean as under: total income" means:
"(i) " where Return of Income is required to be filed under this Ordinance, the profit (before taxation or provision for taxation) as per accounts or the declared income as per the return of income whichever is higher; and
where return of Income is not required to be filed, the profit (before taxation or provision for taxation) as per accounts or four per cent of the receipt as per the statement filed under section 115 of the Ordinance, whichever is higher."
(ii) The effects of above change in the definition of 'total income' under the Workers Welfare Ordinance, 1971 are discussed as under:-
6.2.1 Taxpayers filing Return of Income
In case of income liable to tax under normal law the return of Income is required to be filed.
In such circumstances, the Workers Welfare Fund is payable at 2% of the income as per the accounts or income as per the Income Tax Ordinance whichever is higher.
It is to be noted that main difference between accounting income and taxable income arise on account of timing difference in claiming of depreciation allowances. In taxation law, initial depreciation is allowed on all new assets purchased by the taxpayer in addition to normal depreciation. Moreover, the rate of depreciation may also differ in accounting and tax laws. Therefore, the taxing higher of the both income would mean that the taxpayer will be denied the genuine expense of depreciation. In other words, the Workers Welfare Fund would be charged without allowing deduction of major expense in shape of investment made in the project. Therefore, the Workers Welfare Fund would be payable on income which is not real income of the industrial undertaking. The above treatment is not legally tenable and is also against the spirit of Workers Welfare Fund which allows the workers to participate in genuine profits of the industrial undertaking.
Moreover, under the International Financial Reporting Standard, the income of the subsidiary/associated company is also clubbed in the accounting income of the holding company under equity method. Therefore, in these circumstances, accounting income and holding company may include income of subsidiary, which has either itself paid the Workers Welfare Fund on its income or is not an industrial undertaking at all. Under the new scheme, the company will be burdened to pay Workers Welfare Fund on income of subsidiary which is totally unreasonable and not legally tenable.
6.2.2 Taxpayers filing Statement of Final Tax (PTR cases)
This scheme is for all those cases which fall in the presumptive tax regime and are not required to file the return of income. Under the above regime the tax payer will be required to pay the Workers Welfare Fund on higher of profit as per accounts or 4% of the receipt. It practically means that even a loss making unit has to pay Workers Welfare Fund at 2% of 4% of receipt as the same will be higher in case the company is making loss as per accounts.
As discussed in (a) above, this treatment is against the basic concept of Workers Welfare Fund scheme and put extra burden on industrial undertaking.
The Workers Welfare Fund may be charged on a consistent basis based on taxable profit as under the old scheme.
Employers should be allowed to retain certain portion of the contribution enabling them to make investments for welfare of workers The pre-amended position be restored for restricting the levy to establishments where industrial labour/workers are involved for whose benefit the fund was originally established ie establishments covered under the Shops and Establishment Act, 1969 should be excluded;
Workers Welfare Fund should be charged on a consistent basis based on taxable
profit as under the old scheme.
6.3 WORKERS' PROFIT PARTICIPATION FUND [WPPF]
The Income Tax Ordinance, 2001 ("Ordinance") provides exemption in the hands of workers receiving sums out of the WPP Fund vide Clause (26) of Part I of the Second Schedule and allows deduction of the sum allocated to the WPP Fund by the Company vide section 60B of the Ordinance.
Under the law all business establishments are required to contribute a sum equal to 5 percent of the profit as WPPF. This amount is in principle required to be distributed amongst the workers of that establishment. However, due to constant and intentional bureaucratic mismanagement this share of labour in profit has been converted into a direct levy for such establishment.
This intentional mismanagement has been undertaken by placing unnatural and unreasonable restrictions on the distribution of such amount. Under the law only the workers getting salary of a very low level are entitled to receive any sum out of such fund. Any excess not so distributed amongst the workers is transferred to the Fund that effectively ends up with the Government. Thus for all practical purposes it is Government levy.
In the case of organised sector, the salary and wages of the workers are such that in almost all the cases workers do not get any sum out of WPPF. This is definitely not the objective of WPPF.
Allow the establishments to utilise the contribution of WPPF for the welfare of labour in the form of providing health, education and housing for the labour. This was exactly the intention of the law when it was introduced.
Enhance the threshold of worker's salary in line with current prevailing structure.
7. SPECIFIC INDUSTRY ISSUES
7.1 BANKS AND FINANCIAL INSTITUTIONS
7.1.1 Restriction on claim of provision for Bad debts
The Seventh Schedule was introduced through the Finance Act 2007 and provided agreed, practical and convenient procedure for the allowability of charge for irrecoverable debts to the extent of provisions created by banks under the Prudential Regulation which are applicable to all banks under the Banking Companies Ordinance, 1962.
After intermittent amendments, through Finance Act 2009, a restriction on claim of provision for bad debts has been placed at a maximum of 1% of total advances, whereas Finance Act 2010 introduced allowability of provision at 5% of total advances for consumers and SMEs. Provision if less than 1% is allowed on actual however, any provision in excess of 1% is allowed to be carried over to succeeding year, whereas, law is silent about carrying over provision of 5% for consumer financing bad debts.
The restriction on claim of provision for bad debt at 1% is too low in view of the Banking industry's NPL position, whereas especially in the case of consumer NPL, while carrying over of provision for consumer financing need to be allowed.
This measure of introducing changes in piecemeal has effectively withdrawn the very essence of Seventh Schedule which was primarily purported to brought in to address the issue of allow ability of bad debts.
The position of Seventh Schedule on bad debts before as enacted vide Finance Act, 2007 may be revived. However, if the above is not acceptable to FBR than the threshold should be relaxed to at least the following as suggested by Pakistan Banks' Association-2% for corporate loan bad debts Provision in excess of 5% for consumer financing bad debts be carried forward to succeeding year.
Carry forward of provision in excess of 5% to future years for Consumers and SMEs Loans Through the Finance Act, 2010, the Banking Companies have now been allowed to claim bad debts provisions for Consumer and Small & Medium Enterprises' (SME) advances and off-balance sheet items at 5% of total advances. However, due to inappropriate drafting of the amendment corresponding changes for carry over of claim of bad debts in excess of 5% limit is not clearly stated which may give room to improper interpret ation to restrict further carry forward of such unclaimed bad debts The last sentence of, and the proviso to, clause (c) of Rule (1) of the Seventh Schedule reads as under:
"Provisioning in excess of 1% would be allowed to be carried over to succeeding years".
7.1.4 "Provided that if provisioning is less than 1% of the advances then actual provisioning for the year shall be allowed."
The absence of reference to "5%" in the foregoing provisions of law implies that: the un-absorbed amount of provision for bad debts on Consumer and SMEs advances in excess of 5% in a year cannot be carried forward and adjusted against subsequent years; and the provision for bad debts on consumer and SMEs advances of less than 5% is not deductible.
This would be against the basic principle of law that gives every taxpayer a vested right to claim legitimate business expenses. Tax law may restrict the allowance of expense in a certain period but cannot take away the right of allow ability in toto.
The last sentence of, and the proviso to, clause (c) of Rule (1) of the Seventh Schedule should be suitably amended to remove the ambiguity.
Allow ability of 1% or 5% of advances as charge against Bad & Doubtful Debts
The Taxation Officers are interpreting total advances as 'Advances' shown on the face of the balance sheet which are net of provision for bad debts (non-performing debts) specifically created by the banks. This means an illogical calculation of admissible provision for bad debts on the net advances (gross advances minus provision made in the accounts) as shown on the face of the balance sheet instead of the gross advances. In other words, to exclude the provisions from the gross advances would be to disallow the actual provisions twice which cannot otherwise be claimed under any provisions of the Seventh Schedule.
An explanation should be inserted in Rule 1(c) of the Seventh Schedule that total advances means 'Gross Advances' before the accounting provisions for Bad & Doubtful Debts.
Transitional provisions - Rule 8A
184.108.40.206 Through the Finance Act, 2010, the Seventh Schedule was amended to include that amounts provided for in or prior to the tax year 2008 which were neither claimed nor allowed as a tax deductible in any tax year, will be allowed in the tax year in which such advances are actually written off against such provisions, in accordance with the provisions of sections 29 and 29A.
All such debts that have been written off are legally admissible deductions. In case they have not yet been allowed, all such claims should be allowed as a deduction. It is hard to comprehend a situation whereby a Bank can demonstrate that a write off of bad debts was neither claimed by the tax payer nor disallowed by the tax authorities.
Rule (8A) of the Seventh Schedule requires suitable amendment in order to avoid misinterpretation and removal of the ambiguity. It is the suggested that existing Rule 8A (1) be replaced with the following text:
"Amounts provided for in the tax year 2008 and prior to the said tax year for or against irrevocable or doubtful advances which were not allowed as tax deductible in any tax year, shall be allowed as a deduction in the tax year, when there are reasonable ground for believing that the debt is irrecoverable."
220.127.116.11 Reference to section 29A in Rule (8A) of the Seventh Schedule is misplaced as the same is no more applicable to Banking Companies vide amendments made through Finance Act, 2009.
Reference to section 29A in Rule 8A should be removed from the transitional
7.1.5 IAS 39 & 40 whilst arriving at Taxable income
The banking companies have not adopted and applied the requirements of IAS 39 and 40 in the preparation of their annual accounts, in view of the instructions issued by the SBP under BSD circulars. However, the taxation officer tends to amend the assessment on this account by invoking clause (g) of Rule (1) of Seventh Schedule and subjecting to tax the Mark-to-Market (MTM) adjustment by taxing the unrealised losses.
Since the applicability of IASs 39 and 40 have specifically been deferred by the SBP, the financial assets and liabilities of the banks are classified, measured and reported under the SBP's BSD circulars. Accordingly, additions made by the tax department on the plea that unrealised losses due to Mark-to-Market are in accordance with IAS 39 and 40 are both factually and legally incorrect. It would be completely absurd to presume that the requirements of these are in line with the measurement criteria of IAS 39 and 40.
Explanation should be added under Rule (1)(g) of the Seventh Schedule in order to avoid misinterpretation and removal of the ambiguity.
7.1.6 Auditor's Certification under Clause (c) of Rule (1) of Seventh Schedule
The charge for provision of bad debts in the financial statements is subject to verification by the external auditors', who also examine the adherence to the Prudential Regulations.
In the presence of an overall auditor's report (which also covers adherence to Prudential Regulations), the requirement of furnishing a separate auditors' certificate for the claim of bad debts is superfluous and duplication.
The requirements of furnishing a separate auditor's certificate should be dispensed with by making appropriate amendment in Rule 1(c) of the Seventh Schedule.
7.2 INSURANCE COMPANIES
7.2.1 Deduction of tax at source (as recipient)
In the case of banking companies subject to Seventh Schedule under Rule 5 (2), an exemption has been provided to banks from withholding tax as 'recipient' as such entities are all in organised sector and are subject to advance payment of tax.
It is recommended that same principle be adopted for the insurance companies.
Withholding tax on Maturity proceeds of Life Insurance Policies
Benefits paid out under life insurance contracts have always been exempt from income tax. In the recent past, however, the Income Tax Department have sought to pressurise life insurers to deduct withholding tax under Section 151(1)(d) of the Income Tax Ordinance 2001 from maturity values paid out on life insurance policies under the grab of section 151 of the Income Tax Ordinance, 2001. The relevant section is as follows:
7.2.2 Profit on debt:- Where
(d) a banking company, a financial institution, a company referred to in sub-
clauses (i) and (ii) of clause (b) of sub-section (2) of section 80, or a finance society pays any profit on any bond, certificate or debenture or instrument of any kind (other than a loan agreement between a borrower and a banking company or development finance institution) to any person other than financial institution. the payer of the profit shall specify tax at the rate specified in Division I of Part III of the First Schedule from the gross amount of the yield or profit paid as reduced by the amount of Zakat, if any, paid by the recipient under the Zakat and Ushr Ordinance, 1980 (XVII of 1980), at the time the profit is paid to the recipient."
The sub-section reproduced above clearly is meant to apply to financial instruments and not to policies of life insurance.
In order to remove any ambiguity it is suggested that a provision be included in the Income Tax Ordinance clearly stating that section 151 does not apply to any amounts paid out under a contract of life insurance.
A new sub-section - 151 (2A) should be introduced as under:
"This section shall not apply to any amount paid out under a contract of life insurance as
defined in Section 2(xxvii) of the Insurance Ordinance, 2000 (XXXIX of 2000)."
7.3 MANUFACTURING AND PHARMACEUTICAL SECTORS - TRANSFER PRICING
Throughout the world, fiscal regulations prescribe provisions relating to non-arm's length consideration and taxing the sum falling outside this purview. This is termed as taxation of 'Transfer Pricing'.
Through the Income Tax Ordinance, 2001 special provisions were introduced for that purpose (Section 108). These provisions are almost in line with the international best practices as laid down in the principles laid down by the Organisation for Economic Co-operation Development (OECD). Almost all the entities engaged in manufacturing sector, especially those in pharmaceutical group, were subjected to arbitrary additions to income on that account under the repealed Act. These additions were contested in appeals and some companies are engaged in protracted litigation. That experience has revealed that there is no deficiency or shortcoming in the law. The problems arose in implementation and arbitrary attitude of tax officials. Provisions relating to non-arm's length consideration were streamlined in the Income Tax Ordinance, 2001. Furthermore, it has been specifically provided that such laws will be implemented in line with the guidelines laid down by OECD.
Since the introduction of the Income Tax Ordinance, 2001 there are very few cases where tax proceedings have been finalised under the new provisions of the Ordinance. All the cases from Tax Year 2004 to Tax Year 2008 are effectively exposed to action by the tax officers on that matter. It is considered that unless well laid down processes and procedures are agreed upon between tax officials and the taxpayers in accordance with the principles laid down by the OECD, it is expected that problems which arose under the repealed Act are expected to be repeated notwithstanding the improved and well laid down laws. That eventuality has to be avoided.
The institute can undertake an effective role in the implementation of revised and improved provisions relating to non-arm's length consideration. It has been experienced throughout the world that fiscal issues relating to non-arm's length consideration are matter of determination of fact rather than application and interpretation of any law. OECD model also supports the same principle.
It is suggested that an exercise and then agreed upon processes be undertaken to prescribe the procedures for implementation of fiscal measure for taxing non-arm's length transactions.
We understand that the Government of Pakistan is mulling over the idea of imposition of wealth tax which was abolished in the year 2000. The Institute is of the view that it would not be advisable to again introduce the above law due to following reasons:
The wealth tax law is a regressive form of taxation as it taxes the wealth which has already suffered taxation in the form of income tax. This means that every paisa that you earn and is offered to tax under the Income Tax Ordinance 2001 would be subject to tax again as a part of your wealth each year. So, except for the income consumed the rest of the saving goes into the net of wealth tax.
This tax actually penalises and burdens the tax payer for his honesty and diligence to pay the income tax, while a person outside the net still enjoys the immunity as before. Therefore, this tax acts as deterrent for the taxpayer to declare true income for the fear that the same would result into perpetual taxation and saving in the form of wealth tax.
The above conclusion is based on assumption that the FBR will fail to discover new taxpayer outside the net. Because if we assume that it can unearth wealth outside the net then there would be no case for wealth tax as it would generate enough income tax to cover any short fall.
After abolishment of the wealth tax, there has been an improvement in the trend of the declaration of assets amongst the tax payer. If a comparison is carried out by the FBR for wealth declaration made by the tax payer after the year 2000, they will witness a manifold rise in the declared net worth. This has helped in documentation of the economy and honest declaration by the tax payer.
The wealth tax if levied would reverse this trend and might prove to be counter productive.
Another important aspect which should be considered is the cost of collection of the above tax and, therefore, a cost benefit analysis may outweigh the proposed revenue stream. The total expected collection should be compared with the cost that would be required to collect the above tax including the cost associated with litigations and dispute resolutions. The comparison would provide a good guide toward the efficacy of revenues to be generated from the above tax.
We are of the view that human resources of FBR will also be burdened by enactment of above law.
The revenue collecting agency is already under pressure for quality resources and capacity for effective implementation of Income Tax and Sales Tax Regimes both in the shape of broadening tax base conducting effective audit and enforcement & collection process. Therefore, burdening the Board with this additional work might affect the other two revenue generating streams which are much more important for economy and future progress of the revenue growth.
Wealth Tax is a tax which has been discarded in most of the jurisdiction of the world due to being counter-productive. The adoption of such a tax would be against the international trends and hence requires more due diligence.
We are of the view that if at all the same is to be considered, then, it should be restricted to those assets which are unproductive and do not contribute to growth of the economy. Therefore, all investments in the shape of capital, shares, advances to business etc. should be out of its purview.
Similarly, all those assets which generate income and offer tax on the same should be out of purview, like properties income being offered to income tax and subjected to property tax under the Provincial Law. However, all the unproductive assets such as jewellery, cars, plots, more than one self- occupied property etc should be subjected to the above tax. The taxpayer should be allowed liberal exemption for self-occupied house or Rs 10 million keeping in view the current rate of inflation.
1. INDIRECT TAXES
1.1 BROADENING THE TAX BASE
1.2 WITHHOLDING SALES TAX
The tool of withholding tax should be used for broadening the tax base in the indirect tax regime. An attempt was made to adapt the instrument of sales withholding tax in mid of Year 2009 when the government amended the Sales Tax Withholding Tax Rules 2007 vide SRO 309(I)/2009. According to such SRO, the definition of 'withholding tax agents' was enlarged to bring public sector organisations and taxpayers falling within the jurisdiction of Large Taxpayers Unit. All such withholding tax agents were required to withhold sales tax at applicable rate(s) on all of their purchases from non-registered persons. Later on, upon insistence from LTU Taxpayers, such condition was withdrawn by the Government.
An analysis of the sales tax registrations made during such period during which the aforesaid stipulations remained in the statute, reveal that substantial unregistered businesses came into the tax net to avoid unnecessary cut in their profits. Therefore, it is suggested that the concept of tax withholding by existing taxpayers may be restored and made applicable on all taxable goods /services supplied / rendered by unregistered persons to registered taxpayers.
1.3 RATE OF SALES TAX
The tax rate is quite high which is adding fuel to inflation. Sales Tax @ 17% combined with Special Excise Duty @ 2.5% is effectively resulting in an effective incidence of 19.5% indirect tax being passed on to consumers. Thus, it is vital that a strategic review of sales tax rate may be made and the same may be brought down to 12.5% instead of 17% over a suitable period of time.
SALES TAX ON SUPPLY OF SUGAR
In line with the amendments brought in vide Sales Tax Amendment Ordinance 2011, the rate of sales tax on supply of sugar should be restored @ 17% instead of 8%.
1.4 TURNOVER TAX FOR RETAILERS
The scheme of Turnover Tax for Retailers announced in 2006 has failed to achieve its desired objectives despite a very low rate of tax and very simplified procedure. The number of retailers registered under the scheme, are in hundreds which speak volume about the ability, resources and political will to implement VAT in its classical form in this country. We feel that sale tax cannot be effectively implemented without extending the same to the retail sector. Therefore there is an urgent need to review the above scheme. We are of the view that in an ideal VAT mode the same cannot continue and should be withdrawn and retailers may be taxed under the Normal Tax Regime.
2. POLICY FRAMEWORK
2.1 TAXATION OF INDUSTRIAL SECTOR VS. TRADING
Unlike all the developing countries of the world, Pakistan does not offer any substantial protection to its manufacturing / industrial sector. Consequently, generally businesses prefer to operate as traders and enjoy associated tax / duty benefits. To address the growing inflation, unemployment and shrinking business environment, not only the rate of indirect taxes needs to be reviewed but also indigenously manufactured goods should be made competitive against imported goods.
2.2 SALES TAX ON SERVICE SECTOR
At present around 35% to 40% of the GDP is contributed by the services sector. However, service sector's contribution to overall revenue collection is substantially disproportionate.
Sectors such as Transport, Media, Professionals, etc are effectively outside the ambit of sales tax regime. Lack of collection from such sectors places extraordinary pressures on the manufacturing sectors as whole collection is directly or indirectly concentrated there. There is a need to place in operation a comprehensive package for VAT encompassing all sectors
and segments of the economy specially the services sector.
2.3 IMPORT PRICE / MINIMUM VALUE ADDITION / IMPLIED WHITENING OF INCOME
Pakistan is effectively the only country in the world where whitening of black money is possible with a minimal cost equal to the presumptive tax. The negative effect of this system is a major handicap in development of tax base and documentation. This has been explained as under:
Under and over invoicing has become a very serious issue which is badly affecting the collection of taxes at import stage. Under invoicing also promotes outflow of differential proceeds via Hundi / Hawala, which is detrimental to the economy.
In view of value addition tax scheme offered to commercial imports coupled with immunity from audit, there is effectively a ceiling on the genuine value addition as very few businesses declare actual value addition which leads to serious distortion.
Implied whitening of income by way of paying 6% Income Tax & 18% Sales Tax and declaring any sale price which is final liability for Income Tax purposes is another aspect which needs to be addressed on war footings.
Value Addition tax @ 2% was levied to ensure Government revenue which otherwise is leaked on supply chain dealing in imported goods. However, in view of the above factors, a substantial part of manufacturing sector is presently induced to operate [in the absence of conducive environment]
in the unorganised sector to avoid standard tax regimes.
This mechanism is not correct in principle, however, unless there is an overhaul or introduction of sales tax on the whole supply chain, this seems to be the only measure to collect tax from such sectors.
In line with VAT International Best Practices, Value Addition Tax / Minimum Value Addition Regimes should be abolished forthwith. Besides, associated audit immunity should also be withdrawn.
2.4 INTEGRATION OF DATA BASE
There is a need to integrate the data base of SECP and FBR in order to identify and ensure the
corporate entities registered with the SECP are duly included among the tax payers (if applicable).
3. AMENDMENTS IN SALES TAX ACT 1990
3.1 RATE OF TAX
The general rate of sales tax is 17%. There is an additional 2% value addition tax on commercial imports.
Originally the rate of sales tax was 12.5% which was enhanced to 15%, then 16% on account of merger of octroi on its abolition. Finally, it landed at 17%.From an economic context, especially in relation to the present state of affairs there is a need to review the present rate of VAT in Pakistan.
This matter will be more clearly appreciated on the review of the composition of total collection and sectors contributing to the same. There is no general consensus on the rate of VAT around the world. However, it has to be appreciated that in the region being China, India, Thailand, Malaysia and UAE, there is no or much lesser incidence of VAT in the form of sales tax. For example, in India it is provincial subject with a straight tax rate of around 5% to 10%. In China, there is effectively no VAT. The only country in the region with a full fledged VAT is Bangladesh where the incidence
is closer to Pakistan.
The amended definition of the term 'supply' does not include "Other Disposition" as part of supply.
"Other Disposition" was discussed in para 1(E) of Sales Tax General Order (STGO) No 2/2004
dated 12 June 2004 wherein the FBR had opined that return of goods by the vendor back to the
principal tantamount to "Other Disposition" and accordingly liable to sales tax. It appears that Toll Manufacturing is now out of the tax ambit.
Besides our contention as above, the Sindh High Court, in case reported as 2006 PTD 1459 has also declared that no sales tax is payable by the vendor either on the value of goods returned to its principal or on the charges received for the conversion of goods made by him.
Since now Toll manufacturing is out of 'supply', it is suggested that Part I (E) of above STGO may also be withdrawn to avoid potential problems for the taxpayers during audit.
2(37) Tax Fraud
There is a need to review the definition of Tax Fraud.
Currently supply of taxable goods without getting registration with the department is treated as 'tax fraud' on the part of the supplier. Therefore a genuine businessman is facing problems to commence his business till the time he is awarded his sales tax registration number. On the contrary, supply of taxable goods without getting actually registered could penalise him with the most serious offence of 'tax fraud' under the Act.
2(44) Proposals for the Federal Budget 2011-12
Moreover, this is inconsistent with the exemption available to businesses having turnover lower than Rs 5 million during the last 12 months.
It would be more business friendly to encourage a new entity to start the commercial activity immediately without requiring for procedural compliance at the starting stage provided a bank guarantee for a requisite amount is provided and a registration is acquired within a stipulated time. Moreover, FBR may also consider allotting provisional Sales Tax Registration
2(46) Time of Supply
There is a need to clarify tax incidence on 'hire purchase' transaction. As it involves periodical instalments received/earned over a period of time, charging tax on full amount at the signing of hire purchase agreement is not justified and is in conflict with the definition of value of supply that is the consideration which the supplier receives from the recipient for the supply. Recommendation:
It is suggested to bring the chargeability of hire purchase transactions in accordance with the international practice and coherence (timing and the amount on which the sales tax is payable) ie tax should be levied at the time of payment of the instalments.
Value of Supply
2(46)(a) In terms of Federal Excise Notification 655(I)/2007 dated 29 June 2007, Special Excise Duty (SED) is not taken into account for the purpose of computing "value of supply" under Sales Tax Act 1990. This exemption is incorrectly placed in Federal Excise Law instead of Sales Tax and thus lacks due intended legal support
2(46)(e) To resolve the frequent disputes of under valuation by the registered persons, it is suggested that, identical to ADRC, a panel comprising of business community may be formed by FBR and all disputes regarding the value of supply may be referred to such
valuation committees under 2(46)(e).
3.3 PLANT, MACHINERY AND EQUIPMENT
With effect from 15 March 2011, zero-rating on plant, machinery and equipment including parts thereof whether manufactured locally or imported has been withdrawn. In this respect, necessary amendments have been made in SRO 549(I)/2008 dated 11 June 2008 and withdrawal of zero-rating has been made effective vide SRO 230(I)/2011 dated 15 March 2011. We understand levy of sales tax on capital goods may result in liquidity crunch for most businesses
since, on one hand, they will incur an additional cost @ 19.5% (sales tax @17% and SED @ 2.5%), while on the other hand, may only be allowed to claim sales tax in 12 equal monthly instalments with no adjustment against capital. goods being permissible in SRO 655(I0/2007 dated 29 June 2009. Hence, while the outflow of duty / taxes would be at once, the corresponding tax credit would be partial and in piecemeal.
To mitigate hardship to the acquirers of capital goods / fixed assets, it is recommended that tax credit on fixed assets full allowance may be allowed to the taxpayers in the tax period in which such capital items were imported / purchased.
3.4 REGULATION OF SALES TAX ON VAT PRINCIPLES - SECTION 7A
In an attempt to broaden the tax base, the Government has introduced minimum value addition schemes for different sectors ie importers, steel re-rollers and melters etc. The sales tax collected at import or local procurement stage is treated as full and final liability of such specified registered
persons. Charging sales tax in presumptive mode is a deviation from core VAT principles.
For the sake of simplification and compatibility with the core principles of VAT, it is proposed that the sales tax laws may suitably be amended by abolishing all fixed tax schemes.
3.5 TAX CREDIT NOT ALLOWED - SECTION 8
Input Tax Credit on Electricity and Gas consumed in Residential Colony of Independent Power Producers (IPPS)
The tax auditors have been objecting adjustment of input tax paid by the taxpayer on electricity and gas consumed in residential blocks of the factory where its production facilities are located. The tax department is of the view that this area falls under the mischief of section 8(1)(a) and thus such
claims of input tax are inadmissible.
For IPPs, the in-house consumption of electricity is also included in the overall cost of production, which is charged to sales tax when billed to WAPDA. Such in-house consumption justifies to be considered for sales tax exemption.
It is pertinent to note that the Customs Excise & Sales Tax Appellate Tribunal (CESTAT) has already allowed input tax credit related to electricity and gas consumed in residential blocks of the taxpayer's factory. Even otherwise such input tax very much becomes refundable to the taxpayer's since it is paid on workforce without which the factory operations cannot function. It is, therefore, suggested that suitable provisions may be added in the law regarding the issue.
3.6 CROSS VERIFICATION OF TAX - SECTION 8(1)(CA)
The provision of section 8(1)(ca) prescribes that input tax credit is not admissible to the registered buyer if the corresponding output tax was not paid by the supplier. In recent times, frivolous cases have been made when the FBR Web Portal failed to cross match the output tax in the tax return of seller and corresponding input tax in the tax return of the buyer.
Keeping in view the mechanism of e-filing recently introduced in sales tax laws, we understand cross matching of tax returns may not be possible due to:
Timing differences envisaged in Section 7(1) of the Act Erroneous reporting in tax return by Seller by treating the registered buyer as unregistered Reporting concessions available to few sectors like utility companies, etc Lack of communication between buyer and sellers.
In view of the above and to avoid frivolous litigation between the tax department and taxpayers, it is suggested that a Standard Operating Procedure (SOP) may be issued by FBR to cater all the foregoing factors and possible resolution in case FBR Web Portal fails to recognise payment of output tax paid by supplier.
3.7 JOINT & SEVERAL LIABILITY OF REGISTERED PERSONS IN SUPPLY CHAIN WHERE TAX IS UNPAID - SECTION 8A
This section requires that a registered person shall be made jointly and severally liable if the sales tax is not paid by the seller of the goods from whom the seller had purchased goods. In numerous cases, show cause notices have been issued and adverse orders passed under Section 8A against genuine businesses where the corresponding output tax was not paid by respective sellers. Based on such an anomaly, legitimate input tax was disallowed to such taxpayers without establishing collusion between the parties, which is the essence of section 8A.
It is strongly recommended that this section should be deleted as, in any case, registered person (purchaser) cannot be made liable if respective seller failed to pay sales tax. Further this section is also against the law of justice where a person is punished for an offense which he has not committed.
3.8 ADJUSTABLE INPUT TAX - SECTION 8B
The concept of minimum value addition across the board was first introduced in the statute vide Section 8B which primarily was inserted in the law to guarantee certain monthly cash flows to the exchequer in the form of sales tax.
Any provision requiring mandatory payment from taxpayers and deferring their legitimate refunds is not justified in any fiscal law. Even otherwise, with new tax measures recently announced by the Government, the tax incidence has gone up to a significant extent and Government revenues budgeted accordingly. Therefore, it is imperative that the sword of Section 8B may be removed
from the statute.
3.9 DEBIT / CREDIT NOTES - SECTION 9
In the present era where technology checks can be placed, as long as the registered person is able to prove the genuineness of original and revised transaction, no time limits may be imposed upon him under the rules for issuing credit and debit note or enjoying related tax credit / adjustment. At least, the minimum time period should be extended to 365 days.
3.10 REFUNDS - SECTION 10
3.10.1 Apart from the list of supportive documents prescribed in Rule 38 of Sales Tax Rules 2006, the department requires the refund claimant to furnish records, returns, accounts, statements, summaries pertaining to his suppliers to cross match the payment of output tax. Such departmental requirements are not backed by the statute or the rules. Further, under the law, the supplier is not bound to furnish his returns, summaries and other statutory declarations to his buyer. In certain reported and unreported judgements, the Appellate Tribunal Inland Revenue (ATIR) have held verification of transactions through STARR as not sufficient and have directed the tax officers to make human efforts for desired verifications.
To streamline the entire refund verification and sanctioning process particularly in the light of dictum of ATIR, the FBR should device necessary mechanism for the whole country in the light of the Section 10 and Sales Tax Rules 2006 thus ending practical hassles, liquidity problems for refund claimants and frivolous litigation pertaining to refunds.
3.10.2 Secondly, tax attributed to exports and zero rated supplies is refundable to the registered person. However, the law does not prescribe any formula / method of proration of input tax between exports and local supplies.
It is suggested that a formula / mechanism identical to the 'Apportionment of Input Tax Rules' should be introduced in the statute. Else the exporter may be allowed to carry forward entire excess input tax to the next tax period without any exception.
3.10.3 STARR system of FBR defers some of sales tax refund claims on ground of discrepancies in filing of sales tax returns on the part of suppliers of taxpayers. There was a procedure in place whereby sales tax officials used to overrule these objections on the basis of documentary evidences provided by taxpayers. FBR has now ceased accepting documents from taxpayers and system of manual overruling has been abolished. The department is planning to institute a new mechanism in which sales tax officials will update STARR system on their own by rechecking documents / returns submitted by taxpayers.
The new system is likely to be introduced after sometime. Till then, deferred sales tax refunds will be stuck with the Government. Therefore, it is suggested that manual over ruling system, should be reintroduced.
3.10.4 Allowable refund claim for a particular month has been restricted to 1% of total sales in case of textile companies. There is no provision in the law to that effect. Due to this a significant amounts of refund claims are denied every month.
The above practice, being ultra vires to the law, should be discontinued.
3.10.5 Some of deferred claims are released on the basis of replication of STARR system upon which some of the discrepancies in suppliers returns previously observed are removed. Further, taxpayers need updated status of their deferred refunds so that they can arrange documents from the suppliers to remove objections. Obtaining this status from departments is a herculean task and cause unnecessary delays.
To streamline the process, we suggest that such process can be expedited, or even automated, if view-only access to STARR system is granted to taxpayers on FBR portal.
3.11 ASSESSMENT OF TAX - SECTION 11(5)
The provision provides for a presumptive assessment in case the taxpayer fails to file the return.
The parameters of presumptive assessment may be made are defined in Para (I) of Part II of Sales Tax General Order 3 of 2004.
However, in numerous cases, the superior courts have held that any assessment on the basis of assumptions is not legal and permissible under the law. Therefore, it is suggested that this section and the related Para I of Sales Tax General Order 3 of 2004 may be deleted altogether. Section 11(5) is also not consistent with the provisions of section 36 of the Act.
FBR may also consider merging provisions of section 11 into section 36 to make it a more comprehensive section dealing with the assessment of tax under various circumstances.
3.12 DELISTING, BLACK LISTING & SUSPENSION OF REGISTRATION - SECTION 21
There should be proviso that before declaring any person as Blacklisted, the charge for issuing
fake invoice or committing tax fraud should also be established in the Order-in-Original rather than only in the show cause notice.
Further, input tax on account of purchases by a genuine buyer (from a subsequently declared Blacklisted person) should be allowable to the extent of purchase until Blacklisted declaration date, as the genuine buyer would have bought the goods in the good faith and no such, declaration was appearing on the FBR website at the time of purchases. There are numerous reported and unreported judgements by ATIR whereby the Tribunal has held that blacklisting may only operate prospectively and no retrospective effect may be given to deprive the buyer from his legitimate right of input tax.
3.13 RECORDS - SECTION 22
While conducting audit under Section 25, the tax officers usually demand records / information which is not specified under Section 22 of the Act or the Sales Tax Rules 2006. For instance, apart from prescribed sales tax records, auditors usually demand income tax returns, cost audit report, etc which is not permissible in any fiscal statue. Consequently, tax demands have been created on the basis of such extra records submitted by the taxpayers before tax auditors.
In is notable that the ATIR has already held that sales tax liability created on the basis of income tax returns, not specified in Section 22, is not legal and permissible.
(a) In sub- section 2(a) the word 'fiscal' be removed.
The FBR and Federation of Pakistan Chamber of Commerce & Industry (FPCCI) have already agreed upon records which may be sought by the tax administration during tax audit. This agreement was also made public vide FBR's letter dated 17 November 2001.
(b) It is suggested that the suitable amendments be made in section 22 of the Act by incorporating the above FBR letter as part of the statute.
3.14 REVISED RETURN - SECTION 26
It is suggested that necessary amendments may be made and reference of section 27 may also be incorporated in section 26(3) of the Act so as to enable the taxpayer to rectify any omission in the special return.
3.15 ADDITIONAL TAX / DEFAULT SURCHARGE - SECTION 34(1)
It should be clarified that in case of past cases (cases related to all preceding years) additional tax will be levied at the rate presently applicable as default surcharge subject to a maximum of principal tax liability.
Simultaneous levy or penalty and additional Tax under the Act may need to be removed, being unjustified, since both the provisions are of punitive nature. There should be only one penalty on a single default. Moreover, default surcharge should not be charged on an inadvertent error as was the case of additional tax.
3.16 RECOVERY OF TAX NOT LEVIED OR SHORT LEVIED OR ERRONEOUSLY REFUNDED -
It should be clarified that section 36(1) will apply in case of 'tax fraud' only.
3.17 POWER TO ARREST - SECTION 37(A)
This section should only be applicable where the case of tax fraud has already been established at the stage of Order-in-Appeal.
3.18 APPEALS TO TRIBUNAL - SECTION 46
It is suggested that the condition of expiry of stay after six months be removed (by administrative instructions).
Further, in the larger interest of justice and fair play, the criteria for appointment of "Accountant Member" in the Appellate Tribunal may be modified. Accordingly, 'Accountant Member' may be the individual who is a 'Chartered Accountant' within the meaning of Chartered Accountants' Ordinance 1961 who
has been in tax practice for the last 10 years or more; a serving FBR Officer not below the rank of Grade 21.
Likewise, a 'Judicial member' may be a person who has been an advocate for the last 10 years with 5 years experience in tax practice.
3.19 APPEALS TO HIGH COURT - SECTION 47(8)
It is proposed that section 47(8), which allows stay to the extent of 6 months only, may be deleted.
3.20 LIABILITY FOR PAYMENT OF TAX - SECTION 58
The Section 58 dealing with the "Liability for payment of tax in the case of private companies or business enterprises" is not happily worded. Under the existing law a person who was a shareholder representing even one share can be held responsible for the liability of the company. Similarly a person who is a nominee director or employee director can be held responsible for the liability of the company.
In the Income Ordinance 2001 such matters are covered under section 139 which comprehensively deals with the liability both in case of company and association of persons. The section 139 needs to be replicated in the Sales Tax Act on the similar lines.
3.21 VERIFICATION OF TRANSACTIONS - SECTION 73
As per section 73 of the Sales Tax Act, 1990, Buyer will not be entitled to claim input tax credit, adjustment etc if the amount of related Sales Tax Invoice is not paid within 180 days.
The aforesaid provision is similar to a provision in Income tax Ordinance, 2001 which lays that if a liability is not paid within three years of accrual than its expense will be disallowed. The said Income Tax provision, however, allows the company to claim this expense when actual payment is made.
We understand that even in Sales Tax law when an expense is disallowed due to non-payment within aforesaid period it would be subsequently allowed when payment is actually made however; such a provision is not expressly included in law. Accordingly, it is suggested that a provision should be expressly included to the effect that any disallowed input on account of non compliance of section 73 be allowed to be claimed once sales tax liability is actually paid through prescribed banking channels.
3.22 SUPPLY TO EXPORT PROCESSING ZONES - FIFTH SCHEDULE
Sales tax at the rate of zero percent is applicable on supply of raw materials, components and goods for further manufacture of goods in the Export Processing Zone vide serial number 5 of Fifth Schedule to the Sales Tax Act, 1990. This means, supply of goods which are not used in manufacturing of goods in EPZ are not entitled to zero rating of sales tax.
The intention behind not allowing zero rating sales tax on goods used otherwise than in manufacturing / production was in the context of SRO 578 (I)/98 dated June 12, 1998 which interalia had disallowed input sales tax on building materials. Since now under the existing provisions of the Sales Tax Act, 1990 input sales tax is allowed on building material, it is proposed that zero rated sales tax supply may be allowed on building material to EPZ as well.
3.23 APPEAL EFFECTS
It is suggested that a new section be introduced to the effect that any issue decided by the Appellate Tribunal Inland Revenue, High Court or the Supreme Court will be given effect in the returns / orders for the subsequent period. If that order or decision is reversed then such assessment / returns be revised to that effect. This section should in principle be in line with section 124A of the Income Tax Ordinance, 2001. It may be noted that absence of similar provision leads to unwarranted litigation.
3.24 THIRD SCHEDULE
Third Schedule should be deleted. On items included in this schedule, sales tax is recovered from the manufacturer at the retail price which is against the concept of VAT. In 1996 amendments had been made to reduce number of items to three. In the recent past a regressive approach has been
adopted for the same that needs to be changed and items from the Third Schedule provisions be gradually deleted.
3.25 ACTIVE TAXPAYERS LIST - SALES TAX GENERAL ORDER 34/2010
The aforesaid Sales Tax General Order 34/2010 (STGO) has been issued in terms of section 55 of the Act and introduces a wider definition of 'non active taxpayers'. Besides, various serious repercussions have been listed therein when either such non active taxpayers carry out businesses or when business transactions are made with them.
We understand the STGO suffers from fundamental legal infirmity since, on one hand, the Act does not contain any specific definition or criteria whereby a taxpayer may be classified as 'non active', on the other hand, the STGO does not only lists down a self contradictory definition of 'non active taxpayers' but also specifies the repercussions if business is conducted by / with such taxpayers.
In short, the FBR has attempted to legislate an entirely new mechanism which obviously cannot be made under Section 55 through a General Order. In short, following are the various stipulations of STGO and legal defects thereof which, in our view, should be considered by the Government in the upcoming budget:
Stipulations of STGO Legal Defects / Comments
Every person who fails to file the return Usually FBR Web Portal suffers from system
under section 26 of the Act within the problems near the filing date which delays
prescribed period for two consecutive timely filing by the taxpayer. Nonetheless,
months has been classified as a Non Active no such cushion has been made in the
Taxpayer. STGO where the delay in filing is beyond
the control of businesses.
Secondly, this requirement is in direct conflict
with Rule 11(4) of Sales Tax Rules 2006
(the rules) whereby non filing of tax returns
for consecutive 6 months may lead to de-
registration of concerned taxpayer. A person
who fails to file any missing return within
15 days of notice issued to him can also be
classified as non active. However, it has
not been specified whether this reference
is made towards missing return in the
departmental data base or otherwise.
Anyone who fails to file any due Income Tax The term 'non active' has also not been
return under section 114 or who fails to file defined in the Ordinance.
the monthly withholding tax statement under Also, in the absence of any inter-tax / contra
section 165 of the income Tax Ordinance penal action prescribed in both Act and the
2001 for two consecutive quarters will also Ordinance, the proposed action under
stand disqualified as Non Active Taxpayer. STGO lacks due legal backing. In two
identical judgements pronounced by the
Appellate Tribunal Inland Revenue, it was
held that the department is not authorised
to use the data or information and figures,
supplied by the businessmen in their Income
Tax Returns, as basis for assessment of
sales tax liability.
Whosoever fails to respond to the The condition of filing invoice summary
discrepancy notice" or any other notice statements in no longer prescribed in the
issued by tax authorities within 15 days of statute since it was done away with 2 years
the issuance of such notice will also be back. Moreover, the clause regarding
treated as non active. The term discrepancy mismatching of invoices in taxpayers' tax
has been defined in STGO to mean return is also legally defective since such
mismatching of invoice summary statements mismatching is duly protected under section
between registered buyers and sellers, 7(1) of the Act which empowers the buyer
mismatching of import goods declaration in to claim his input tax credit in any of the 6
the sales tax return by the registered person succeeding tax periods to which the
vis.a.vis data furnished by the Customs or purchase relates.
any other discrepancy intimated by the tax
administration to the taxpayer .
Mismatching of Goods Declaration between Such mismatching could also be when a
taxpayer's records and that furnished by particular import was not recorded /
customs may result in penal action against uploaded by Customs' in its own database.
The discrepancy, sent to taxpayer's email Under Section 56, a notice shall only be
address or placed in his e-folder at efbr treated as having served to the taxpayer if
portal, will need to be removed by taxpayer it is personally delivered to him or his
getting himself 'audited' by tax authorities representative, sent by registered post or
or explaining his position. courier or served as prescribed under Code
of Civil Procedure 1908.
Even otherwise, the service of notices
through email is also likely to incite other
questions such as proof of service to the
taxpayer, date of email, etc.
In clause 2(vi) of STGO, the taxpayer is Interestingly, on other hand, clause 3(ii)
required to furnish reply against discrepancy requires him to furnish his reply within 15
notice within 15 days of issuance. days of the receipt of discrepancy notice.
Thus, STGO appears to be carrying serious
The taxpayer may be declared as 'non active' The absence of such a mandatory
without service of any formal show cause procedure is against all norms of natural
notice and associated appealable order justice and fair play and negates the
being served upon him. fundamental principle of equity which is the
basis of every taxation system.
The buyer procuring goods from Non Active No mention of the law under which the
Taxpayer would be deprived of related input department seeks to disallow the sales tax
tax credit in case he purchases goods from credit of a person if he fails to file his income
a non active supplier. In such a case, the tax return.
FBR's web portal would blink such message
whenever he tries to feed his purchases
over his tax return.
Taxpayers have been advised not to have The STGO has crossed the ambit of statute
any transaction with non-active taxpayers which categorically prescribes settlement
unless they are restored on active taxpayers of business transactions through banking
list on the recommendation of their respective channel only when the value of supply
tax office or appellate forum. The 'advice' exceeds Rs 50,000.
has also placed upon another restriction of
settlement of transaction with non active
taxpayers through banking channels even
if the value of goods is below the limit of Rs 500,000 prescribed in section 73 of the Act.
3.26 INITIATION OF RECOVERY ACTION - RULE 71
By virtue of Section 45B of Sales Tax Act 1990, the registered person aggrieved by any decision, may file an appeal within 30 days from the date of receipt of such order. However, on the contrary, under Rule 71 of Sales Tax Rules 2006, the proceedings for recovery of impugned tax may be initiated after 30 days from the date of order. This anomaly results in initiation of recovery proceedings where the registered person receives order after sometime from the date of order and he still enjoys right of appeal under section 45B of the Act.
Therefore, to make harmony and in the spirit of natural justice, Rule 71 may be amended to provide commencement of recovery proceedings after 30 days from the receipt of order.
4. FEDERAL EXCISE ACT 2005
Excise duties are, in principle, levied to curb consumption of luxury and unwarranted products. Nevertheless, that general principle is being seriously violated in Pakistan. There are excises on many essential items. There is a need to determine the equitable basis for commodities and services which should be subject to the levy of Federal Excise. At present, Federal Excise is effectively an additional indirect tax on major manufacturing sectors. This high incidence of indirect taxation encourages evasion. It is due to this reasons that there is very high evasion of taxes in those sectors
where both excise duty and sales tax is leviable. This also promotes manufacturing in unorganised sector eg paints etc.
There is a need to review the issue of overall incidence of indirect taxes so that possibilities and comparative advantages for evasion are reduced or minimized.
4.2 ADJUSTMENT OF DUTY - SECTION 3A & 6
Under section 6, Federal Excise Duty is adjustable only if the registered person holds a valid proof to the effect that he has paid the price of goods purchased by him including FED and received the price of goods sold by him including FED through banking channels. The condition of payment and receipt is creating lot of problems for the taxpayers. On the other hand, Special Excise Duty is adjustable on payment basis.
To bring harmony among FED and SED, it is suggested that both FED and SED should be made adjustable on accrual / paid basis as per section 7 of Sales Tax Act 1990. Further the duty adjustment should not be made subject to receipt of sale proceeds and related duty.
Secondly, FED paid on excisable goods, which are used directly as input goods for the manufacture of dutiable goods, is adjustable against the final liability. On the other hand, SED paid on industrial inputs is adjustable against the SED chargeable on the goods manufactured there from. The term
'industrial input' has not been specified under the law.
In the absence of any definition of 'industrial inputs', it could be construed to include everything consumed for the business activity like spares, printing, stores, equipment, etc. In order to avoid litigation on this account, it is suggested that the term 'industrial inputs' may be defined in the law.
4.3 DEBIT / CREDIT NOTE - RULE 14A
Identical to section 9 of Sales Tax Act 1990, Rule 14A also allows adjustment(s) in tax invoice or return for dutiable goods. However, the benefit of such Rule has not been extended to dutiable services.
It is suggested that necessary amendments may be made in Rule 14A to include reference of dutiable goods and dutiable services.
4.4 MANDATORY PAYMENT BEFORE FILING APPEAL - SECTION 37
Before preferring appeal before Office of Commissioner (Appeals) or Appellate Tribunal, a taxpayer
is required to deposit the impugned duty demanded or penalty imposed in the appealable order. This mandatory compulsion is considered as a hindrance in the dispensation of justice.
The identical provisions in Income Tax and Sales Tax have already been repealed. Therefore, it is suggested that the same should also be removed from the excise law.
5. SPECIFIC INDUSTRY ISSUES
5.1 INPUT TAX ADJUSTMENT UNDER SALES TAX & FEDERAL EXCISE DUTY
An effective VAT system requires taxing the whole supply chain and credits for all taxes borne at input stage. In Pakistan, on account of the weaknesses, as briefly identified in the earlier paragraphs, distortions have been created in that system. As a result in many cases credit or input taxes are treated as inadmissible, whilst determining the overall tax l iability. This results in effective higher rate for sales tax and federal excises.
This problem, like many others in our system, emanates on account of improper implementation rather than any provision of law. It is required that implementation issues in the admissibility of input tax in sales tax be resolved and proper guidance on that matter be obtained from other countries where such systems are effectively in operation. The best examples are UK in the developed world and Bangladesh in our region.
The status in case of Federal Excise duty is different. In that case in many sectors the input tax is effectively not allowable under the law. This places the said tax outside the ambit of VAT regime. In that situation as a measure of policy it needs to be decided by the Government whether such a levy is to be operated as VAT or a straight indirect tax. If the second option is to be implemented, that rate of tax will have to be reduced.
The Institute considers that implementation of full fledged VAT with same rate, is a better option. One of the examples of adverse application is availability of input excise in the case of beverage industry on the purchase or import of concentrate. There are many other such examples. This matter needs to be settled in principle.
5.2 ROYALTY PAYMENTS
'Royalty' payments have been subject to Federal Excise Duty. The term used in the law is 'Franchise fee' which at times distinguishable with royalties in strict commercial and practical sense. This has lead to serious issues of interpretation and misapplication in many entities. Taxpayers are more
seriously affected for the reason that in such cases on account of use of technology etc and their nature of operation, such entities engaged in various activities, necessarily require such payments.
It is recommended that FED procedures for franchise fee be streamlined and the same be brought in line with the State Bank's regulation. Such measures will resolve the issue correctly as most of the organised entities remit such fees through SBP and there are well laid down procedures for the same.
5.3 COLLECTION OF FED ON LUBRICATING OIL
According to the serial No 22 & 23 of the First Schedule of the Federal Excise Act 2005, FED is being charged on Lubricating Oil on the basis of Retail Price @10%, while FED on reclaimed oil has been reduced from Rs 5 to Rs 2 per liter.
This has given rise to the following problems.
Smuggling and adulteration is encouraged, due to widening in the gap between virgin and reclaimed oil.
Difficulty in calculation of FED, if one claims, that the product is formulated with more percentage of reclaimed oil.
Difficulty in monitoring of volume of lubricants sold containing reclaimed oil. Uniform duty structure will discourage smuggling of base oil that is misdeclared as reclaimed oil for evasion of excise duty by the unorganised sector.
There are approximately 100 different grades of lubricants having different Retail Prices. Therefore, preparation of monthly Federal Excise return on the basis of varying retail price is time consuming exercise.
It is therefore, suggested that there should be a fixed rate of FED on the basis of quantity produced as per the previous practice otherwise FED may be allowed on the value of supplies instead of Retail Price.
5.4 ADJUSTMENT OF PETROLEUM DEVELOPMENT LEVY (PDL)
Under Federal Excise General Order 1 of 2005 (FEGO), the POL products supplied to Pakistan Navy, outgoing vessels or international flights are entitled to exemption from Excise Duty. This exemption of Excise Duty shall be reflected by the concerned Oil Refinery in their invoices issued to the Oil Marketing Companies mentioning that the products covered therein are meant exclusively for the said users.
The problem arises that only adjustment of Federal Excise duty is allowed in the said FEGO, however, the adjustment of Petroleum Development Levy (PDL) already paid on products exported, supplies to out going vessels or international flights is not allowed. Further the said FEGO does not allow adjustment in case of export. Our refund of PDL against exports & supplies of POL products to outgoing vessels or international flights are pending with the Large Tax Payers Unit, Karachi since long.
The said FEGO should be amended to allow such adjustment in case of other exports.
The adjustment of PDL may be allowed by the concerned refinery in a manner prevalent for adjustment of FED under the said FEGO.
6. CUSTOMS DUTY
6.1 CASCADING OF RATE OF TAX ON LOCAL INDUSTRY
Over the last two decades custom duty rates on raw materials, intermediaries and finished products have been substantially reduced. The objective is to reduce possibilities of evasion and avoidance on account of high rates of duties.
There are two primary reasons for the same viz:
(i) The whole world has changed on account of financial turmoil in the USA and there is a consensual view that ultimate stability in economics will require concentration on manufacturing sectors; and in the wake of reduction of custom duty 'cascading' with the duty structures were not appropriately taken care of due to which local manufacturing sector has been seriously hampered.
(ii) There is a need to review the custom duty structure afresh to facilitate the promotion of local manufacturing industry. In the absence of proper cascading in the duty structure such opportunity cannot be effectively availed. Present structure supports the promotion of trade in commodities
rather than manufacturing the same in Pakistan. This results in unemployment and poverty.
6.2 COMPOSITION OF MAJOR COLLECTION
The present collection is being made from very few sectors. Major contributories are:
i) crude oil imports;
ii) import of commodities like edible oils etc;
iii) import of consumables; and
(iv) minimum import duties on plant and machinery items
This analysis of collection reveals that there is a need to align the objective of overall economic policy with the fiscal measures. Pakistan's annual import bill is around US $40 billion requires a substantial reduction to meet the constant pressures on foreign reserves. Rationalisation of custom duties will ensure facilitation of the local manufacturing sector. This requires a comprehensive tariff review. Furthermore, it should be ensured that custom duty is taken as a measure to manage the trade policy rather than tax collection.
6.3 AFGHAN TRANSIT TRADE AND UNDER INVOICING
Pakistan is faced with two fundamental menaces in relation to implementation of import duty structure and abolition of smuggling. These are:
- Abuse of Afghan Transit Trade (ATT); and
- Under invoicing at import stage.
Both of these issues are directly affecting the organised sectors. No meaningful improvement can occur unless such abuses are either abolished or substantially reduced in the short run. This in itself is a complete subject of fiscal policy, however, at the outset following suggestions may lead
to constructive framework:
(i) Proposals for the Federal Budget 2011-12
In case of ATT, like all other land locked countries, the agreement [treaty] for facilitation of imports with Afghanistan be revised. There has to be 'quantitative ceiling' for imports required for Afghanistan; and
(ii) Exchange control mechanism be streamlined so that economic barriers are placed for financing of under invoiced goods. At present, liberation of exchange controls are being abused to finance such under invoiced imports.
A mechanism should be introduced to collect duty on ATT at import stage to be refunded on confirmation of passage from Pakistan to the Afghan border should also be subject to quantitative restrictions.